Investment Magazine October by Conexus Financial

INTELLIGENCE FOR INSTITUTIONAL INVESTORS

ISSUE 143

OCTOBER 2017

CLOSING UP SHOP State Super chief investment officer RICHARD HEDLEY on being at the vanguard for the deaccumulation challenge

FUTURE FUND THE SOVEREIGN WEALTH FUND’S HEAD OF EQUITIES, BJÖRN KVARNSKOG, HAS REVAMPED THE PORTFOLIO CHAIR’S SEAT FIRST STATE SUPER CHAIR NEIL COCHRANE IS UPBEAT ABOUT THE INTEGRATION OF STATEPLUS MAKE SUPER FAIR WOMEN IN SUPER’S SANDRA BUCKLEY OUTLINES HER AMBITIONS FOR THE GENDER EQUITY CAMPAIGN DE-CENTRALISED FORMER US FEDERAL RESERVE BOARD MEMBER RANDY KROSZNER URGES STRUCTURAL REFORMS

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CONTENTS OCTOBER 2017

CHAIR’S SEAT

“Our alignment with StatePlus presents some exciting opportunities” – NEIL COCHRANE – CHAIR FIRST STATE SUPER

CIO PROFILE State Super investment chief Richard Hedley and his team are grappling with the challenges of managing a fund in drawdown phase years ahead of their peers.

FUTURE FUND Nearly two years into his role as the sovereign wealth fund’s head of equities, Björn Kvarnskog reveals how he reviewed then revamped the portfolio.

MAKE SUPER FAIR Women in Super executive officer Sandra Buckley outlines her ambitions for the group’s campaign to tackle the gender gap in retirement savings.

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LIFESKILLS HESTA general manager of administration and insurance, Kelly Smith, shares what the fund learnt from its customer experience program.

LEADERSHIP The holy trinity for stakeholder alignment is clients, shareholders, and staff, QIC managing director of global business development David Asplin writes.

GLOBAL ECONOMY Former US Federal Reserve board member Randy Kroszner has no regrets about zero rates and QE but warns now is the time for structural reforms.

MYRETIREMENT Allowing customisation, setting a deadline, and encouraging governance frameworks are three ideas to improve Treasury’s CIPR regime, Jeremy Cooper says.

REGULATION Super funds are under pressure from ASIC and APRA to adapt to new reporting rules relating to fees, cost and performance.

RESILIENCE Spending 400 days in an Egyptian prison on false terrorism charges gave Peter Greste an opportunity to reflect on the limitations of positive thinking.

OC TO B E R 201 7

\ FROM THE EDITOR

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

EDITOR

Sally Rose DIRECTOR OF INSTITUTIONAL CONTENT

Amanda White

A LETTER from the editor

IS LIFE COVER WASTED ON THE YOUNG?

EDITOR-AT-LARGE

Simon Hoyle HEAD OF DESIGN

Kelly Patterson ART DIRECTOR

Suzanne Elworthy SUB-EDITOR

Haki P. Crisden PHOTOGRAPHER

Matt Fatches matt@mattfatches.com.au

HANGE IS AFOOT in the group insurance sector, particularly for younger members. In July, Cbus Super announced it had halved the default death cover offered to its members aged under 21. Then in September, AustralianSuper, the nation’s biggest industry fund, became the first to scrap default life insurance altogether for members aged under 25. AustralianSuper group executive of membership, Rose Kerlin, said the fund made the move after extensive analysis of member experience, feedback on the impact of automatic default insurance premiums, and consultation with the regulator. Based on current prices, the move is tipped to save a member who joins the fund at age 15 a total of $637 in premiums over 10 years. By retirement at age 65, that savings is projected to increase the member’s retirement balance by nearly $9000, or about $1600 in today’s dollars. A few days after AustralianSuper unveiled its new insurance deal, the Insurance in Superannuation Industry Working Group released its first draft of a new code of conduct. This draft code covers issues related to benefit design, premium caps, cessation agreements, duplicate insurance cover, member communications, claims handling, and a push for better data standards and transparency. Under the code, funds will agree to ensure automatic insurance benefits are “appropriate and affordable” for their membership generally and for certain segments – notably younger

OCTOBER 2017

members, those making low or infrequent contributions, and those nearing retirement. The code will also require trustees to try to ensure that the cost of cover does not exceed 1 per cent of an average member’s estimated earnings, with this threshold even lower, at 0.5 per cent, for members under 25. Other changes designed to prevent premiums from eroding members’ balances include an obligation to stop automatic premium deductions 13 months after contributions cease, and a requirement that trustees offer to help new members identify any group insurance policies they already have with other funds. Signatories to the code will also undertake to improve their member communications with plain English definitions and make the process of opting out of insurance more straightforward, and improve their claims handling and response times. Better data standards and improved transparency have also been recommended to help members compare their choices and make more informed decisions. A day after the release of the working group’s draft for industry funds, it was announced that the Commonwealth Bank of Australia had sold its beleaguered life insurance arm, CommInsure, to AIA Australia for $3.8 billion. Given National Australia Bank had already offloaded 80 per cent of its life insurance arm, this latest sale signals a changing of the guard, as Australia’s biggest retail banks retreat from life insurance.

CHIEF EXECUTIVE

Colin Tate

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ADVISORY BOARD MEMBERS Graeme Arnott, chief operating officer, First State Super | Richard Brandweiner, partner, Leapfrog Investments | Peter Curtis, head of investment operations, AustralianSuper | Joanna Davison, chief executive, FEAL | Kristian Fok, executive manager for investment strategy, Cbus | Damian Graham, chief investment officer, First State Super | 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

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Superannuation 2018

| MARCH 8, 2018 | IVY BALLROOM, Sydney, NSW |

NOMINATIONS OPEN

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Entries are open for the 2018 Conexus Financial Superannuation Awards. The awards recognise excellence in the superannuation industry and aim to encourage funds to raise the bar in all aspects of their operations, ultimately for the betterment of all members and consumers. These are the only superannuation awards that are truly independent, without the involvement of a research house that may be commercially linked with industry participants. AWARD CATEGORIES Best Insurance Offering

Best Advice Offering

Medium Fund of the Year ($5-10 billion)

Default Fund of the Year

Best Technology Offering

Large Fund of the Year (>$10 billion)

Pension Fund of the Year

Innovation and Transformation

CIO of the Year

Member Services Fund of the Year

Small Fund of the Year (<$5 billion)

Super Fund of the Year

MORE INFORMATION awards@conexusfinancial.com.au | conexussuperawards.com.au Entry forms have been forwarded to eligible funds

\ CIO PROFILE

LONG Th e

GOODBYE

OCTOBER 2017

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CIO PROFILE \

CHIEF INVESTMENT OFFICER for the NSW Government’s State Super, RICHARD HEDLEY, has already been forced to confront the retirement income management challenges many of his peers in the industry are just beginning to wrap their heads around. By Simon Hoyle + Photos Matt Fatches

HILE MOST SUPERANNUATION funds grapple with member retention and growth, SAS Trustee Corporation is coming to grips with the opposite issue: how to manage a closed fund, in negative cash flow, with a membership nearing retirement and a long tail of defined benefit pension liabilities. SAS is trustee for four funds that collectively go under the brand name State Super: State Authorities Superannuation Scheme (SASS), State Superannuation Scheme (SSS), Police Superannuation Scheme (PSS) and the State Authorities Non-contributory Superannuation Scheme (SANCS). As at June 2016, State Super had assets of about $42 billion and a total membership of about 110,000, including 65,000 definedbenefit (DB) members. About $34 billion is managed for DB members, who on retirement receive lifetime pensions, determined by the terms of their employment contracts and unrelated to the performance of investment markets. State Super is one of the largest providers of lifetime pensions in the country.

