The quest for alpha

Cerulli Associates, Asia Pacific Edge, May 2008

Australia, like many western markets, has embraced the idea of alpha versus beta. Superannuation funds, growing steadily in sophistication, are tired of paying active fees for passive performance; increasingly, they are opting for core-satellite manager selection and are bringing more and more of that selection in-house rather than going through consultants.

One sees this on both sides of the line: fund managers and the institutions they serve. The clearest example is in the manager selections to date by the Future Fund, the closest thing Australia has to a sovereign wealth fund, with A$59.6 billion under management as of February. Every manager appointed so far is known for its index approach: Vanguard for Australian equities, global equities and listed property; State Street for international equities. The only ones known for active management – Colonial First State and Queensland Investment Corporation – have been given mandates for cash instead.

Instead, the fund intends to make its alpha elsewhere, and has so far concentrated its hiring on people with expertise in areas like infrastructure and timber, where it believes with a long term approach it can generate much more value than in the public markets. Two senior investment staff, Nadine Lennie and Raphael Arndt are tasked with private markets, particularly infrastructure and timberlands; that’s alongside other people focusing on property and alternatives. By contrast, there have so far only been two hires announced who will look at equities – anywhere.

Super funds like Westscheme and MTAA have moved to models which combine two portfolios, one for mainstream asset classes and one for alternatives. This second one, which MTAA calls a target return portfolio and which accounted for 42.2% of the fund’s balance option in 2007, invests in areas such as hedge funds, direct property, timber and a host of unlisted infrastructure assets from Australian airports to a port in Gdansk, Poland. Even within the market portfolio segment, there is evidence of a tendency to go with index managers, so as to draw the real alpha elsewhere: the two biggest allocations to international equity managers when last disclosed where to Barclays Global Investors and State Street, both known for index methods. For Westscheme’s part, when it last disclosed allocations on June 30, it had 17.6% of its funds in subordinated debt or infrastructure, alongside 8.8% in private equity, 10.3% in direct property, and a significant allocation to timber. Funds like these want their alpha from alternatives or direct investments, not from stock markets.

Vanguard, which has done so well out of the Future Fund mandates, has been beating a drum about the value of passive investment, combined with some truly active bets, for years. The message seems to be getting through.

Australia is also seeing a number of product launches that fit the alpha/beta split. Exchange traded funds have been offered domestically, most notably by State Street, for years, but this year Barclays has launched a whole series of ETFs over international markets, from the US to a number of individual Asian markets. This offers cheap exposure to overall markets without any active management.

Noting this trend, more and more Australian fund managers take an approach free of benchmark constraints. Looking at international funds run from Australia, many of the best performance numbers in the market come from managers pretty much free to do what they want. According to Mercer Investment Consulting, the five leading core-style overseas share funds in Australia in the year to March 31 were Zurich International Equities, Deutsche Global Thematic, Fidelity Global Equities, Fidelity Select Global Equities and Merrill Lynch Wholesale Shares. The Deutsche and Zurich products are thematic, with no ties to benchmarks; the first Fidelity product boasts a “go-anywhere mandate”;  and the Merrill fund is based on sector convictions rather than any geographical restrictions like the MSCI indices. Only the second Fidelity fund really tracks a benchmark in its allocations.

One could argue that the increased trend towards specialisation in fund offers is part of the same theme – although one could equally argue that it reflects the faddishness of investment and a thirst for the next big thing. Morningstar Research observed in March that 33 new retail and wholesale unit trusts had been launched since August 1, not counting the addition of existing investment strategies onto other managers’ investment platforms. They included four Asian funds from Macquarie in its Gateway range, two of them more specialised still, covering Asian financials; a BRIC fund from Goldman Sachs JB Were; an Indian equity product from Fiducian; food or agriculture funds from Goldman, Macquarie and Liontamer (since joined by a structured product from JP Morgan);  and green or climate change-related products from Hunter Hall, DWS and Colonial First State. Funds like these eschew the general and go for increasing levels of specialisation instead, perhaps in part reflecting the institutional need for something special and specific from any active fund.

There is a great deal of talk in Australia about 130/30 funds, although not many have yet seen the light of day. However international managers active in Australia have experienced growing interest, notably Acadian Asset Management, Axa Rosenberg and AQR Capital. Superannuation funds like the idea of 130/30: they like the freedom it gives to fund managers to use their best ideas, but by netting out the long and short exposure it doesn’t skew their allocations in a way that would be difficult to get past their trustees. Hesta, a leading industry fund, uses all three of these managers; Hostplus, another industry fund, seeded Acadian’s strategy in Australia, and the same manager is known to have mandates from Care Super and Just Super.

This, in turn, demonstrates the savvy of super fund managers, particularly industry funds, who are cementing the increased inflows that have come with choice of super by trying to do some smart things with their money. Groups like Unisuper, Queensland Investment Corporation and Australian Super have started to do the sort of work they used to go to Russell or Mercer for in-house: manager selection and direct investments in illiquid asset classes. This is often being accompanied by a fondness for index styles for the bulk of equities exposure and some active bets alongside, particularly in alternatives. The decision a few years ago of Sunsuper to take a stake in a private equity manager, Carnegie Wylie, giving it first refusal on participation in new funds, is part of the same trend.

It would be reckless to call time on mainstream asset managers, though. Australia has well over A$1 trillion under management now, most of it in super but with a significant retail chunk as well, and the 9% superannuation guarantee in Australia is just going to keep those assets going up. In that environment, nobody is experiencing net outflows of any note; a rising tide lifts all boats. Benchmark-huggers may be out of fashion but there are still plenty of funds whose trustees are sufficiently scared by risk to want to ensure returns never deviate too much from benchmarks, and plenty of consultants who will recommend accordingly.