Investment Magazine March 2017 by Conexus Financial

INTELLIGENCE FOR INSTITUTIONAL INVESTORS

ISSUE 136

MARCH 2017

AustralianSuper’s MARK DELANEY is putting his stock in maximising the fund’s internal strength

COUNT ON

what’s inside

REAL ASSETS SUPER FUND INVESTMENT CHIEFS ARE QUESTIONING HOW LONG PROPERTY’S DREAM RUN CAN CONTINUE GROUP INSURANCE THE SECTOR THAT RELIES ON DEFAULT DEATH COVER IN SUPER COULD SOON BE FIGHTING FOR ITS LIFE GOVERNANCE MINISTER FOR FINANCIAL SERVICES KELLY O’DWYER IS NOT BACKING DOWN ON INDEPENDENTS MYRETIREMENT THE CIPR RULES ARE STILL BEING WRITTEN BUT SOME FUNDS ARE ALREADY TAKING ACTION

CONTENTS

MARCH 2017

REAL ESTATE

“The big question: Will the tailwind just cease, or will it turn into a headwind?” GRANT HARRISON CBUS SUPER INVESTMENT MANAGER PRIVATE MARKETS

EDITOR’S LETTER The Fraser Review is a disappointing call for more of the same.

AGENCY RISK Researcher Dr Geoff Warren is convinced managing agency risk is the key to long-term investing.

CIO PROFILE AustralianSuper chief investment officer Mark Delaney is forging ahead with plans to bring more asset management in-house.

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GROUP INSURANCE The Parliamentary Joint Committee inquiry into life insurance has promised to jolt super funds into action.

KELLY O’DWYER The Minister for Financial Services was unimpressed by the Bernie Fraser Review and is not backing down on independents.

DAMIEN MU

The AIA Australia boss says it’s time for life insurers to change their processes for handling claims.

COST CONTROL A new survey shows Australian super fund investment chiefs have fund managers’ fees in their sights.

FEE TRANSPARENCY AIST’s Karen Volpato says if the government is serious about disclosure, its RG 97 regime must apply to platforms.

MYRETIREMENT The rules for what makes a CIPR are still being written, but some funds are already innovating.

M A R C H 201 7

\ FROM THE EDITOR

EDITORIAL EDITOR

SALLY ROSE / sally.rose@conexusfinancial.com.au

Sally Rose MANAGING EDITOR

Keith Barrett DIRECTOR OF INSTITUTIONAL CONTENT

A LETTER from the editor

Amanda White JOURNALIST

Dan Purves HEAD OF DESIGN

Kelly Patterson ART DIRECTOR

Suzanne Elworthy SUB-EDITOR

VALUE OF INDEPENDENCE

Haki P. Crisden PHOTOGRAPHER

Matt Fatches

matt@mattfatches.com.au

S THIS EDITION was going to print, Industry Super Australia and The Australian Institute of Superannuation Trustees released the Fraser Governance Review. Everything about the way the review into governance at not-forprofit super funds was handled fostered low expectations, yet it still disappointed. The two major peak bodies for the not-for-profit super sector teamed up in December 2015 to commission Bernie Fraser to conduct the review, in an 11th-hour salvo to scuttle legislation that would force all super funds to appoint a minimum of one-third independent directors, including an independent chair. Fraser, a former Reserve Bank of Australia governor and Treasury secretary who was also a longstanding director of AustralianSuper and an Industry Super spokesperson, concluded that the government had “failed to make its case” for the benefits of independent directors. That may well be true. When Financial Services Minister Kelly O’Dwyer claims there is “nothing ideological” about the plan to dismantle the base of union powerbrokers in the industry super sector (see page 20) it is hard not to take her words with a grain of salt. The problem is that the industry fund lobby, and Fraser, have failed even more miserably to make their case that funds should not be forced to bring in independent directors. Fraser himself notes that the booming sector will probably employ more independent trustees of its own accord, as the talent pool of appropriately skilled candidates available within its

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own ranks dwindles. Why then should the need for independents not be mandated, to protect the interests of those workers in less progressive funds? The argument that a history of superior investment returns is justification enough to preserve the industry fund sector’s ‘equal representation’ board model simply doesn’t wash. Fraser called for a mandatory code of conduct to lift director skills and AIST simultaneously released a draft code slated to come into full effect from July 1, 2018. There is nothing wrong in this code, in fact it would be disturbing if most funds were not already following its suggestions. It simply does not go far enough in demanding higher standards. It is ironic that Fraser puts so little stock in the benefit of independent directors, when he clearly made such an important impact as one himself. In our CIO profile, (see page 12) AustralianSuper’s Mark Delaney describes the influence Fraser, who chaired the fund’s investment committee for 12 years, had on him. And now, a mea culpa. I signed off last month’s letter by promising a follow up to that issue’s Salary Survey – which outlined the remuneration packages of the head honchos at the 60 largest notfor-profit super funds – with a detailed look at how their counterparts at the country’s biggest retail funds get paid. I spoke too soon. We need a little more time to complete that research, but are working on it and will be bringing you the story in an upcoming edition. Ñ

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Special T Print

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ADVISORY BOARD MEMBERS

Graeme Arnott, chief operating officer, First State Super | Richard Brandweiner, partner, Leapfrog Investments | Joanna Davison, chief executive, FEAL | Brian Delaney, global head of clients, QIC | Kristian Fok, executive manager for investment strategy, Cbus | Damian Graham, chief investment officer, First State Super | Rob Hogg, head of global strategies and quant methods, UniSuper | Sheridan Lee, principal, Shed Enterprises | Geoff Lloyd, managing director, Perpetual | Graeme Mather, head of distribution, product and marketing, Schroders | Damien Mu, chief executive, AIA Australia | Mary Murphy, chief digital officer, First State Super | Fiona TraffordWalker, director of consulting, Frontier Advisors

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\ RE AL ESTATE

STILL MORE to the

STOREY? For those tasked with increasing their fund members’ life savings, property has largely been A SOLID BET IN RECENT YEARS. The question investment chiefs and asset allocation experts face now is whether real estate’s dream run can continue. By Larissa Ham

MARCH 2017

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RE AL ESTATE \

AS INTEREST RATES and bond yields fell and demand for commercial real estate rose over recent years, global investors redirected vast sums of money into commercial property, such as office blocks and shopping centres. It worked, supercharging capital growth. In 2016, research company SuperRatings found that commercial property (including international) recorded net returns of 9.6 per cent, slightly below Australian shares (10.3 per cent), but beating international shares (6.6 per cent) and cash (1.8 per cent). Now, however, real-estate valuations in major cities are at historical peaks, and banks are pulling back from commercial real estate lending. There are signs that the good times for property might be coming to an end – or at least slowing. So is the tailwind in real estate about to change direction? And if so, how are super funds preparing for the shift? Grant Harrison, investment manager of private markets at Cbus Super, says the $35 billion industry super fund for construction workers is in a state of “heightened caution”. He acknowledges the historic reduction in bond interest rates has boosted the value of property and infrastructure and warns, “Now that long-term interest rates may start to rise, the tailwind may cease.”

In its latest statement, on February 7, the Reserve Bank of Australia noted that while long-term bond yields had moved higher, they remained low in a historical context. “The big question is: Will the tailwind just cease or will it turn into a headwind?” Harrison says. “Will capital values fall or will capital values now stagnate?” As such, it’s a cautious time for Cbus, he says. “We’re looking to clearly understand all the risks inside of our portfolio and continue to focus on core – i.e. lower-risk, more defensive – assets.” Those lower-risk assets come in the form of modern, high-demand office buildings with long-term tenants, large shopping centres and, to a lesser degree, prime industrial. Cbus Super’s subsidiary, Cbus Property, recently completed the A-grade commercial building at 1 William Street, Brisbane. Dubbed the “tower of power”, it now houses the Queensland Government. Cbus Property’s portfolio also includes 1 Bligh St, Sydney, where Prime Minister Malcolm Turnbull has an office. Harrison says there is a chance global capital will start to flow from property and infrastructure back into long-term bonds – that’s if US bond rates move above 4 per cent. Even so, he doesn’t have any huge concerns about the fundamentals of the Australian

1 William St reet, Melbour ne , Cbus Super

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\ RE AL ESTATE

property market. “But I am watching carefully in terms of the possible impact of global capital flows if, globally, institutions start to say, ‘Well maybe there are more attractive asset classes, from a risk-return perspective.’ ” Cbus is definitely not “ringing the bell on the property asset class”, he says. “But we’re extremely conscious of the strong pricing environment we’re in and, therefore, we have a strong focus on where the risks lie within the portfolio.”