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Only about $8 billion of the fund’s total assets are managed for defined-contribution (DC) members, who must take a lump sum and leave the fund by age 70. However, the age members typically depart the fund is 63, and the average member age sits at 55 – just eight years away from retirement. Unlike most super funds, which have the benefit of operating a business model fuelled by mandated contributions, State Super is in managed wind-down phase, working towards turning the lights off in about 2080. These peculiar constraints have forced State Super chief investment officer Richard Hedley and his five-member investment team to become trailblazers in dealing with the next crop of challenges the bulk of the industry will face as the Baby Boomers retire. “We’re highly cognisant of that,” Hedley says. “In a sense, we’re right at the forefront of what the industry is going to face when it moves into that de-accumulation phase: How do you deal with the fact that investment horizons have shortened for an individual member, who may have only two, three, four, five years left in the fund? How do you manage the portfolio for that person?” Amid the industry debate on the merits of the government’s plan to implement comprehensive income products for retirement (CIPRs), State Super is an enthusiastic voice on issues such as managing longevity and other risks. This is despite it being unable to offer post-retirement products to its DC members, under the terms of its constituent legislation. Instead, it refers them to StatePlus, the financial planning business the fund sold to First State Super for a reported $1 billion in 2016, a project Hedley led. Hedley’s main responsibility is setting the broad investment strategy and strategic asset allocation, and defining objectives for investment options, keeping in mind the profile of members.

OCTOBER 2017

\ CIO PROFILE

The trick to managing service providers is to set precise and detailed objectives and then let them get on with it, with careful monitoring of results

The actual investment function is outsourced. NSW Treasury Corporation (TCorp) handles the DB component, overseen by Hedley’s team. A number of State Super staff transferred to TCorp when it won the mandate in mid-2015, ensuring deep understanding of the fund and its members’ needs continued. The DC portfolio is spread across 35 external managers, selected with guidance from asset consultants Frontier.

‘NOSES IN, FINGERS OUT’

Of every dollar State Super spends on investments and services to members, about 95 cents goes to external suppliers. Hedley says the trick to managing service providers is to set precise and detailed

OCTOBER 2017

objectives and then let them get on with it, with careful monitoring of results. “It’s noses in, fingers out,” Hedley says. It also means being prepared to take action when suppliers are failing to deliver or not behaving appropriately. For the DC component of the fund, Hedley says, Frontier provides the investment resources that the fund itself lacks. “They can get out and see so many more people in the market than we can, to help us identify who is the best manager out there to implement the strategy we’ve set,” he says. Hedley, in a previous role, worked for one of the managers State Super employs, Deutsche Asset Management, specialising in infrastructure and private equity. He joined State Super in August 2015, initially

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CIO PROFILE \

TOUGH OUTLOOK

R i ch a rd H e d l e y STATE SUPER CHIEF INVESTMENT OFFICER

Appointed October 2016 PREVIOUS ROLES 2015-16 2014-15 2001-14

1998-99 1995-98

State Super, head of unlisted assets and alternatives Raniera Capital Advisers, principal Deutsche Asset Management, various roles culminating as head of portfolio and asset management, Asia-Pacific infrastructure investments; associated non-executive director roles during this period included chairing Australia Pacific Airports Corporation and Port of Geelong. Dresdner Kleinwort Benson (London), transaction lawyer Bell Gully (Auckland), solicitor

QUALIFICATIONS 2016

Fellow of the Australian Institute of Company Directors

2001

Master’s of applied finance, Macquarie University

1996

Admitted as a barrister and solicitor of the High Court of New Zealand

1994

Bachelor of laws (honours), University of Otago, New Zealand

as head of unlisted assets and alternatives, before being appointed CIO in October 2016. He says he got two surprises on joining the organisation. A pleasant discovery was the level of investment knowledge and expertise resident within the organisation. The less pleasant realisation was just “how thinly resourced the organisation is” compared with the private sector. “It really runs off the smell of an oily rag,” he says. “Compared with a fund manager or an investment bank, where if you want something, you just dial up and it’s delivered to you pretty quickly. Here … we really have to prioritise the resource allocation.” State Super chief executive John Livanas says the outsourcing of investment places a premium on hiring staff who have the experience to work with limited resources – an approach he says has been characterised as “small team, big brains”. “Over the last 12 months, we’ve reviewed our strategy and our forward-looking projections of who we are and who we’d like to be,” he says. “We’ve moved to an increased outsourcing model.

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FOCUS ON ALLOCATIONS

The most important function for Hedley and his team is getting the fund’s strategic asset allocation (SAA) right. Hedley says the internal team interprets the information external suppliers provide, and has the capacity to make changes. State Super general manager, asset allocation, Charles Wu, was recently recognised by the Australian Institute of Superannuation Trustees with its 2017 Investment Rising Star award, in part for his innovation in how the fund conducts its SAA reviews. The reviews take place annually, setting views on asset class returns, appropriate investment targets, expected returns and risk, also assessing the potential to include new asset classes in the mix. Hedley says it’s “a huge body of work” that informs the fund’s target returns and sets a basis for its portfolios. “Quarterly, we undertake a formal dynamic asset allocation review where we take a shorter duration view on markets, and form a view on where we want to overweight or underweight our SAA position.”

As at July 1, 2017, the SAA for State Super’s balanced option was 36 per cent in liquid growth assets, 27.5 per cent in alternatives, 36.5 per cent in liquid defensive assets and 26.5 per cent in cash. This represented a reduction in exposure to growth assets and an increase in exposure to alternatives. Return targets for the fund’s investment options were also reduced from July 1. The target on the balanced fund was dropped from CPI + 3 per cent a year to CPI plus 2.25 per cent a year, over rolling seven-year periods. Likewise, the yearly target for the fund’s growth option was revised from CPI plus 4.0 per cent to CPI plus 3.5 per cent. “Over that time horizon, we’ve taken the view, on advice from our asset consultant but also consistent with a lot of funds in the market, that return expectations are likely to be lower than they’ve been historically,” Hedley says. “We wanted to be very clear with members what return they should reasonably expect.” State Super members typically do not have the luxury of 20 years to recover if there’s a significant downturn in markets, Hedley says. The fund employs illiquid assets and an equity options overlay to help smooth returns, and insulate members from potential downturns. The equity options overlay strategy is designed to protect the DC portfolio from equity market falls ranging from about 5 per cent to 20 per cent. The fund also works closely with the managers of its illiquid assets to assess opportunities to monetise their value to bring forward returns, and to redeploy capital. “We can’t just sell them all, convert those assets to cash or put them in our liquid portfolio, because the overall portfolio would suffer,” Hedley says. “We’ve sold almost $500 million of infrastructure assets out of that defined contribution portfolio in the last 12 months, and we’ve deployed a substantial amount of those divestment proceeds into new unlisted assets.” The options overlay allows the fund to maintain an overweight position in growth assets, such as Australian equities.

OCTOBER 2017

\ EQUITIES

Future Fund HOW THE

TOOK S T O C K

Australia’s sovereign wealth fund has REVAMPED its equities portfolio to be more DELIBERATE about its factor exposures and TARGET idiosyncratic risk. The fund’s head of equities, BJÖRN KVARNSKOG, explains. By Amanda White + Photos Matt Fatches

IT HAS BEEN 20 months since Björn Kvarnskog moved from Stockholm, Sweden, to Melbourne to become head of equities at the Future Fund. Since then, the former head of global equities for $130 billion Swedish pension fund AP4 has been busy conducting a complete review of the $133 billion Future Fund’s $38 billion equities portfolio. When Future Fund chief investment officer Raphael Arndt hired Kvarnskog, he gave the international recruit an open mandate to look at the strengths and weaknesses in the equities portfolio and propose what needed to be done to improve its value proposition. The result is a new objective and a recalibrated portfolio that separates mandates along active and passive lines and rehires managers with more active risk to generate its alpha.

OCTOBER 2017

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EQUITIES \

Ready to talk publicly for the first time since taking on the role – and with much to say – Kvarnskog agreed to be interviewed live on stage at the 2017 Investment Magazine Equities Summit, in Melbourne on September 12. “The listed equities program had been performing well, but we thought it could do better,” Kvarnskog said. “It was not something that was broken and needed to be fixed. All organisations have strengths and weaknesses and need to manage those wisely.” As the team embarked on the review of the equities portfolio, it found a “lot of factor risk”, Kvarnskog said. Sometimes that was deliberate, with targeting of certain factors, but other times it wasn’t. As multiple long-only managers had been added over time, the tracking error, or risk, in general had been diluted. While this is one of the benefits of diversification, it also added much factor risk, particularly around the momentum theme in the longshort portfolio. “I’ve seen this in trading as well and I think it applies to hedge funds,” Kvarnskog told the summit. “You have traders or funds taking deliberate risks but when you put everything together there are certain risks that pile up and sometimes you don’t get rewarded for that.” This was the case for the Future Fund’s equities portfolio, so plenty of work was undertaken to address its structure.

TAKING BACK CONTROL

Once it was clear what was under the bonnet, the Future Fund set about recalibrating to address the unwanted factor risk. Then Kvarnskog’s team, in consultation with the board and investment committee, found a new objective. “We focused on how we could take control of the portfolio; that was probably the most important task,” he explained. “The listed equities program had been serving several masters in the past. We had been involved in completion trades, thematic investments, stockpicking mandates, and factor mandates. We needed to take a step back and define what we were targeting.” It was agreed that the most important objectives for the portfolio were to take as much desired risk as possible, and to play a role in portfolio completion. A new strategy was designed to accomplish those aims. “This meant bringing in the factor exposures we had in other areas,” Kvarnskog said.

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OCTOBER 2017

\ EQUITIES

The equities team is now more particular in where it targets its factor exposures, and is cognisant of the many factor risks the Future Fund is exposed to at a total portfolio level; for example, in fixed income or private equity. The equities portfolio now has a reduced exposure to the momentum factor and has refocused the way it targets what Kvarnskog calls the “more solid” factors, such as value and quality.

SIMPLER STRUCTURE

The new streamlined structure is simpler. The portfolio is divided into a number of sub-categories, with each having a unique objective and role to play. Kvarnskog described it as “almost a barbell approach”, and said that while he is reluctant to label the process an alpha/beta separation, the vast majority of the assets are now in beta and alternative beta mandates. “The objective for these portfolios is super simple – to tap into market risk premia or alternative risk premia and get properly compensated for taking risk,” he explained. “That said, we are not benchmark huggers. We think there are benefits to moving away from the [market-cap weighted index], but using a benchmark approach to structure the portfolios.” High-risk, alpha mandates complement the beta mandates, with a preference for hedge funds – mostly market-neutral ones.

“Instead of having long-only managers in between, carrying a lot of deadweight in terms of holding stocks where they don’t have high conviction, we put more risk into the alpha space and use replication strategies in the beta and alternative-beta book,” Kvarnskog said. “It’s important to stress the model doesn’t trump the way we implement. Even if we use many passive replication strategies, we have components of long-only mandates as well, but more in areas where we think [it’s more difficult to] replicate the strategies.”

YOUNG, HUNGRY MANAGERS

Previously, the Future Fund had a number of large mandates with some of the “fancy big hedge fund names”, including an equity long-short mandate of $2.5 billion. “We also had a number of managers operating with a lot of net exposure. This is not an optimal way to use the balance sheet in the hedge fund space.” The fund has shifted focus to smaller, more nimble, stockpicking mandates, where the objective is to maximise idiosyncratic risk. The fund now also targets managers at an earlier stage in their lifecycle. “There are heaps of benefits to this. These managers tend to be hungrier, easier to negotiate with, and we get better terms and conditions and better transparency, which is extremely useful,” Kvarnskog explained. But it wasn’t just the type of manager that changed in the portfolio clean-up; the fund also addressed the “systems” used for information and communication with managers.

Instead of having long-only managers in between, carrying a lot of deadweight in terms of holding stocks where they don’t have high conviction, we put more risk into the alpha space and use replication strategies in the beta and alternative-beta book

OCTOBER 2017

“We can’t just have a quarterly call with managers; we need to integrate the data and see what is going on, and view it through a factor lens,” Kvarnskog said. “For the big guys, this is very sensitive information, I get that. We are trying to engage with smaller, more nimble managers operating with market-neutral mandates. They are not that active in the crowded names, so it’s good for us because we won’t end up with bad hedge fund risk or bad momentum risk.”

BETTER DEAL ON FEES

Not only is the new setup a more efficient way of allocating capital, it’s a better way of spending fees. The Future Fund can replicate a strategy that a long-only manager charges 30-60 basis points for and end up paying a fraction of one basis point. “We are happy to pay fees for skill and for managers that can handle idiosyncratic risk or harvest complexity,” Kvarnskog said. “But for a large chunk of the beta book, especially, for long-only managers riding factors for many years, we don’t want to pay for that. “This is a business of scale. We can create our own indices and hand them over to State Street or Vanguard and players like that, and in a low-returning world, that is an efficient way to make money by not paying fees.” Essentially, the portfolio has adopted a different way of addressing risk, with fewer big mandates, but is also more efficient. “We pay less [in] fees in the alpha and beta book so, in general, we have saved a lot of money by doing this,” Kvarnskog said. “Fees are an important governance tool, especially in the hedge fund space. You can give managers a rule book but nothing works as well as a fee structure.”

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COLUMN \

Let’s make super fair In large part, the answer to improving the economic security of women in retirement is surprisingly gender neutral. WOMEN IN SUPER has launched a new campaign to make the system work for low-income earners.

compulsory employer contributions and compound interest over their lifetimes. Leading businesses are increasingly offering all employees the ability to work flexibly, whatever the reason – whether to bring up a family, care for an elderly parent or sick partner, volunteer, or pursue further study. Still, for most of the workforce, quality, well-paid, flexible jobs are hard to find.

ALL TALK, NO ACTION

THE FASTEST-GROWING COHORT of homeless people in Australia is older single women, a trend that shows no sign of slowing down. We must take steps now to improve women’s economic security in retirement, not just for those retiring now, but for future generations, too. Making the system fairer for all lowincome earners, be they men or women, will go a long way towards closing the gender gap in retirement savings. That is why Women in Super launched the Make Super Fair campaign. It is unacceptable that in 2017, despite 25 years of compulsory superannuation, women still retire with average account balances 47 per cent lower than men. Telling women to take control of their finances or become more financially literate is not the solution. Nor is the outdated belief that a husband is an adequate retirement plan. Over half the female workforce earns less than $37,000 a year and one-third of women retire single.