QUEST FOR RESILIENCE

UniSuper is another fund with big interests in commercial property that is taking a cautious approach against an uncertain backdrop. Kent Robbins, head of property and private markets at the $55 billion default fund for university staff, says history shows that picking the peak in the property market is extremely difficult. But values across most asset classes are at record highs, he says, with UniSuper experiencing seven consecutive years of positive returns from unlisted Australian property. “All we know from our end is that cap rates (yields) on, say, super regional malls – like the Chadstone Shopping Centres of the world [in Melbourne] – have never been lower,” he says. “So we’re in this territory where prices paid for assets have never been higher, which leads us to believe, OK, well maybe property is reaching towards its peak.” However, UniSuper has no plans to start ditching property willy-nilly; instead, it’s just acting cautiously by not acquiring too many assets at current prices. Those the fund does acquire must be good quality with little or no leverage, Robbins says. It’s all about creating a highly resilient portfolio made up of property such as Sydney CBD offices and “fortress assets” such as high-yielding malls and airports. “With these more resilient sectors, we say, ‘OK, that’s where we want to be because we feel they will perform better if the market retreats,’ ” Robbins says. “If we don’t have much debt associated with it, then any loss we may incur won’t be magnified.” In recent history, UniSuper has favoured unlisted trusts, he says. “We haven’t had to incur any stamp duty on buying those and they’ve been priced at valuation … A lot of assets have been transacting in excess of their values in the open market.”

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Robbins says UniSuper is steering away from non-core geared assets, which he described as the fund’s “kryptonite”. On the avoid list are poorly located, non-CBD offices and small-scale industrial sites. “I just think if the market does correct, that would be the area most adversely hit [due to potential tenant vacancies, or falls in values],” he says.

TIME FOR EXTRA CAUTION

Increased global uncertainty, thanks to the likes of Brexit and the election of US President Donald Trump, is leading many of the country’s biggest property investors to be extra prudent. Spiros Deftereos, head of property at Hostplus, says there has been a “global flight to quality”, creating excess demand for institutional-grade core property. “Investors have been chasing assets that provide greater certainty on the income side, whether that means low vacancy, blue-chip tenants or a longer weighted average lease expiry (the average time period over which all leases in a property, for example a shopping centre, expire).” In such an environment, Deftereos says, it’s become difficult to find value opportunities, but the $20 billion hospitality industry fund continues to see merit in investing in domestic and offshore markets. With a comparatively young member base, Deftereos says, Hostplus isn’t necessarily dictated to by short-term property cycles, taking a long-term view instead. However, he says demand for unlisted property has led to strong returns across the board in recent years. “As we’ve seen property yields firm,” he explains, “there has been fairly strong capital growth in addition to reasonably stable income, and that’s resulted in double-digit returns.” He doesn’t expect that to last indefinitely. “I think at some point soon, yields will stop firming and capital growth won’t be as strong as it has been in recent years,” Deftereos says. “You then become more reliant on the income component of your return, so you want that income to be as stable and secure as possible.” He says long-term success lies in a well-diversified core property portfolio. For Hostplus, that includes premium offices, dominant shopping centres and logistics assets. A strong portfolio might also be complemented by non-traditional sectors, such as freehold pubs that are set up to deliver stable and secure income streams.

Prices paid for assets have never been higher, which leads us to believe, OK, well maybe property is reaching towards its peak UNISUPER’S KENT ROBBINS

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RE AL ESTATE \

TOP: 700 Bourke St reet, Melbour ne, Cbus Super BOTTOM: UniSuper is a major shareholder in Sydney Air por t

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BEGINNING OF AN UPSWING

Ask John Dynon, head of separate accounts at AMP Capital, whether the tailwind is slowing, and his response is more upbeat than most. “The answer is, definitely not – as a matter of fact it is quite the opposite,” Dynon says. A low office vacancy rate in major cities is driving rent – and capital values – ever skyward, he explains. AMP Capital is the $161 billion wealth-management arm of AMP Ltd, and controls one of the country’s biggest property portfolios. “For Sydney and Melbourne offices, we are at the beginning of what we call a cyclical upswing, and that is driven by the demand for office buildings by tenants,” Dynon says. “What we’re seeing at the moment is there is a very, very low vacancy rate in both Sydney and Melbourne.”

In fact, he says, Sydney’s office vacancy rate is at 4.5 per cent, and he predicts it will drop to about 3 per cent in the next two years. He says that will be driven partly by more office stock being taken from the market for residential developments and infrastructure, such as the light rail planned for Sydney’s George Street. Meanwhile, he says, Australia’s commercial property market is becoming more international and more liquid. He says Australia is attractive for many, including offshore funds and sovereign funds, because of a long recession-free period, real growth and the fact it fared comparatively well in the global financial crisis. Tim Stringer, head of property at Frontier Advisors, agrees that the office market – in Australia, and in the US and UK – is still quite attractive. “The office sector has stood out as a strong performer pretty much internationally, and that’s obviously been driven primarily through the recovery in the business cycle, reasonable economic growth, and certainly strong job growth, particularly in the US,” Stringer says. But he predicts commercial property will moderate, and that double-digit returns can’t continue. “The academics would say that real estate should give you a return somewhere between investing in bonds and investing in equities but, over the last 25 years, real estate has, in fact, outperformed both those asset classes,” he says. “You don’t expect it to continue to do that; it’s against the forces of nature.” Frontier is one of the four major asset consulting groups and advises some of the country’s largest super funds on their asset allocation. Stringer says commercial property not only needs to be purchased at the right price, but also must be managed highly effectively. He also argues that super funds shouldn’t be restricting themselves to domestic markets. “Australia represents, in a global context, only 3 per cent of the (commercial) property market,” he explains. “If you’ve not got a more international perspective, you’re missing out on 97 per cent of the opportunities. We believe fishing in such a little pond here is not the right long-term strategy.” It should also be remembered that while capital growth is handy, income – for example a long-term rental return of 70 per cent to 75 per cent – is also crucial, he says. “Sometimes, that’s kind of lost on people in the enthusiasm for capital growth.” Ñ

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\ COLUMN

THERE ARE MANY things required for an institution to be successful in adopting a truly long-term approach to investing. Over many years of studying the obstacles to long-termism, I have come to the conclusion that it’s a question of latitude and attitude, and that perhaps the most important variable is how organisations manage their agency risk. Obviously, fund flows have to be secure enough to give an asset owner the latitude to act as patient capital. Most superannuation funds, with the exception of those losing members, do have the long-term funding model in place to support a long-term investment strategy. But even when the latitude to think long term is there, it is equally important to develop an organisational culture in which all decisions are taken with an attitude consistent with long-term investing goals. These are some of the conclusions drawn from four separate Centre for International Finance and Regulation (CIFR) research projects in 2016 that examined the characteristics of long-term investors.

who may even have sector heads to whom they delegate, and quite often that money gets delegated to external managers. That is a chain of agency delegations filled with risks. Remuneration and tenure policies are two of the most important levers in mitigating this risk. The problem with long-term investing is that the end-goal is a long way into the future. You never quite know if a strategy is going to be successful. BY It would be sort of nice to say, ‘Here GEOFF WARREN is the money for 10 years. Go away ___ and I’ll come back and evaluate you then.’ But the world does not Dr Geoff Warren is a finance academic at operate that way and it probably The Australian National University. He shouldn’t. People should be held was formerly research director of the now accountable along the path. defunct Centre for International Finance and Regulation. This is where it all gets tricky.

ALIGN PAY

Tamp down agency risk to promote long-term investing The chain of stakeholders in an investment organisation encourages short-term thinking. Applying the right levers to align incentives with longer-term behaviour and outcomes CAN SOLVE THIS PROBLEM. Most people think of long-term investing as synonymous with value investing, but it’s not necessarily. A growth investor that buys a company for long-term growth is a long-term investor. Similarly, people often consider holding periods the measure of whether or not an organisation is a genuine long-term investor, but this is too simplistic.