STRUCTURAL BARRIERS

As the 2016 Senate Inquiry into Women’s Economic Security in Retirement found, the gender pay gap persists and is the biggest driver of the gender super gap. The pay gap starts early. The latest Workplace Gender Equality Agency (WGEA) figures show female graduates earn 4 per cent less than their male peers and the gap

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The super gender gap has attracted much media, industry and government attention in recent years, yet as a nation, we have failed to act. Structural inequity requires structural solutions. As a priority, we need increased government support for workers (women and men) on lower incomes and those whose earning capacity is affected by caring responsibilities. In launching the Make Super Fair campaign, Women in Super hopes to build on our successful effort to save the BY Low Income Super Contribution (LISC), SANDRA BUCKLEY which was, in effect, retained in the 2017 federal budget as the Low Income Sandra Buckley is the executive officer Superannuation Tax Offset (LISTO). of Women in Super. LISTO rebates the extra tax lowincome earners are charged on their compulsory super contributions, with the average payment coming to about $250 a year. To put this into context, Treasury spends $30 billion dollars a year delivering super tax concessions to high-income earners (mostly men) and just $1 billion on concessions to low-income earners (mostly women). This distribution of tax concessions seems neither fair, sustainable nor equitable. The Make Super Fair campaign is Women typically miss out on advocating for: tens of thousands of dollars • No further delays to the scheduled of compulsory employer superannuation guarantee (SG) increases. contributions and compound • The application of the SG to the government paid parental leave scheme. interest over their lifetimes • The removal of the $450 monthly income threshold on SG contributions. • A requirement that government undertake and publish a gender impact statement for widens as women progress up the career any changes to age pension or retirement ladder. income policy, in addition to the ongoing Women are more likely to take career tracking by WGEA of the gender super gap. breaks to care for children and many mothers All Australians have the right to a dignified then return to work part-time, a decision retirement and superannuation is the key to made perhaps as a result of being paid less delivering that. As an industry, we have the than their partners in the first place! power to alter the narrative and accomplish All this means women typically miss meaningful change. out on tens of thousands of dollars of

OCTOBER 2017

\ SP ONSORED CONTENT

THIS REPORT is sponsored by Macquarie Investment Management

INVESTORS ARE FACING the most challenging market environment in many years. Between that and the burgeoning challenge of how to provide retirement income for ageing members, superannuation funds are demanding more than ever from their fund managers and service providers. Over the last 25 years, Australians have collectively amassed a $2.3 trillion pool of retirement savings that is forecast by Deloitte to reach $9 trillion by 2033. It’s an impressive sum, but not enough. Roughly 80 per cent of Australians still retire on a full or part age pension. Innovation is needed if the ideal of a universal system to empower average workers to self-fund their retirement is ever to be achieved. Especially in an era when world interest rates are hovering around record lows and asset prices are inflated from years of stimulatory global monetary policy, that is now being partially tapered, meaning the return outlook for the next 25 years is much more subdued. “Our view is that we are going to be in a low-return world and…the chances of savers investing their way out of their self-funding problem are not that high,” Macquarie Asset Management head Shemara Wikramanayake told the group’s annual Research Insights Forum in Sydney on August 31, 2017.

EXPLORING INSOURCING OPTION

An area of focus for Macquarie’s super fund clients is to reduce the leakage from fees and costs. This is true despite average super fees having already fallen from 1.3 per cent to 1.03 per cent over the last decade, according to Rice Warner. One of the ways some of the country’s super funds are seeking to reduce their costs is bringing more of their investment management and advice capabilities in-house. This presents some challenges, the forum heard. Macquarie quantitative equities portfolio manager Scot Thompson said many of the firm’s institutional clients have already insourced some of their investment management or are thinking about it. “People are thinking about this because

OCTOBER 2017

Taking future ON THE

MACQUARIE INVESTMENT MANAGEMENT recently held its annual Research Insights Forum for institutional investors. Speakers at the event reflected on the CHALLENGES investors face and presented Macquarie’s latest research and thinking to help overcome them. By Mark Fenton-Jones

although the investment opportunity set is growing, they don’t appear to be getting what they need,” Thompson said. “But it’s a balancing act.” While the cost benefits of insourcing might appear attractive, Thompson suggests institutions be mindful of the risks it brings, both competitive and regulatory. He suggested there might be an alternative where the client is able to access flexibility, control and reduced cost by engaging with an asset manager to build a multifactor core portfolio. The benefit of a multifactor core portfolio is that it complements the active manager line-up. Building a portfolio of active managers may result in some unwanted risk exposures, which may lead to a result that’s less than optimal. A multifactor approach can change the overall risk exposure by combining various smart-beta strategies. “A multifactor portfolio can either be a total equity core solution or just a part of the portfolio that is too small at the moment to justify having a full-blown suite,” Thompson explained. “Or maybe it’s just a piece of that internal low-risk portfolio, but there are alternatives and people to help you work through those.” Thompson suggests that rather than bringing the core portfolio in-house, clients negotiate alternative management fee structures to reflect the size of their core portfolio or implement innovative fee structures, such as True Index products.

In developing multifactor solutions, Macquarie can assist clients in a range of ways to leverage their relationship, including quantitative research and technological solutions. Those clients that are able to implement a flexible, low-cost core portfolio are then able to use their risk and fee budget to employ highly specialised managers that provide diversified sources of return, Thompson explained.

BALANCING RISKS AND RETURNS

While keeping a tight rein on costs is critical, super funds also need to ensure they are managing risks and tapping new sources of returns. Wikramanayake told the forum that even if the local super industry reduced its average investment fee from 1 per cent to 50 basis points, it would not make a material difference to the rate at which retirement savings are compounding. A holistic approach is required. “In addition to focusing on fees and cost, we as an industry need to think much more about capital preservation and superior return for risk,” she said. Wikramanayake also noted the need for super funds to ensure their investment strategies reflect the risk profile of their ageing members. “In a low-yield environment, sequencing risk becomes a much bigger issue if you have a big downturn in your savings pool,” she said.

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SP ONSORED CONTENT \

SHEMARA WIKRAMANAYAKE Head of Macquarie Asset Management

“It takes a long time to catch up so we need to be protecting capital a lot more in this world we are in, but we also need to be looking at how we can add more meaningful returns without stepping up risk.” Macquarie executive director and head of fixed income research Dean Stewart told the forum that even in the current low-yield environment, bonds can play a major role in capital preservation. “Protecting against sequencing risk is actually far more important, and more effective, from bonds in this low-yield environment,” he said. Stewart noted that over the last three decades, the average super fund allocation to bonds has dropped from 40 per cent to 10 per cent. Despite this, he argued, the asset class still has an important role to play in portfolio construction. “If we are trying to deliver something that is not going to give members a lot of surprises or shocks when they go to use that money, we need to be investing in things that move with the liability, and bonds are the asset class that goes up when retirement liabilities go up,” he said.

INFRASTRUCTURE AS AN ASSET CLASS

Infrastructure is an alternative source of yield that has been an important contributor to the returns delivered by the super industry over the past two decades. Macquarie executive director and AsiaPacific co-head of infrastructure and real assets, Frank Kwok, told the forum that he expects the sentiment surrounding infrastructure to remain positive, despite the increase in valuations in recent years.

SCOT THOMPSON Macquarie quantitative equities portfolio manager

He is confident that continued demand from pension funds will fuel innovation in this asset class. Macquarie was a pioneer of infrastructure investing, having taken a stake in more than 200 infrastructure companies through its infrastructure and real-assets division over the last 20 years, with more than one-quarter of those investments now realised. As infrastructure as an investment class matures, pension funds are increasingly focused on the composition of their infrastructure allocation, determining what subsets of the asset class and respective return profile – infrastructure debt, super core, core or core-plus infrastructure – best fit their desired portfolio. With increased demand for the asset class, sourcing good investments is even more critical. One of the ways Macquarie is sourcing infrastructure investments is by identifying captive infrastructure assets within large companies in sectors such as energy, transportation, resources and telecommunications. These companies are increasingly seeing the benefit of disposing of their infrastructure assets via long-term investors who value these assets at a lower cost of capital.