IT’S ALL ABOUT AGENCY

One of CIFR’s projects completed in 2016 was undertaken in close collaboration with

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The Future Fund, Australia’s $146 billion sovereign wealth fund. The first thing Future Fund managing director David Neal said to me was that he thought the biggest barrier to long-term investing was “the agency issue”. It took a while to sink in, but the more I thought about it, the more I realised that Neal was right; the agency issue is at the nub of our problem with short-termism. A typical investment organisation has stakeholders who delegate to the governing board, who delegate to a management team,

A combination of regular rewards and long-term conditional vesting is one approach to accountability that I like. Under these arrangements, a manager might earn a bonus, but that bonus wouldn’t vest unless the performance is sustained over, say, five years. Another useful tool The Future Fund employs is the inclusion of subjective components in bonus structures. This is critical for long-term investing. If a portion of a bonus – perhaps 30 per cent – is about behaviour, rather than just outcomes, it encourages the long-term-oriented actions that you want. Tenure expectations are also important for fostering long-term investing. If managers think they will be burned and turned every two or three years, then they are going to start behaving in a short-term fashion. I suggest setting an expectation for preferred manager tenures of about 10 years or more. Fund flows within the industry (both internal and external mandates) respond to short-term performance, particularly with external investment managers, because it affects their profitability and the ability to sustain long positions. Benchmarks and peers act as anchors to short-term behaviour. Building a culture of transparency and trust right up and down the agency chain is critical if super funds want to deflect attention away from short-term returns and act in accordance with behaviours that lead to long-term outcomes. This column is based on a presentation to the 2017 Conexus Financial Chair Forum. Ñ

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\ CIO PROFILE

GLOBAL STRATEGY

inner strength BUILT ON

MARK DELANEY sees an opportunity to make money from Brexit and a bright side to the tumult of US PRESIDENT DONALD TRUMP. Having recently put the brakes on a real-assets shopping spree, AUSTRALIANSUPER is now topping up on equities. This comes as the $109 billion fund looks to more than double the proportion of capital its growing in-house team manages.

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CIO PROFILE \

By Sally Rose Photo Mark Dadswell

LAST YEAR MARKED a decade since Mark Delaney, then chief executive of Superannuation Trust of Australia (STA), and Ian Silk, then chief executive of the Australian Retirement Fund (ARF), pulled off a merger to form the country’s largest industry super fund, since known as AustralianSuper. Silk was named AustralianSuper chief executive, while Delaney, who had been promoted from investment manager to chief executive at STA three years earlier, became his former rival’s second in command, with the dual titles of AustralianSuper deputy chief executive and chief investment officer. They have proved a formidable duo in their respective roles ever since. At a time when the Australian Prudential Regulation Authority is nudging sub-scale and troubled super funds to find merger partners, and the slow pace of industry consolidation has been widely blamed on self-interested executives and directors not wanting to cede lucrative positions, it is worth reflecting on the fact that had Delaney not been prepared to give up the mantle of chief executive, AustralianSuper might never have come into being. Reminiscing on the negotiations, Delaney says he always hoped the deal would leave him in a good position, but

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was prepared to forge ahead regardless. “When the STA-ARF merger was being discussed, it was just such a good idea for the members,” he tells Investment Magazine. “I thought to myself, if you’re looked after, well good. If not, no matter, you’ll find another job...and at least you will have achieved something.” Being prepared to give up a little bit of status in the short-term in order to be a part of something bigger is a trait Delaney credits with shaping his career. In 1981, the economics graduate started out in the banking division of Federal Treasury. In 1986, he left Treasury and moved back home to Melbourne for a job as an economist at National Mutual. While still at the firm, which later became AXA, Delaney discovered an interest in investment strategy, qualified as a Chartered Financial Analyst, and made a move into the firm’s funds management division. By the time he left in 2000, Delaney was head of investment services. It was Paul Costello, who later went on to become the inaugural chief executive of Australia’s sovereign wealth fund, The Future Fund, who hired Delaney to be the lead investment manager at STA in 2000. The move to the industry super sector was a calculated one.

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\ CIO PROFILE

“Around about the time I was thinking about leaving AXA in the late 1990s, I was doing some work on corporate planning that exposed me to some projections of how big the superannuation sector, and industry funds in particular, were going to become,” he says. “A lot of people focus only on what seat they’ve got on the train, their title or whatever. Probably my strongest piece of career advice is to think instead about where the train you are on is headed. A growing organisation creates opportunities, while a contracting one is very difficult to work in.” In 2000, Australia’s pool of compulsory retirement savings was worth $484 million, today it is valued and $2.1 trillion and is forecast by Deloitte to hit $9.5 trillion by 2035. The idea of working in a system with mandated contributions was also attractive because of the opportunity it created to

AUSTRALIANSUPER ASSET ALLOCATION

Balanced fund at December 30, 2016 Australian shares

24% (10-45%)

International shares

31% (10-45%)

Direct property

9% (0-30%)

Infrastructure

10% (0-30%)

Private equity

4% (0-10%)

Credit

10% (0-20%)

Fixed interest

7% (0-25%)

Cash

5% (0-15%)

Other assets

0% (0-5%)

AUSTRALIANSUPER HISTORICAL PERFORMANCE

Balanced investment option at June 30, 2016 9.03

6.05 4.54

7.92 5.35

2.81

1 YEAR

5 YEARS 10 YEARS (% PA)

pursue long-term investment goals. “I liked what industry funds were trying to achieve,” he says. In 2006, at the time the STA-ARF merger was inked to form AustralianSuper, the combined entity had $18 billion in funds under management. Over the last decade, that has swollen more than sixfold, to $109 billion. It is the largest industry fund in the country. “Scale brings lots of advantages,” Delaney says.

A WORLDLY STRATEGY

In 2013, he began bringing responsibility for some of the fund’s asset management in-house, starting first with unlisted property and infrastructure before dabbling in large-cap Australian shares. It is an experiment that is paying off. By mid-2015, it was forecast the strategy would save the fund $150 million a year in costs by 2018. The proportion of funds managed internally now stands at 22 per cent, a figure Delaney hopes to get to 50 per cent within the next five years. Total funds under management are projected to swell to about $200 billion by 2022. Internal investment teams are now in place across all major asset classes: property and infrastructure, Australian equities (large and small caps), fixed income, currency and, most recently, global equities. “We have a target of running internal management to be at least one-third or even a half of members’ assets over a five-year horizon,” Delaney says. Each team is allocated more capital progressively as they prove themselves. It has been just six months since the new global equities team, assembled under Richard Ginty, got its seed capital, and Delaney is happy enough with their performance to be ramping up their funding. “We brought global equities in-house last because they were the hardest…but if the team proves to be skilful, then allocating them a large amount of money makes sense.” Among other large super funds that have been busy building in-house investment teams in recent years – such as UniSuper, Cbus Super, First State Super, and more recently HESTA – there has been a reticence to dive headlong into picking global stocks. It is often said that Australia’s geographical isolation and out-of-whack time zone puts home-based global equity managers at

a disadvantage to those operating in offshore markets. Delaney thinks such fears are overblown in an era of online updates and webcasting. “There is a matter of distance, and the global team will have to do a bit of travel, but for a lot of companies, the information comes down through the web. So, they are at no more of a disadvantage than anyone else,” he argues. “And when you’re taking a long-term approach to investing, getting the news six hours late doesn’t make that much difference.” The sheer scale of opportunities in global equity markets, compared with the local market, is exciting. “Global markets are very deep, meaning we can run lots of money without running into any capacity constraints,” he says.

MUSINGS ON LEADERSHIP

Delaney says the biggest challenges in implementing the in-house strategy have been on the people management side of things, rather than in investment management. “Just before this interview, I was eating my lunch and reading the Harvard Business Review’s leadership edition thinking, ‘I’ve got to get a bit better at some of this stuff,’ ” he says. AustralianSuper chair Heather Ridout is satisfied he’s got it covered. “The leadership Mark has shown in building that internal team has been very impressive,” she says. “He’s got a great eye for hiring good people and has been strong at bringing the whole team along with him on what has been a step-change for the organisation.” Delaney may have been indulging in a bit of false modesty about his leadership skills, but was clearly sincere when crediting those mentors who have helped him. “Geoff Ashton, who was my chair at STA and then the inaugural chair of AustralianSuper, was the guy who really taught me how to be a C-suite executive. How to manage upwards and downwards,” he says. “Ever since, I’ve tried to emulate his combination of blunt feedback and practical advice.” Another important mentor was former Reserve Bank governor Bernie Fraser, who chaired the AustralianSuper investment committee for the first 12 years of the fund’s life.

Benchmark

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CIO PROFILE \

MARK DELANEY Deputy chief executive and chief investment officer AustralianSuper Since: July 2006 Other current roles: Industry Superannuation Property Trust (ISPT), director. IFM Investors, advisory board member.

Recent previous roles: February 2003 to June 2006: Superannuation Trust of Australia chief executive until merger with Australian Retirement Fund to form AustralianSuper. 1986 to 2000: National Mutual, later AXA, moving his way through the company from economist to senior manager of investment services. 1981 to 1986: Federal Department of Treasury economist.

Education: Bachelor of Economics (Hons) 1983, Monash University. Chartered Financial Analyst (CFA).