BIG DATA

The impact of big data and machine learning on the investment landscape was also examined at the forum, which heard

from Björn Österberg, the chief investment officer and head of research of Stockholmbased Informed Portfolio Management (IPM). “Machine learning is not new, I was experimenting with supervised and unsupervised neural networks back in the early ’90s,” Österberg said. “However, big data is new and is making new datasets for investment signals available.” Österberg provided a fascinating example of how it is now possible to use satellite imagery data to measure economic activity directly, rather than having to wait and rely on official GDP data. “New data vendors are emerging and making these new data sets available to investment markets,” he said. “From an investment perspective, knowing how to develop investment signals from these new data sets, and how to build portfolios to profit from those signals, is where the lion’s share of the value add remains.” Australian investors can now access IPM’s systematic global macro strategy via the Macquarie Professional Series. Taken together with the other innovations and insights that were detailed throughout the forum, Macquarie’s approach is to look for value and efficiencies in existing assets and processes, rather than dramatically replacing them. That way, their clients’ members will be on a surer footing to provide for their retirement when faced with the present low-return environment.

DISCLAIMER: The information in this article is not, and should not be construed as, an advertisement, an invitation, an offer, a solicitation of an offer or a recommendation to participate in any investment strategy or take any other action, including to buy or sell any product or security or offer any banking or financial service or facility by any member of the Macquarie Group. This document has been prepared without taking into account any person’s objectives, financial situation or needs. Recipients should not construe the contents of this document as financial, investment or other advice. It should not be relied on in making any investment decision. Other than Macquarie Bank Limited (MBL), none of the entities noted in this document are authorised deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of these entities, unless noted otherwise.

investmentmagazine.com.au

OCTOBER 2017

\ CHAIR’S SE AT

INVESTING in

A DV ICE In 2016, FIRST STATE SUPER purchased the NSW Government’s financial planning business, STATEPLUS, for a reported $1 billion. The tie-up means the $80 billion default fund for NSW public servants now has one of the largest financial planning networks of any non-profit superannuation fund in the country. In this Q&A with INVESTMENT MAGAZINE, First State Super chair Neil Cochrane shares why he is upbeat about the integration of the two businesses.

Edited by Sally Rose + Photos Matt Fatches

Q. HOW IS THE INTEGRATION OF STATEPLUS GOING? WHAT IS THE MOST CHALLENGING ASPECT OF BRINGING THE TWO BUSINESSES TOGETHER?

A. The integration and alignment of the two businesses is going extremely well. Our decision to acquire StatePlus last year was motivated by the belief that quality advice

OCTOBER 2017

changes lives. The StatePlus acquisition is held as an investment in the First State Super portfolio. That means our members benefit from the capital appreciation of the investment and the dividend paid from the profits of StatePlus. Plus, by combining the advice capability of First State Super and StatePlus, we have expanded our geographical reach and increased the number of advisers available to assist our members.

investmentmagazine.com.au

CHAIR’S SE AT \

Q. ARE FURTHER ACQUISITIONS PART OF FIRST STATE SUPER’S STRATEGY?

A. Absolutely. We are always interested in acquisitions and investment opportunities that will help us build scale, improve the services we offer to members and generate sustainable long-term investment returns. Q. WHAT IS THE MOST EXCITING PROJECT THE FIRST STATE SUPER BOARD IS WORKING ON AT THE MOMENT?

A. Our alignment with StatePlus presents some exciting opportunities. We now have 26 offices nationally, and almost 220 financial planners – giving us the largest member-owned financial planning network in Australia. Several projects are under way to help us maximise the potential of this powerful alliance and leverage the best of both organisations, optimising the access to advice services for our members, opening career opportunities for many of our people and creating a solid platform for future growth. Q. THE FIRST STATE SUPER

BOARD HAS EXCELLENT GENDER BALANCE, WITH SIX OUT OF 13 OF ITS DIRECTORS WOMEN. DID THAT TAKE A CONCERTED EFFORT? WHAT BENEFITS HAVE YOU SEEN?

A. We were deliberate about our desire for gender balance but it was not a difficult goal to achieve. Nearly 70 per cent of First State Super’s members are women, so for us it is especially important to have women on the board who can draw on their personal experiences and perspectives to help influence the decisions we make on behalf of our members. There is no doubt that we have a stronger governance framework and make better decisions because of the blended experience of the people who sit around our board table. Last year, we were also proud to be named a Workplace Gender Equality Agency (WGEA) employer of choice. Diversity of all kinds, not only in gender, is something we strive for at every level of our organisation.

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If my colleagues want to raise an issue or challenge a decision, then it is helpful to discuss it with me ahead of the meeting. I do this not to shut down the issue; rather, I want to open it up and create space for it

Q. HOW HAVE YOUR VIEWS ABOUT WHAT MAKES A GOOD CHAIR CHANGED SINCE YOU TOOK YOUR FIRST CHAIR ROLE AT COMMONWEALTH BANK GROUP SUPER IN NOVEMBER 2009?

A. I’ve learnt that I must firstly get to know and understand the individual directors and listen to their points of view. It is essential that all meetings provide directors with the opportunity to contribute, and discuss and debate issues in a respectful and collaborative environment. A large part of my role is to create an environment that enables that exchange of ideas. Q. WHAT IS YOUR TOP TIP FOR HOW TO FACILITATE A CONSTRUCTIVE BOARD MEETING?

Q. WHAT IS YOUR NEXT PRIORITY FOR IMPROVING DIVERSITY?

A. Diversity means more than achieving equal representation of men and women. As our fund grows in size, scale and complexity, we need to ensure that the board continues to have the right mix of backgrounds, experience, skills and perspectives. It’s my role, together with our nominations committee, to work with our stakeholders to achieve this, and then to ensure that all of these diverse attributes can contribute to the ongoing success of First State Super. Q. FROM YOUR PERSPECTIVE AS A FORMER DEPUTY CHIEF EXECUTIVE OF COLONIAL FIRST STATE GLOBAL ASSET MANAGEMENT AND CHIEF EXECUTIVE OF REST INDUSTRY SUPER, WHAT DO YOU MAKE OF THE BITTER PUBLIC RIVALRY BETWEEN THE RETAIL AND INDUSTRY SUPERANNUATION LOBBIES?

A. The two groups have more things in common than they have differences. Chiefly, a growing cohort of ageing members and clients who are depending on all of us to deliver the products, services and investment returns they need to achieve peace of mind and a dignified retirement.

A. If my colleagues want to raise an issue or challenge a decision, then it is helpful to discuss it with me ahead of the meeting. I do this not to shut down the issue; rather, I want to open it up and create space for it. I have a responsibility to ensure that each one of my directors is given the space to be heard. Q. WHO WERE YOUR MOST IMPORTANT MENTORS?

A. The great inspirations of my life were my parents. My father was an extraordinary physician and medical researcher doing ground-breaking work on asbestosis in South Africa and my mother was a founding member of the Black Sash, one of the most effective anti-apartheid movements. They both taught me the importance of trying to live the golden rule of ‘do as you would be done by’. With the great privileges of being born white in South Africa came the equal demand to give back in meaningful ways. Q. WHO DO YOU TURN TO FOR ADVICE NOW?

A. While I have been formally mentored in the past and still act as a mentor to others, I now see my professional community as my counsellor and coach. One of the most rewarding learning relationships I have is with First State Super chief executive Michael Dwyer I think we both utterly trust each other and so are able to explore ideas without one of us thinking the other has lost his mind.