AUSTRALIANSUPER Number of members: 2.1 million Mean account balance: $47,000 Proportion of members in accumulation: 98 per cent Total funds under management: $109 billion

Proportion of funds managed internally: 22 per cent Total staff: 556 Investment team staff: 196 Key people: chair Heather Ridout, chief executive Ian Silk, deputy chief executive and chief investment officer Mark Delaney.

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\ CIO PROFILE

After the financial crisis, regulators prioritised system stability above system efficiency and capital allocation. We may now be seeing a righting of that

“Bernie taught me a lot about how to understand economies and markets, think about issues and come to decisions,” Delaney says. “He wasn’t a theoretician, rather he was always big on the importance of seeing what was there, rather than looking for what you hoped to see.” It’s a mantra Delaney has been coming back to a lot in recent months. “Volatility is nothing new,” he muses. “Since 2014, global equity markets have had three moves of almost 20 per cent. The Trump phenomenon has really only corresponded to the last half of the last move. But, potentially, he could be more important. “The orthodoxy of the period since the global financial crisis has been one of very low interest rates, very tight fiscal policy, a free-trade approach, and re-regulation of financial markets.” Trump wants faster US economic growth, increased fiscal spending, less regulation, and big corporate tax cuts. “All those things point to an environment that will tend to favour equities,” Delaney says. Shifting the burden away from monetary policy onto other instruments will, other things being equal, put upward pressure on interest rates, he says.

MARCH 2017

Trump’s plans to repeal portions of the Dodd-Frank Wall Street Reform and Consumer Protection Act could also be a boon for markets, if done right, he argues. “I am no expert on Dodd-Frank, but there are undoubtedly parts of it that could be done better,” Delaney says. “After the financial crisis regulators prioritised system stability above system efficiency and capital allocation. We may now be seeing a righting of that.” Delaney is unfazed by the wildcard element of some of Trump’s unpredictable foreign policy stances. “The rest of the world is going pretty well. China has bounced off the bottom. Europe is going quite nicely and Japan’s going pretty well. Equity markets were up in 2016 because the world was recovering. In retrospect, we might view 2015 as a classic midcycle slowdown,” he says. Another market shock of 2016, that on first take seemed likely to be negative for markets but has played out in unexpected ways, was the United Kingdom’s vote to leave the European Union. “Brexit has had a material impact on the UK economy, the financial services sector in particular. But given the 20 per cent fall in the exchange rate, the competitiveness gains from the change in the currency may compensate for, or even swamp, the competitiveness losses from no longer being part of the EU trade zone,” Delaney says. “The most important thing about Brexit was that it was the first really large cannon shot about the change in orthodoxy of how to do things. Trump was the second one. Our job as investors is to be opportunistic about how to make money in the world we are in. You can’t wish things were different.” The fallout from Brexit is important for AustralianSuper’s small London office, which manages its UK property portfolio. In January 2016, the fund took a $900 million majority stake in a 27-hectare mixed-use Kings Cross development. In October, AustralianSuper in

a consortium with IFM Investors, lobbed a $16.2 billion unsolicited bid that the NSW Government accepted in exchange for 50.4 per cent of the state’s electricity poles and wires operator, Ausgrid, on a 99-year lease. Now Delaney is putting the brakes on what has been a three-year long shopping spree for unlisted property and infrastructure, trimming the fund’s fixed-income holdings, and topping up on equities. “We were large accumulators of unlisted assets for the period from 2013 through 2016 and we are slowing that down now,” Delaney says. A combination of unlisted assets being relatively more expensive than they were and low interest rates already being priced in has made the sector less attractive than as it was three or four years ago. The beauty of having stocked up on property and infrastructure when the price was right is that it can now be held for a long time, providing a source of diversification, capital growth and income. An ability to give ordinary workers the chance to own a stake in things like Hawaiian shopping centres, international ports, and office towers is one of the things that gives Delaney the most job satisfaction. “When I started at STA 17 years ago, I put all my super in the fund’s balanced option (which rolled into AustralianSuper’s balanced option following the merger). To this day, that’s the only place I’ve got super and I’ve never once made a single switch.” And he plans to stay there for a long time yet. Delaney is a vocal advocate of the need for older members to retain an exposure to growth assets into the retirement years. “Someone retiring at 60 probably still has an investment horizon of 20 years. They need capital and growth,” he argues. The imperative to help retirees keep building their balance is huge, given the average AustralianSuper member has a balance of just $47,000. Luckily 98 per cent of them are still in the accumulation phase. Ñ

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2017 FUND EXECUTIVE FORUM

Strategic Decision Making R E G I S T R AT I O N S N O W O P E N : Wednesday 8 March Forum Dinner (FEAL members and guests)

Thursday 9 March Fund Executive Forum (FEAL members only)

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SESSIONS INCLUDE Why do we make the decisions we do? How do our brains work? Dr Carsten Murawski, Decision Neuroscience Laboratory

Decision making in critical situations

Individual financial decision making

Greg Mullins, Former Commissioner Fire & Rescue NSW

Professor Susan Thorp, Sydney University

FORUM DINNER Guest Speaker Major General John Cantwell AM

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\ GROUP INSURANCE

DEFAULT DEATH COVER

fights life for its

Australia’s superannuation sector is braced for a fresh GOVERNMENT INQUIRY INTO LIFE INSURANCE. Insiders fear the review will recommend scrapping default group insurance in super – the tap that pours $8 billion a year in premiums. The need for proactive steps is THE TALK OF THE INDUSTRY. By Taylee Lewis

CHAIR OF THE Parliamentary Joint Committee (PJC) inquiry into the life insurance industry, Liberal MP Steve Irons, has warned the industry may need to be “jolted” into action to improve standards. Irons spoke to Investment Magazine about his plans to put the group insurance sector under the spotlight ahead of the inquiry convening in late February. He says both the government and industry need to do better and promises the PJC inquiry will “push both in the right direction”. The PJC will examine a range of issues related to group insurance in super, including: the value and effectiveness of group insurance products, the quality of service provided to members during a claims process, member education and understanding, and the unique needs of different age cohorts – particularly younger millennial generation members. It is whispers of a potential push to dump universally mandated default group insurance via super, however, that is causing the most consternation. There is no question that gutting mandated group insurance would rip a hole in the safety net that these default arrangements provide to millions of workers. There is also no question that many funds and their insurers need to provide better value and service to members. In the financial year ended June 2015, $7.9 billion worth of premiums were collected from group insurance sold via super funds. That year, the sector paid out $4.4 billion in successful claims. BT general manager of superannuation Melinda Howes says default group insurance provides a valuable consumer protection and social good.

MARCH 2017

“The [government’s] decision to make the cover opt-out was designed to protect more Australians and ensure engagement from customers,” she says. “This is working.”

WARNINGS AGAINST DITCHING OPT-OUT SYSTEM

Under the current system, all members of MySuper funds – the low-cost, no-frills products that are eligible to be named in employment agreements as default super accounts – must automatically be signed up to group policies for death and total and permanent disability (TPD) cover. Funds may augment this by also offering an additional policy for income protection on either an opt-in or opt-out basis. Most funds offer only death and TPD. Members may opt-out of any or all of these policies, or choose to dial their level of coverage up or down. However, the vast majority of people make no change to the default cover their fund selects. Dumping the opt-out mechanism for an opt-in system would be an “absolute disaster”, warns industry stalwart Jim Minto, who chairs the Insurance in Superannuation Industry Working Group. The working group, formed in late 2016, has pledged to create a compulsory code of conduct to lift standards in the sector by the end of this year. “If we did not have automatic life insurance, a huge percentage of the Australian population would have no insurance coverage,” says Minto, who is also director of Dai-ichi Life Asia Pacific. Eliminating mandated default group insurance inside super would leave millions of Australians with existing health conditions, or who work

investmentmagazine.com.au

GROUP INSURANCE \

in hazardous environments, vulnerable, Minto says. It could also have big implications for Australia’s social welfare system.

While he opposes scrapping default death cover for young people altogether, he does concede it often needs to be dialed down and that more focus should be placed on ensuring these members have adequate income-protection in case they are injured and can’t work for an extended period. “For most young people, their ability to earn an income is their most important asset and protecting that is very important, particularly because they haven’t typically built a level of debt that would justify a large TPD payout.” SuperRatings general manager of research, Kirby Rappell, says the good news is that there are signs the industry is already moving in the right direction. “Some funds are reducing default cover for young members who are not expected to have material financial commitments but increasing this when people are in their 30s and 40s, when they are more likely to have a mortgage and dependents,” Rappell says.

PRESSURE ON THE PUBLIC PURSE

A 2014 report by actuarial and consulting firm Rice Warner found group insurance within super saved the federal government roughly $403 million a year in social welfare payouts. Australian Institute of Superannuation Trustees (AIST) director Catherine Bolger, who is the peak body’s representative on the Insurance in Superannuation Industry Working Group, says scrapping default group insurance in super would put an unreasonable strain on the public purse. “Australia already has a significant problem with under-insurance, so a move away from opt-out insurance in super would only exacerbate this,” Bolger says. “Members unable to work would draw on other forms of assistance, whether it be Medicare, the National Disability Insurance Scheme or Centrelink benefits and the like.” Irons maintains that the PJC will look at all potential unintended consequences that any changes to the existing system would have on members, the industry and taxpayers.

LITTLE VALUE FOR YOUNGER MEMBERS

One of the easiest targets for critics of default group insurance is the relatively poor value it provides to younger super fund members, particularly those aged under 25. Research firm SuperRatings finds that the average 35-year-old male in a whitecollar occupation has an account balance of $58,550 and pays $226 a year in group insurance premiums. Meanwhile, the average 25-year-old male in a white-collar occupation has a balance of less than $4000, but he is still paying almost as much, $203 a year, in group insurance premiums. AIA Australia chief executive Damien Mu, who is also co-chair of the Financial Services Council (FSC) life insurance committee, and another member of the Insurance in Superannuation Industry Working Group, says the sector must deal with this challenge in a more sophisticated way. “Cover is essential at all ages, but the question that needs to be better addressed is exactly what type of cover and how much of it,” Mu says.

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EFFORTS TO KEEP THE GOVERNMENT OUT OF IT

In the financial year ended June 2015,

$7.9 billion

worth of premiums were collected from group insurance sold via super funds. That year, the sector paid out

$4.4 billion

in successful claims. Source: APRA

Group insurance within super saves the government roughly

$403 million

per year in social welfare payouts. Source: Rice Warner

Still, the industry continues to cop criticism, with consumer watchdog Choice taking aim. “There is a worrying lack of transparency around default life insurance policies,” Choice head of campaigns and policy Erin Turner says. Irons says this is something the PJC intends to address. “Understanding, transparency and clarity of the premium,” he says. “That’s where, hopefully, the inquiry and the insurance industry itself will head.” Mu agrees the industry has room for improvement when it comes to communicating with members. “Now is the time to improve engagement and confidence in the industry,” he says. Minto also called on his peers to take voluntary action to improve standards in a bid to ward off unwanted government intervention. Irons indicated he maintains an open mind about what the industry can achieve on its own. “There is an opportunity for the industry to lead the reform, instead of being regulated into” it, Irons says. “Insurers and superannuation funds have the capacity to reform, but they may need to be jolted into that.” Ñ

MARCH 2017

\ GOVERNANCE

NO BACKING

DOWN ON independent directors

MINISTER FOR FINANCIAL Services Kelly O’Dwyer has slammed the Bernie Fraser Review and resisted heated calls to amend the definition of “independence” in the government’s legislation to reshape super fund boards. She argues that to do so would be caving to vested interests. The government wants to force super funds to appoint a minimum of one-third independent directors to their boards, including an independent chair. It is a reform vehemently opposed by the industry fund establishment, which favours the ‘equal representation’ board model, of appointing directors from employer and union groups. Few were surprised that the Fraser Review, commissioned by the Australian Institute of Superannuation Trustees (AIST) and Industry Super Australia, backed those groups’ prevailing view that independent directors are not needed. The report was commissioned in December 2015 as an 11th-hour salvo to stave off the

By Sally Rose Photo Matt Fatches

The TURNBULL GOVERNMENT’S feud with the not-for-profit superannuation lobby, over legislation designed to force super funds to appoint INDEPENDENT DIRECTORS, is at a deadlock.

KELLY O’DWYER Minister for Financial Services

MARCH 2017

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GOVERNANCE \

proposed legislation and was released on February 16, 2017. O’Dwyer labelled the review a “delaying tactic to kill off reforms” and was scathing in her critique of its findings. She said there was nothing in the report that negated the need for the government’s independent directors bill. As an alternative to the one-third rule, the Fraser Review recommended the industry adopt a mandatory code of conduct to lift board standards. The AIST simultaneously released a draft code, which O’Dwyer said appeared to “at best entrench the status quo and at worst further dilute the value of… superannuation fund boards”.

DEFINING INDEPENDENCE

Two weeks earlier, at an exclusive gathering of chairs from some of the country’s biggest industry funds, O’Dwyer was implored to simplify the legislation to reflect the definition of independence

investmentmagazine.com.au

applied to directors of ASX-listed companies. This could be a pragmatic way to break the deadlock that led to scuttling of the reforms last year, the chairs argued. Even among those in the industry who see merit in mandating independents, there is widespread concern that the proposed standards would rule out too many well-qualified individuals. These arguments did not sway O’Dwyer. She said such a compromise would be tantamount to caving in to those with vested interests. “I am not interested in window dressing,” she said. “Some in the industry, not all mind you, are doggedly opposed to any change to improve governance, or any changes that attempt to create more transparency and accountability.” She said the compulsory nature of super made high standards paramount. “No one forces someone to buy Qantas shares, while people are forced to put their money into superannuation funds,” she said. “[Yet] the standard of governance and accountability of superannuation funds remains lower than the standards that apply to companies listed on the Australian Securities Exchange.” This drew the ire of industry fund chairs, who argued it was laughable to say banks had stronger governance standards than super funds. One delegate, with experience on the boards of both retail and industry super funds, questioned how any directors of bank-owned super funds could be considered independent – given the parent company appoints all of them. O’Dwyer did not address that concern directly but gave assurances the new rules “are not some ideological agenda” and would be applied consistently across the entire super sector. Most bank-owned and retail funds now have a majority of independent directors, since the Financial Services Council made it a condition of membership in the wake of the 2010 Super System Review led by Jeremy Cooper. The 2014 Financial System Inquiry, led by David Murray, recommended the government introduce the one-third rule as a compromise. O’Dwyer pointed to the reluctance of many funds to pursue mergers despite struggling to meet the prudential regulator’s scale test as evidence of the need for independents on boards to help combat conflicts of interest.

“You want decisions to be made in the best interest of members, not in the interest of some of those people sitting around the table who’d like to remain on particular boards and [continue] receiving fees for being on those boards,” she said. The minister made her comments at the Conexus Financial Chair Forum, in Healesville Victoria, held on January 30-31. It was a gathering of chairs, deputy chairs and investment committee chairs. Delegates represented 39 superannuation funds, collectively responsible for roughly $700 billion of the nation’s $2.1 trillion compulsory retirement savings pool.

MORE ON THE AGENDA

O’Dwyer said independents would also help funds cope with the need to develop more sophisticated retirement accounts for members. In December 2016, the government released a discussion paper seeking feedback on its plan to force all MySuper funds to offer retiring members a default option, tentatively called MyRetirement. This followed the 2014 Financial System Inquiry’s recommendation to force funds to offer comprehensive income products for retirement. Another area of product and service design that is high on the agenda for super fund boards and the government in 2017 is group insurance. O’Dwyer told the forum she would be following closely an upcoming Parliamentary Joint Committee inquiry into the life insurance sector. The inquiry, chaired by Liberal MP Steve Irons, is set to consider whether group life and total and permanent disability (TPD) insurance should remain a default inclusion within MySuper. “It has been put to me that young people, under the age of 25 let’s say, generally speaking, don’t really have any assets or dependents; so why would it make sense for those people to pay for insurance as a default? … And that is an interesting question,” she said. O’Dwyer said the government was “very mindful” of the problem of high insurance premiums eroding young people’s retirement savings balances. “We are interested in exploring this… in actually looking at the data and the evidence and whether the default group insurance framework should stay the same or requires further refinement,” she said. Ñ

MARCH 2017

\ COLUMN

Reimagine the insurance experience, to engage and empower As the GROUP INSURANCE INDUSTRY tries to convince the Parliamentary Joint Committee Inquiry into Life Insurance that more regulatory intervention is unnecessary, funds and insurers MUST WORK TOGETHER to improve practices for handling claims. IT IS NOT until the unfortunate happens that anyone thinks seriously of the process of making a claim on their life insurance. Fortunately, 92 per cent of Australians now have some form of life insurance cover, due to superannuation or through their financial advisers. This safety net provides Australians peace of mind and protects them and their families financially. However, for those who do need to turn to their insurance, it is during a particularly stressful time, and the process can appear overwhelming. This is the moment of truth, when we as an industry need to deliver on our promise. The question is, how do we provide a claims experience where people are engaged and empowered? We must all implement a fundamental change in claims philosophy, with the focus on a claimant’s ability, rather than disability, and the knowledge that claimants need both sensitivity and professionalism. From looking at AIA Australia’s own journey, I believe it starts by talking to claimants; listening to what they are going through after an unexpected traumatic event that leaves them living with an injury or illness. This is a time when people can’t work, and in some instances cannot manage day-to-day tasks like doing the shopping. In recognising this, we can better understand their needs and how we can play an important role through the claims process as one of the key parties that claimants deal with at this critical time. We can be there not

just to pay a claim in a timely manner but also to support them as they navigate this life change – providing a real service and not just a transaction. Every claimant is unique. It’s important to focus on open communication, demonstrating an awareness of the situation with sensitivity and empathy. In the case of rehabilitation, before implementing a return-to-work plan we may need to help the person integrate back into the community and get some exercise to start feeling good again. In some instances, the reason a return-to-work program is not successful may not be the original physical ailment. The person may simply be feeling overwhelmed and not yet confident they can do it. Of critical importance is engagement as early as possible. Research indicates that if an employee is off work for 20 days, they have a 70 per cent chance of returning to work; if they are off for 45 days, the chance of returning drops to 50 per cent; and after 70 days it drops to 35 per cent. It is important to ensure that the right services are provided to assist rehabilitation so clients can return to work.