OCTOBER 2017

IN YOUR MEMBERS’ MOMENT OF NEED, WE’RE HERE. In 2016 alone, we paid over $1.4 billion in claims to both Retail and Group members. That’s over $4.4 million every working day.

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Because we’re here for your clients when they need it.

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IN ASSOCIATION WITH

LIFESKILLS \

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MEMBERS

THE WAY

HESTA’s recent experience LISTENING TO THE DEEPLY PERSONAL STORIES of its members has helped the $37 billion industry fund improve its group insurance offering. By Kelly Smith | HESTA general manager of administration and insurance

rewarding to learn of the unique connection they can have with members.

CHANGES IN PLACE

OVER THE LAST 30 years, HESTA has learned a thing or two about our more than 820,000 members. Now a customer experience program is helping us bring that knowledge to life in the form of better products and services – particularly in group insurance. It’s often how things like policy design and claims handling are implemented that makes a big difference to members. As an industry, we need to understand what members say, do, feel and think, so we can design interactions and services to better meet their needs and stay relevant. This is key to the human-centred design approach, which is vitally important when it comes to group insurance. For most of our members, it’s the only personal cover they have.

PERSONAL STORIES

Recently, we took a closer look at how HESTA members interact with us on insurance, from when they first automatically receive default cover, to choosing to personalise that cover, right through to making and being on claim. A broad cross-section of our members came in to spend time with us. We used multiple techniques, including empathy interviews, concept testing, virtual reality and tested software prototypes. We sought direct feedback on our letters and forms. The experience was deeply touching. Members shared personal stories and the insights gained have been invaluable.

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We learnt it’s imperative to tailor the conversation depending on where the member is on their journey. • Sue*, a member receiving treatment for breast cancer, told us she didn’t want to get too much information during those weeks she was in a chemo fog. • Sanj, a 57-year-old recent migrant to Australia, told us he found click-to-chat interactions easier than using the phone because English was his second language. This helped us understand this type of interaction is not just for our Gen Ys and Millennials. • Another member, Martha, who was suffering from a rare form of cancer, told us she was overwhelmed with the paperwork she faced and having an online claims system would better meet her needs. • Karen advised that her income protection payments made the difference between having one meal a day or eating three healthy meals to aid her recovery and return to work. • Anne told of how, during her long depression, the support she received from our team provided a vital connection to the real world and a social lifeline. Without hearing such first-hand perspectives, it is impossible to understand what members face when making a claim in often extremely challenging circumstances. Our insurance team is experienced at dealing with these situations with compassion and empathy, and it has been

Our members bravely sharing their stories has enabled us to make a wide range of changes. We’ve cut the jargon and implemented simple infographics to explain clearly online how members can claim. We now regularly send members SMS updates throughout the underwriting and claims processes, which has reduced complaints. We’ve redesigned our online underwriting process to simplify it. This has resulted in faster turnarounds and fewer incomplete applications. Our team is able to complete the process over the phone if any information is missing. It’s a common misconception that members on claim don’t want to work. Our members on claim told us how important reconnecting to work was. Income protection cover can help keep the conversation open and potentially provide members with rehabilitation. HESTA offers IP cover to eligible members up to age 67. There is now a wide body of evidence that remaining connected to the community through work is the best for an individual’s long-term recovery. And, we know, it can result in a more secure financial future for our members. Our program has helped us challenge our thinking and consider new ways to put the member at the centre of everything we do. * The names of members have been changed to protect their privacy.

OCTOBER 2017

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One direction A week-long intensive course at Harvard BUSINESS SCHOOL highlighted the competitive advantages that come with stakeholder alignment.

BY DAVID ASPLIN

David Asplin is the managing director of global business development at QIC, the Queensland Government’s $80 billion funds-management business.

OUR INDUSTRY IS a people business. Simply put, both investment managers and institutional investors have three core stakeholders they need to manage: their clients, their shareholders and their staff. If you can align clients’ objectives with those of your shareholders and staff, you have pulled off the trifecta. During a recent string of client meetings, I was struck by how quickly conversations kept turning from investment ideas to common challenges with managing talent development initiatives and culture. Many of our super fund clients are growing rapidly and with this comes pressure to attract and retain talent. While some organisations are diligent at crafting key performance indicators and mission statements, they can fall short by using these as standalone administrative tools, rather than as part of a wider cultural framework. However, it has been interesting in recent years to see many super funds taking a more sophisticated approach to how they attract,

OCTOBER 2017

If an investment of time or resources in a product differentiator does not affect a client’s willingness to pay, don’t do it retain, manage and incentivise their people. For staff to deliver consistent investment outcomes, they need to step up to their personal best continually and always seek to improve. This takes commitment from both individuals and the organisation.

STICK TO WHAT WORKS

In the last few years, QIC has invested in our staff through career development initiatives, including a tailored leadership excellence program through which I was recently given the opportunity to attend a Harvard Business School course on building and sustaining competitive advantage. The week-long course included 91 attendees from various industries around the world and it was a wonderful opportunity to hear diverse global views. One of the key messages from the course was that fund managers and super funds need to focus on the competitive differentiators that matter most to their customers to build and sustain competitive

advantage. A product offering must have a sustainable competitive advantage in each market to compete successfully. This is a good reminder of something that is easy to say and difficult to do: If an organisation can enhance the client’s willingness to pay by focusing on the differentiators that matter the most to clients, then sustained value is more likely. Commoditised offerings with low competitive differentiation become price takers as the client’s willingness to pay decreases. In a nutshell, if an investment of time or resources in a product differentiator does not affect a client’s willingness to pay, don’t do it. We often focus on how to differentiate product, which can be easier than generating less tangible differentiators, such as within the people and culture. It is interesting to consider the impact ownership structures inherently have on culture. In my experience, fund manager, who are owned by their clients, have a distinct cultural advantage over managers with impatient, listed owners. The ability to operate in line with clients’ longer-term objectives, without excessive shareholder-driven pressure, is a huge benefit we have at QIC and creates a different culture. It’s also a key reason we have seen such strong growth from profit-for-member superannuation funds.

SHARE FOR SUCCESS

Strong culture starts with clarity around what your organisation stands for. Every fund manager will say their fund is a clientcentric organisation but the ownership structure may show something different. In the example of QIC, our shareholder, the Queensland Government, is also our biggest client. This means, like the government, we are more concerned with long-term investment outcomes than short-term wins. Increasingly, our clients face people challenges and opportunities like our own. We operate with transparency, sharing both our learnings and failings. QIC’s executive director of human resources, Glenn Jackson, has shared information with several of our super fund clients about how we use a range of talentmanagement tools, such as staff engagement surveys and balanced scorecard assessments, that clients are considering implementing within their own organisations. We’re in this together and their success will become ours. We all strive for differentiation and cut through. Alignment of people, product and culture is key.

investmentmagazine.com.au

FEAL & Pimco Institute Scholarship 2018 FEAL is currently inviting applications for the FEAL & PIMCO Institute Scholarship. The scholarship opportunity is designed to help fund executives enhance their skills and knowledge, inspire new ideas, deliver keen insight and support their on-going professional development. Made possible with the support of PIMCO, this scholarship provides a unique opportunity for participants to attend the exclusive PIMCO Institute, learn from leading academics and network with colleagues from around the globe. The three-day seminar emphasises content consistent with advanced academic study and incorporates a dynamic, team-based portfolio simulation exercise.

3 - DAY S E M I N A R 12 - 14 June 2018 Newport Beach, California

Applications close at 5pm (AEDST) Friday, 3 November 2017 TO PI C S I N C LU D E:

> Portfolio Management Simulation Exercise > Outlook for Global Financial Policy and Capital Markets > Credit Markets and Capital Structure > Evolution of Derivative Instruments > Equity Portfolio Construction

S U P PORT E D BY

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Critical Issues in Asset Allocation Emerging Markets: Issues and Opportunities Understanding Factor-Based Risk Metrics Managing Inflation Exposure Role of Alternatives and Absolute Return Investing State of the Housing Market

For more information contact FEAL on (02) 9299 6648 or visit:

www.feal.asn.au

\ MACROECONOMICS

CENTRAL BANKERS OF the world made the right call when they responded to a great market crisis with record-low interest rates and unprecedented levels of artificial liquidity a decade ago; however, today those tools have lost most of their power. Structural reforms must take over where central bank meddling left off, and some of US President Donald Trump’s plans to reduce the tax and regulatory burden on business could help. That is the view of University of Chicago Booth School of Business professor Randy Kroszner, who served as a member of the Board of Governors of the US Federal Reserve from March 2006 to January 2009 and was chair of the central bank’s Committee on Supervisory and Regulatory Affairs during the global financial crisis (GFC). At its September policy meeting, the Fed voted to start reducing its $US4.5 trillion ($5.65 trillion) balance sheet from October, while holding rates in the range of 1 per cent to 1.25 per cent. Kroszner said the decision made good sense. “This ‘great unwind’ of quantitative easing so far has not caused any great tumult in markets,” he said. “This should help the European Central Bank start to move to end its asset purchase program and central banks around the world to gradually normalise their balance sheets.” Kroszner says he has no doubt the swift actions the Fed took in 2007 and 2008, and the co-ordinated response from global central banks that followed, were effective in averting deflation or another great depression. “Part of the reason for the central bank making asset purchases was to avoid the negative impacts that occurred in the early 1930s,” Kroszner says. “In hindsight, these measures did give people greater incentive to take on more risk.” But he cautions that with the Fed and the European Central Bank now focused on winding down their balance sheets, it is important to remember that artifical liquidity measures “aren’t the only game in town” for driving economic growth. Kroszner is worried that too many nations remain slow to tackle structural reforms needed to allow for more competitive markets. He argues that while easing monetary policy was necessary

OCTOBER 2017

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MACROECONOMICS \

RETURN TO FUNDAMENTALS

to avoid deflation, central bankers’ time in the sun is now over and policymakers must step in with fiscal reforms to promote innovation and investment, and revive economic growth. Kroszner spoke to Investment Magazine ahead of a planned visit to Australia to deliver a keynote address on the topic of ‘Trumponomics’ to the 2017 CFA Australia Conference, to be held in Melbourne on November 1.

ANOTHER DECADE TILL NORMAL

After 10 years of loose monetary policy, low rates now provide less stimulus and more side-effects. Kroszner says “the jury is still out” on the question of whether quantitative easing has inflated an asset bubble in US real estate and equities that will end in tears. Nevertheless, he warns it is now time to try a different approach to stimulus. “The concept of using fiscal policy to fine-tune the economy went out of style around the time when economists were trying to work out why real interest rates were unusually high, so perhaps it is time to dust that idea down,” Kroszner says. Despite some healthy job gains, which should be accelerating wages growth and, in turn, forcing companies to raise prices to maintain profits, inflation in the US has been running lower than expected this year. Given that inflation expectations can take a long time to adjust fully to a new target, Kroszner says US Federal Reserve chair Janet Yellen’s “cautious optimism” the bank is on track to its 2 per cent inflation goal seems justified. He tips it will take about another decade to see US monetary policy back within a “normal” realm. With the US having been the first to raise rates, Kroszner expects it will also be the first major economy to return its balance sheet close to normal levels – within three to four years – with other countries, notably China, likely to take much longer.

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Instead of fixating on what the central banks will be doing, Kroszner urges chief investment officers and their portfolio managers to think about which other long-run economic fundamentals – such as efficiency-enhancing structural reforms – are going to influence markets positively in the future. It is still early days, but Kroszner’s encouraged by structural reforms that have started to revive growth in southern European countries like Spain, and expects Italy, which has been a laggard on reform, to follow suit eventually. What happens in China will be key. Structural reforms he expects to help restore growth to the US include the harmonisation of occupational licensing between state jurisdictions. He also expects the removal of disproportionate regulatory and compliance burdens, to make it easier for workers to move into areas where there’s higher demand, while allowing new market entrants to compete. In the US, Trumponomics has so far failed to deliver its promised regulatory reforms and lower tax rates, but Kroszner believes this structural reform agenda remains a clear priority for the US Congress. Despite Trump not being able to roll out his pro-business agenda as quickly as promised, his presidency has boosted market optimism, Kroszner says. “Some

cabinet secretaries within the Trump administration have managed to make [small] regulatory changes, and this has signaled to the market that things are at least moving in the right direction.”

SHOWING NO FEAR

Overall, Kroszner believes the world economy is better placed today to handle future shocks than it was before the GFC. This is in large part a credit to better corporate risk management and the improved liquidity of major banks, he says. “This clearly depends on the nature of future shocks but, generally speaking, we’re better placed to handle them going forward.” What does worry Kroszner is eerily low volatility levels, as evidenced by the CBOE Volatility Index (VIX) – aka the ‘Fear Index’. In late September, despite rising geopolitical risk amid North Korea’s aggressive posturing, this measure was sitting at about 10, way off its intra-day high of 89.53 in October 2008. It concerns Kroszner that geo-political and other political risks appear to be of so little concern to the market. “Admittedly, we’ve seen reasonably good growth throughout the world, so the Fear Index should not be as elevated as it was back then,” he says. “But synchronised global growth since the GFC may have given the [false] impression that future shocks can easily be absorbed.”

FORMER FED MEMBER sees CENTRAL BANKS’

INFLUENCE

fading By Mark Story

One-time United States Federal Reserve board member RANDY KROSZNER has no regrets about the decision to slash rates and implement quantitative easing during the global financial crisis, but he warns the era of all-powerful central banks is over. OCTOBER 2017

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THE TRUSTEE GOVERNANCE debate is heating up again in Canberra, with the Senate set to decide on legislation that could radically change the structure of profit-to-member super fund boards. Members of the Senate Economics Committee have until October 23, 2017, to report on whether they support the government’s second attempt to mandate that profit-to-member funds discard their equal representation governance model and appoint independent directors to make up one-third of their boards. The debate about the board composition of profit-to-member funds has been on and off the boil since the early 2000s, fueled by ideology rather than any hard evidence of the need for change. These funds have outperformed the retail super sector in the lead up to the global financial crisis, during the downturn and in recent years. No super fund has needed to be bailed out and there have been no bank-like scandals. The government’s intervention in profit-tomember fund board composition is entirely unwarranted. The Australian Institute of Superannuation Trustees’ (AIST) policy on the appointment

Most importantly, it aligns the decision-making of the fund’s board with the needs of its members. Unlike retail fund directors, who BY have parent shareholder interests EVA SCHEERLINCK to consider along with those of their members, the directors of profitEva Scheerlinck is chief executive to-member funds have only their of the Australian Institute of members’ interests to consider.

Superannuation Trustees.

WHEN MEMBERS COME SECOND

Independents bill still a bad idea The Australian Institute of Superannuation Trustees is ready to fight another round in the BATTLE TO PROTECT ITS MEMBERS’ equal representation governance model. of trustee directors has been well-documented. AIST supports all profit-to-member boards (including the boards of industry funds) having the flexibility to appoint up to onethird non-representative directors, while maintaining an equal representation of member and employer directors.