CONTINUALLY IMPROVE

In the past, insurers have focused on the efficiency of the claims process and making it faster. So why change? While the intention was good, it in some instances removed the personal engagement aspect and resulted in a very transactional experience in which the claimant may not have felt fully supported. This is an area where the industry needs to improve continually. Customers want and need support, throughout the whole journey.

The question is, how do we provide a claims experience where people are engaged and empowered? MARCH 2017

BY DAMIEN MU ___

Damien Mu is the chief executive of AIA Australia. He is also co-chair of the Financial Services Life Committee and a member of the Insurance in Superannuation Industry Working Group.

The greater the relationship and engagement, the smoother the process will be. Many people don’t know where to turn during the claims process because they don’t understand it and they feel it is too complex. With better education and more frequent communication in simplified language, much of this could be alleviated. It is also envisaged that the rollout of the Life Insurance Code of Practice (effective from July 1, 2017) will assist in enhancing the claims experience, through improved timeliness, transparency and increased communication. We have an important role to play. Our opportunity is to reimagine the claims experience to ensure timely payment but also to support and assist claimants through the process and back into life. Ñ

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The

9th Annual

SYMPOSIUM

Fiduciary Investors

Symposium

May 15-17, 2017 BLUE MOUNTAINS, NSW

Shifts in the paradigm Geopolitical headwinds, inflation pressures, and the growth outlook for developed and emerging markets, crossed with peaks in liquidity, income inequality, passive investment and globalisation, as well as a surprising trough in volatility â&#x20AC;&#x201C; all are key challenges asset owners face. But in this transforming world, there are opportunities to generate trading ideas, optimise fund scale, transition from silo-driven portfolio construction and better understand risk-adjusted returns. It is imperative that asset owners remain current in this changing and complex climate, to better meet their fiduciary responsibility. Stay informed by attending the 9th Fiduciary Investors Symposium to experience the latest thinking, expert opinions, thought leadership and unrivalled networking opportunities.

f i d u c i a r yi nve s to r s . co m. a u OR CONTACT Emma Brodie | emma.brodie@conexusfinancial.com.au | 02 9227 5708

\ COST CONTROL

FEESTHEIN

firing

LINE

By Amanda White

Institutional asset owners worldwide have been successful at NEGOTIATING BIG DISCOUNTS from their external fund managers. Now, Australian superannuation funds are trying to do the same, the third-annual WWW.TOP1000FUNDS.COM/CASEY QUIRK GLOBAL CIO SENTIMENT SURVEY has found.

AUSTRALIA’S LARGEST INSTITUTIONAL investors are readying to follow the lead of their international peers in demanding a better deal on fees from fund managers in 2017. Major asset owners around the globe are under intensifying pressure to control their costs. As a result, the funds management industry, particularly locally, will need to move to more innovative fee structures. In an environment where chief investment officers cannot rely on markets to generate high returns, and can’t control contribution levels, they are looking to what they can manipulate – costs. The third annual www.top1000funds.com/ Casey Quirk Global CIO Sentiment Survey showed that the efforts of major asset owners to reduce their costs have put investment fees under pressure. But institutions aren’t just looking for a cheaper deal, they are also seeking more innovative fee structures that create a better alignment of interests. CIOs from 81 asset owners, across 11 countries, with combined assets under management of more than US$2.2 trillion

MARCH 2017

responded to the detailed survey, revealing their outlook for fees and risk management. All of the funds included in the survey rank among the 1000 largest institutional asset owners in the world. These investors cited low projected returns, along with increasing stakeholder pressure, as reasons for a greater focus on costs. Poor manager performance was not a prominent reason for putting pressure on fees. “Our investment beliefs very clearly include the statement that costs matter and need to be effectively managed,” the investment chief of one of the biggest US pension funds told the survey. The investment chief at another large US pension fund added: “If costs can be lowered without lowering the total net-of-cost return, then net investment outcomes improve.”

DRIVING A HARD BARGAIN

Of the 29 Australian respondents to the survey, 81 per cent rated reducing investment costs as important, versus 62 per cent for the rest of the world.

The preferred method for reducing investment costs worldwide was negotiating harder with external managers, with 77 per cent of total respondents ranking this as their favourite method. The trend was amplified in Australia, where 87 per cent of managers said negotiating a better deal on management fees was their number one cost-saving method. This was true even though half of all respondents worldwide revealed they already get a discount from external managers, and 15 per cent said they receive a discount of more than 20 basis points. Some respondents said they received as much as a 25 per cent concession on fees. Even so, continued pressure on traditional asset-management fees was clear. Despite the much talked about trend to insource asset management in Australia – as observed at The Future Fund, AustralianSuper, UniSuper, Cbus Super, and more recently HESTA – the survey showed other markets still emphasise this much more. In Australia, only 19 per cent of respondents said insourcing investment management was a preferred method to reduce costs. Worldwide, that number was 80 per cent for funds with more than $75 billion in assets under management, and 36 per cent of global funds with less than $75 billion in assets under management. Other methods for reducing costs included allocating to passive or smart beta strategies, which about half of respondents globally said they planned to do. However, just 17 per cent said they would move out of high-fee asset classes, such as private equity, in an attempt to save. Again, this differed from the Australian respondents’ answers, which revealed that 32 per cent intended to allocate more to passive or smart beta strategies to cut costs, and 39 per cent planned to move out of high-fee asset classes, such as private equity, in an attempt to save. Control, rather than cost, was the main motivation for Australian investors to move assets in-house.

FEES UNDER HEAV Y SCRUTINY

When funds did pay premium fees, the most common reasons they gave were limited product capacity and a lack of high-quality substitute managers, followed by strong service and value-add from managers. A number of asset owners indicated they

investmentmagazine.com.au

COST CONTROL \

FEE PRESSURE IS CAUSED BY COST REDUCTION BEING A HIGHER PRIORITY FOR AUSTRALIAN INSTITUTIONS...

... COMBINED WITH HIGHER FOCUS ON NEGOTIATING WITH MANAGERS

IMPORTANCE OF REDUCING INVESTMENT COST

PREFERRED METHOD TO REDUCE INVESTMENT COST

% OF RESPONDENTS

87% 81%

77%

62%

48% 40%

39% 32% 23%

19%

17%

16%

15%

19% 12%

Not important

Moderately important

Global

Important

Negotiating harder with external managers

Shifting out of high fee asset classes (such as pe/vc)

Allocating more to passive or smart beta strategies

Insourcing more investment management

0ther

SOURCE Casey Quirk Institutional Buyer Survey

Australia

CASEY QUIRK is a management consulting business specialising in investment management, and was bought by Deloitte last year. It has partnered with www.top1000funds.com for the last three years on this global survey. www.top1000funds.com is published by Conexus Financial, the publisher of Investment Magazine.

were most likely to waver from their focus on costs and agree to pay premium fees for managers who offered “uncorrelated returns” that strengthened their portfolio’s resilience. “Strategies that are uniquely diversifying to the portfolio, such as those with novel factor exposure profiles, tend to be highly attractive to us and worth a greater fee premium,” one owner said. Tony Skriba, senior consultant at the Casey Quirk Knowledge Centre, says that in addition to reducing fees, asset owners are focused on alignment of interests as well. “Investors are looking at performance fee preferences as a preferred model globally, and asset owners think managers don’t have enough skin in the game,” Skriba says. The survey revealed that performance fee models are of keen interest to investors, particularly the larger institutions; 60 per cent of investors with more than $75 billion in assets preferred a performance-based structure with minimum management fees. Investors want innovation in fee structures, with a focus on retaining more of the gross value added. Tyler Cloherty, senior manager at Casey

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Quirk, says the firm is seeing more innovative fee structures. “When managers move to performance fee structures, and reduce their management fees, it’s usually about retaining clients,” he says. Cloherty says such deals are usually cut with big clients first, but as they become more normal, some fund managers are starting to adjust their business systems and processes to offer them more systematically. He predicted a trend towards a combination of performance fees and fulcrum fees – an additional level of performance payments that kick in when an exceptionally high benchmark is met. The Casey Quirk consultants say an ideal fee structure would probably be one where “managers get a hit on the downside” as well as benefiting from any upside. “Managers need to alter incentives to show they’ll bear some of the risk as well as the upside,” Skriba says.

MANAGING RISK – AND EXPECTATIONS

In addition to wanting to reduce costs, large funds in the survey indicated they

are overwhelmingly looking to lower their return expectations, with 80 per cent of funds having already reduced their return targets or planning to do so in the next year. Locally, 58 per cent of Australian respondents said they had already lowered, or were considering lowering, their return targets. Worldwide, the targets of respondents varied from 2 per cent to 8.5 per cent. However, nearly three-quarters of respondents were either not confident or uncertain these would be achievable in 2017. Nearly one-third (31.5 per cent) of respondents revealed they were “not confident” of meeting their return targets in 2017. A further 42.6 per cent were “uncertain” of reaching their return target. Falling equity markets were cited as the biggest risk to investors’ portfolios in 2017, followed by geopolitical risks and rising interest rates. In Australia, the clear concern for investors was rising interest rates, followed by falling equities markets and geopolitical risk, with US politics causing the most uneasiness. Ñ

MARCH 2017

\ COLUMN

Time to get fair dinkum on disclosure The regulator’s new RG 97 disclosure rules WILL FAIL TO DO THE JOB of providing investors with transparency and comparable data if platform products are excluded from the requirements. AS THE SUPERANNUATION balances of average Australians swell, it is more important than ever for individuals to be able to compare funds. Comparison apps and other services are increasing in popularity, further hotting up calls for all funds to disclose comparable data. In light of this, excluding retail platforms from new disclosure and transparency regulations goes against the best interests of consumers. The Australian Institute of Superannuation Trustees (AIST) has been heavily involved in the protracted negotiations on the Australian Securities and Investment Commission’s Regulatory Guide 97 (RG 97), on disclosure, for the last two years. The exemption of platforms from the disclosure requirements – which AIST does not support – remains a sticking point among various stakeholders. If improved disclosure standards aren’t consistent across the entire sector, then they will not meet the objectives of protecting consumers, transparency and comparability. Amid the recent debate on the super tax concessions and the resultant legislated tax changes, fairness has become a core part of the superannuation narrative. This needs to extend to disclosure, where vested interests of powerful pension providers are stopping some consumers from getting the real story about their super. In its consumer protection principles for pension funds, The Organisation for Economic Co-operation and Development (OECD) stresses the importance of standardisation, comparability and consumer testing of disclosure. It calls for a level playing field across financial services and for remuneration and conflicts of interests to be disclosed where conflicts cannot be avoided. One reason for rigorously applying these principles – that of protecting consumers – is neatly summarised in a comment by the International Organisation of Pension

MARCH 2017

BY KAREN VOLPATO ___

Karen Volpato is a senior policy adviser at the Australian Institute of Superannuation Trustees.

Vested interests of powerful pension providers are stopping some consumers from getting the real story about their super

Supervisors: “…the limited capacity of individuals to choose what is best for them means … too much power in the hands of pension providers. The problem is only exaggerated when pension providers are commercial financial institutions. Conflicts of interest can therefore exist between the fiduciary duty to act in the best interests of the pension fund members and beneficiaries and making profits for shareholders.” But meaningful disclosure isn’t just about the end consumer. Without comparable

data, it is simply not possible to measure the efficiency of our retirement income system accurately. This is something both the Financial System Inquiry and the Productivity Commission have in recent years highlighted as critical to improving our super system. It would also not be possible to benchmark fees and costs and, therefore, enable trustees to know whether the investment management contract before them represents good value for members. The key problem with excluding platformbased products from the new RG 97 rules is that investors on a platform are now told only the wrap administration fee, and are left to try to find the underlying fees and costs buried in the Product Disclosure Statement (PDS) for each individual managed investment option. In other words, there is no single source of information that tells a wrap investor what their total fees and costs are. This is why neither consumers nor analysts of the superannuation system can compare a platform-based product with a profit-to-member fund, which includes comprehensive information in a single PDS for each investment option. There are also implementation issues surrounding RG 97 that remain of concern. These mainly revolve around areas of subjectivity, such as calculation methodologies, being brought into a disclosure regime that should be highly objective. AIST continues to advocate strongly for alignment of both disclosure and reporting across all super products. Our advocacy has sought alignment in the Choice product dashboard and in portfolio holdings disclosure proposals, as well as in select investment reporting. This is important, as there are absurd numbers of investment choices – more than 40,000 – which hold a lot of member retirement savings. We recommend that all investment options, not just the top 10 by funds under management, be included in the regulations. Legacy products should be included and there should be alignment between how providers of MySuper and Choice products have to report to the Australian Prudential Regulation Authority as well. Good, meaningful disclosure requires careful consideration and consumer testing. It’s time for all industry stakeholders to get fair dinkum about disclosure, giving every super fund member a chance to make informed decisions. Ñ

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AIST’S FLAGSHIP EDUCATION OFFERING

Trustee Director Course Australia’s first super-specific director course is AIST’s Trustee Director Course. Join the superannuation industry’s most experienced directors on the Enhance your excellence program. Enhance your excellence has been specifically developed for those in the superannuation industry with a focus on strategy, investment and board governance, decision-making and leading board discussions, which are critical to acting collectively in the best interest of members. Facilitated by AIST and leading industry experts, this unique program is delivered via a combination of interactive case studies and practical experiences that recognises an ever-changing superannuation and economic environment. Graduates will receive 40 CPD hours and use of the prestigious post-nominal GAIST (Adv.). Be recognised as a leading trustee director with up-to-date knowledge across all the required fields. Enrol now for AIST’s flagship educational offering.

Course dates: Brisbane QLD July 2017: 12th, 13th, 14th, 20th & 21st Sydney NSW September 2017: 10th, 11th, 12th, 18th & 19th Melbourne VIC October 2017: 11th, 12th, 13th, 19th & 20th Other states based on demand Express your interest in 2017 by sending your contact details and preferred state via email to training@aist.asn.au.

“ This course recognises the unique skills and heavy responsibilities required of today’s trustee directors – it should be on every trustee’s radar.” John Brumby Chair, MTAA Super

Not sure whether Enhance your excellence is right for you? AIST can offer personalised advice on the best program to meet your needs. Phone Sally Graham, Education Manager on 03 8677 3840.

For more information contact AIST Education via training@aist.asn.au ph: (03) 8677 3800

www.aist.asn.au/education This information is correct at time of printing and may be subject to change. Visit www.aist.asn.au for the latest information.

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LOOMING REGULATORY CHANGE meets business pressure from an ageing population. That’s what superannuation funds are facing as their product innovation skills are put to the test working to develop more sophisticated retirement income accounts. The government, following the recommendation of the 2014 Financial System Inquiry, plans to require the introduction of comprehensive income products for retirement (CIPRs) as a standard alternative to lump-sum payouts at retirement. Those funds that succeed at cracking the retirement income challenge will be bestplaced to thrive over the coming decade, a period when the number of funds able to retain their status as a MySuper provider is tipped to dwindle. MySuper is the licensing regime for the no-frills class of products that are eligible to be nominated in industrial awards and workplace agreements as default superannuation funds. Historically, regulation of the $474 billion default super sector has focused almost

exclusively on the accumulation phase: how funds manage members’ money and build their balances during people’s working lives. Now, as the baby boomer generation is retiring and 25 years after the introduction of the superannuation guarantee, there is an intensifying focus on the obligations incumbent on default funds to help members manage the drawdown of their accumulated savings. In December 2016, Minister for Financial Services Kelly O’Dwyer launched a major discussion paper, titled Development for the framework of comprehensive income products for retirement (CIPRs), outlining the government’s plans and seeking feedback from the industry. The consultation closes on April 28, 2017. Two of the key areas of regulatory uncertainty that funds complain are holding up their ability to develop their own CIPRs are the question of what safe harbours will be in place to protect trustees from legal action, and debate over the role of income guarantees.

By Ben Power

Pressure MEETS opportunity IN CIPRs

New legislation mandating comprehensive income products for retirement is still probably more than a year away but it’s already making waves. Australia’s biggest superannuation funds are grappling with creating this new breed of sophisticated products, and THOSE WHO GET IT RIGHT FIRST WILL HAVE THE EDGE.

MARCH 2017

Meanwhile, funds are also facing the challenge of creating CIPRs that are simple enough for members to understand. Yet another obstacle is member concerns about pooled arrangements, and the resulting loss of balances at death. “At the end of the day, there are product providers willing to manufacture CIPRs, or component products that can be used to build a CIPR,” says Willis Towers Watson head of retirement solutions, Nick Callil. “But ultimately, it will have to be the super funds that put them all together. Funds themselves have got to be able to implement whatever is decided is a CIPR.” The introduction of CIPRs was a recommendation of the 2014 Financial System Inquiry, led by David Murray. Boosting average retirement incomes to improve living standards for the ageing population is the goal. The report states that incomes from CIPRs could be up to 15 per cent to 30 per cent higher than those from the current popular strategy of drawing the minimum amount from account-based pensions. In the recently released discussion paper, the government suggests rebadging the clumsy acronym CIPR as the more consumerfriendly MyRetirement, reflecting the relationship to the MySuper licensing regime.

GUARANTEED INCOME PUZZLE

The government’s discussion paper is consistent with Murray’s vision that a CIPR provide flexibility, manage longevity risk through a stream of broadly constant real income for life, and provide a minimum level of additional income and/or guaranteed income. This requirement for CIPRs to provide a certain level of guaranteed income is expected to be one of the most contentious issues in developing legislation to govern the development of these new products. The discussion paper states that to enable CIPRs to deliver on the goal of better outcomes than the status quo, a minimum income efficiency could be prescribed. Callil says promising a guaranteed income presents two key challenges. The first is establishing the value for retirees. “Members need to be convinced that the price of certainty – as represented by the difference between a guaranteed income and what they can expect to receive (though not with certainty) from a market-based product, like an account-based pension – is worth the additional cost,” he says.

investmentmagazine.com.au

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Problems and ob jec tives for the proposed frame work for CIPRs PROBLEM TO BE ADDRESSED

RELATED OBJECTIVE OF CIPR PRODUCTS AND FRAMEWORK

Individuals are self-assuring against longevity risk and may be living more frugally in retirement than necessary

Increase individuals’ standard of living by facilitating risk pooling – providing security of income for life and the potential for higher income in retirement

Individuals face a lack of diversity and choice in retirement income products, in particular an absence of products that efficiently manage longevity risk

Increase the availability and choice of products that efficiently manage longevity risk

The second is implementation. Unlike banks, super funds generally do not have a balance sheet, hence any guarantee or promise must be implemented via a third party. “This represents a step up from the simple product design most funds are used to,” Callil says. Many funds will need more sophisticated governance to understand the inherent risk and establish the necessary oversights to implement these more complex products. Challenger Life chief executive Richard Howes says the devil will be in the legislative detail. “It does depend on how much of the income is guaranteed and it can be difficult to be absolute on what minimum income should be,” Howes says. “The levels of income that a CIPR would be able to achieve would be a function of market variables, such as prevailing interest rates and prospective returns from asset classes.” Challenger is the country’s biggest annuity maker and is at the forefront of developing products that the super funds will use in producing CIPRs. The ASX-listed company’s share price has added about 35 per cent since the government announced plans in the May 2016 federal budget to legislate a CIPR framework and remove impediments to the development of other innovative pooled-risk and longevity products, such as deferred annuities.

CALLS FOR A SAFE HARBOUR

The superannuation system is not achieving its objective efficiently due to its over-reliance on account-based pensions

Increase the efficiency of the superannuation system so that it can better meet its proposed objective

Individuals face complex financial decisions, a lack of guidance and behavioural biases at retirement but many are unlikely to seek financial advice

Empower trustees to provide members with an easier transition into retirement

SOURCE Treasury

investmentmagazine.com.au

Another issue that could present a major sticking point is exactly what legal protection funds would have if they direct members into a CIPR that underperforms. The discussion paper raises the possibility of a legal safe harbour. “Without [legal protection], issuing a CIPR could potentially put super fund trustees at risk,” Callil says. “If they’re exposed to action from retirees, trustees could shy away from offering CIPRs in the first place, which would affect the success of the whole initiative.” The issue is that nudging retirees towards a product could be seen as some sort of endorsement from the fund, Callil notes, adding that there is a chance trustees will shy away from longevity guarantees because, for some members, they may not make much sense. It is indicated in the discussion paper that a safe harbour is likely to be provided, but that this would not provide a defence or carve-out from financial advice law.

MARCH 2017

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I don’t think anyone has done a good job in this space. They’re too complicated. They’re so complicated that not even the advisers understand them

AUSTRALIAN CATHOLIC AND UNISUPER AT THE FOREFRONT

Callil says developing CIPR-style products is a “business issue forward-thinking funds need to address, whether or not the government is prodding them in that direction”. Few smaller funds have started developing CIPR-like products. One notable exception is Australian Catholic Superannuation and Retirement Fund, a $7.5 billion faith-based fund that was one of the earliest out of the blocks, launching its RetireSmart product in October 2015. While all of the major funds are already devoting resources to coming up with their own CIPR designs, most are keeping hushhush about their plans until the legislation is announced. UniSuper, the $55 billion default fund for university staff, has positioned itself as a market leader by announcing it is in the advanced stages of developing a CIPR-style product, despite the regulatory uncertainty. Its new default retirement income product, FlexiChoice is due to launch later in 2017. The product, which has been under development for three years, spans both accumulation and retirement phases. At retirement, its default benefit, a lifetime income stream, can be combined with an account-based pension component to achieve the CIPR objectives of efficient

longevity protection and flexibility to access a lump sum. UniSuper head of product Ian Lorimer says FlexiChoice was developed within the existing law, but he is confident it will fit comfortably into any new framework required for CIPRs. “Our FlexiChoice product will have exposure to growth assets, which [means it will meet such objectives more easily than traditional lifetime income products], which typically have a greater exposure to fixedinterest securities,” Lorimer explains.

SUNSUPER AND QSUPER ALSO ON THE MOVE

Sunsuper is another fund already developing its own CIPR solution. Shane Mather, who is head of product for the $30 billion Queensland-based industry fund, says the process has been filled with challenges. “Absolutely it’s a challenge [creating a CIPRs-style product],” Mather says. “We’re not going to run away from that at all. But we will overcome it. We have got a good record to date.” The first phase of development has involved member testing. Mather says feedback has indicated that what members want is compatible with what the recent discussion paper proposes. “They want a product that offers everything: longevity, good investment

Possible m in imum prod uc t requirements of a C IPR Minimum additional level of income and/or guaranteed level of income

Broadly constant real income for life

Flexibility

CIPR

returns and flexibility,” he says. “That’s the aim of the MyRetirement offer, those three things. Our members did support that.” Sunsuper is about to move on to the next phase: taking a prototype product for members to get feedback on crucial things such as what modelling and pricing will look like. Mather says it’s too early to provide details. The biggest obstacle, he says, is creating a simple product that members can understand. “I don’t think anyone has done a good job in this space,” he says. “They’re too complicated. They’re so complicated that not even the advisers understand them.” An even bigger challenge will be educating members. Funds will battle members’ mindsets on paying into risk-pooling arrangements and the fact that if they die they forfeit the balance and the kids’ inheritance will be lost. Mather says there is an attitude among members that they shouldn’t be forfeiting money.

MORE FUNDS TO FOLLOW

QSuper, the $65 billion default fund for Queensland public servants, is also moving out in front of the CIPR legislation by developing a new smart default option for retired members who select an income account allocated pension. “At the moment, pension members who select an income account are asked to select their preferred investment strategy option,” QSuper chief executive Michael Pennisi says. “They will still be able to [do this], but the new default will be a mix of cash (set aside to make regular payments) with the rest invested in a balanced investment strategy. “We thought it was the right move to put a default investment strategy in place for the retirement income account. Many of our retiring members get financial advice through QInvest, but [quite a few] just want us, as a trustee, to make it as simple as possible for them with an appropriate default.” Willis Towers Watson’s Callil tips that even though it is likely to be another year at least before CIPR legislation is finalised and passed, more funds will make announcements about new retirement income accounts in the coming months. The leadership by early adopters is giving them too much of a competitive advantage for others not to follow. Ñ

SOURCE Treasury

MARCH 2017

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