CORNERSTONE OF ACCOUNTABILIT Y

The government’s push to abolish the legislative basis for equal representation is concerning. This model of governance has been the cornerstone of member representation and accountability in the

OCTOBER 2017

superannuation industry for decades. Far from being peculiar to Australian super funds, the representative trustee system is prevalent in many overseas occupational pension funds and is recognised as providing an important mechanism for accountability to members. Many of the top pension fund systems in the world, as measured by the highly respected Melbourne Mercer Global Pension Index, feature an equal representation system of governance. Ensuring there are representatives for both workers and employers on super fund boards maintains a balance in decision-making and a true understanding of the membership base.

It would appear that the consideration of shareholder interests ahead of member interests was behind the poor treatment of existing default members by some retail funds following the introduction of MySuper legislation in 2013. While most profit-to-member funds were quick to transfer existing default members across to new MySuper products, the retail sector dragged its feet. Taking full advantage of the three-year transition period that ended on July 1, 2017, many thousands of existing retail customers were kept in high-fee legacy default products right up until the 11th hour. Rainmaker has estimated this transition delay cost retail fund members about $800 million from 2014 to 2017. That’s a whopping $800 million less in super savings for those members and $800 million extra to the bottom line of retail funds and their parent-company shareholders. One can only guess at how the trustee directors of the retail funds involved – among them many independent directors – justified this costly penalty as something in their members’ best interests. It is certainly unlikely that a profit-to-member board with direct member and employer representation would ever allow this to happen. Profit-to-member funds were jointly created by unions and employers to serve working Australians, and they have been run successfully for more than 20 years. They have invested for the long term, insulated the Australian economy and invested heavily in Australia’s infrastructure. Interfering with how super fund owners run their fund, by mandating how their boards are structured, is not something the government does to listed companies nor to any other prudentially regulated financial institutions. It runs counter to international best practice and, most worryingly, it could have a material impact on members’ retirement.

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KEEP YOUR FINGER ON THE SUPER PULSE Download the new AIST Super News app to get the latest industry news from trade and mainstream press in one easy to access place. The more stories you read, the better our app is able to understand your interests and provide you with articles that are most relevant to you.

DOWNLOAD THE NEW AIST SUPER NEWS APP ONTO YOUR MOBILE DEVICE TODAY!

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The way forward for MyRetirement THREE WAYS the government could strengthen its planned CIPR FRAMEWORK: allowing customisation, setting an implementation deadline for funds, and supporting governance. THE DUST IS starting to settle on the government’s discussion paper for Comprehensive Income Products for BY Retirement (CIPRs), with Treasury JEREMY COOPER now scrutinising submissions. It wouldn’t surprise many people to hear that Challenger* supported the Jeremy Cooper is the chairman for government’s initiative to provide retirees retirement income at Challenger. He was with a higher standard of living and more the author of the government’s 2010 security. Super System Review. What might be more interesting to readers is where we made suggestions about how CIPRs could work more effectively. To start with, we support Treasury’s suggestion to rebadge the CIPR framework MyRetirement – a far better name that hints at the complementary role to MySuper. So, what were the areas where Challenger took a different view? The broad idea of a single mass-customised MyRetirement offering with no advice, subject to disclosure and fitness-for-purpose tests, is something we support. However, some funds will want to do more and will be able to segment their membership by assets, age pension entitlements and other factors. Those funds will want to design a MyRetirement offering for each of those segments, while still offering only one solution to each retiree. Trustees should, therefore, be able to have multiple versions of their MyRetirement products. It is also important for MyRetirement to be offered across a range of platforms and distribution channels, rather than designed to meet only one segment.

One way to take this forward would be to codify an obligation for trustees to consider retirement-income factors OCTOBER 2017

DEADLINE NECESSARY

After a proposed three-year transition, a firm date should be set for trustees to be required to offer a MyRetirement product to retiring members. Under the MyRetirement proposal, the framework is to be based on choice, rather than a default. As a result, retirees will have the option to select a MyRetirement product, stay with an account-based pension or withdraw a lump sum (or a combination of all three). The point of making the offer of a MyRetirement product compulsory is to harmonise the retirement experiences of the large number of Australians at whom it will be directed. It would be an odd result if two neighbours, each of whom had been in MySuper for the last few decades of their working lives, got completely different outcomes in retirement simply because fund A chose to offer MyRetirement and fund B did not.

GOVERNANCE MATTERS

Governance is another issue that, while not canvassed in Treasury’s discussion paper, we noted was also worthy of the government’s consideration. The debate on MyRetirement has so far been fixated on the product side of the equation. While this is a key part of better member outcomes, there perhaps needs to be an equal focus on the governance side. In other words, what will be asked of trustee directors when it comes to retirement income? Trustee covenants are specific when it comes to accumulation investment strategy, insurance and risk management, but silent when it comes to retirement income. Yet there seems to be good industry support for requiring trustees to devise a separate investment strategy or framework for retired members. One way to take this forward would be to codify an obligation for trustees to consider retirement-income factors, including regard for longevity and inflation risk, in the Superannuation Industry (Supervision) Act. The trustee covenants could be amended to guide trustees through the formulation of a strategy for retired members, much in the way the insurance covenants now operate. This could provide an additional lens through which these important reforms could be debated prior to implementation. * Challenger is an ASX-listed financial services firm and Australia’s largest supplier of annuities, which are tipped to form an important component of many MyRetirement solutions.

investmentmagazine.com.au

The

9th Annual

SYMPOSIUM

Fiduciary Investors

Symposium

November 13-15, 2017

RACV, Healesville, VIC Radical uncertainty: unknown consequences lurking in the shadows 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. Hear from three CIOs on their investment outlook and asset allocation and operational challenges in our opening panel.

OPENING PANEL

STEWART BRENTNALL Chief investment officer, TCorp

GRAEME RUSSELL Chief investment officer, Media Super

DANIEL FARMER Chief investment officer, IOOF

\ REGUL ATION

FULL DI S CLO SU R E The superannuation industry’s two most SENIOR REGULATORS are rock solid in their conviction that MORE STRINGENT RULES for reporting of fees, costs and performance will lead to a stronger industry. By Sally Rose

SUPERANNUATION FUNDS AND investment managers have awakened to the dawn of a new era of transparency when it comes to their obligations to disclose fees and costs – and the transition has not been easy. From October 1, 2017, most super funds will have to comply with the Australian Securities and Investments Commission’s (ASIC) new Regulatory Guide 97 (RG 97). The updated guidance ushers in more onerous rules for how super funds must disclose both direct and indirect fees and costs in their product disclosure statements (PDS) and the periodic statements they provide members. The final deadline for compliance expired on September 30, 2017, after being pushed out three times. There remain a few particularly problematic areas where ASIC is still prepared to grant an exception, however, such as the new rules for reporting building and facility management costs related to property assets. More controversially, industry players are divided over whether the RG 97 regime lets providers who distribute their products via retail platforms off the hook. The struggle to implement RG 97, and its relative merits, were topics of much discussion at the Australian Institute of Superannuation Trustees’ (AIST) annual Superannuation Investment Conference (ASI 2017), held on the Gold Coast, September 6-8. “While we still have issues with key aspects of RG 97 and will continue to advocate for improvement, it has been pleasing to see ASIC address some of our concerns and defer some of the more contentious requirements,” AIST chief executive Eva Scheerlinck said in her opening address.

OCTOBER 2017

RG 97 DEADLINE

ASIC senior executive leader, investment managers and superannuation, Ged Fitzpatrick told the gathering that the corporate regulator was aware of the difficulties many funds have had preparing for the introduction of RG 97, but would be monitoring compliance from October 1. Analysis of RG 97-compliance information ASIC has already received has shown an increase in the average amount of the fees and costs disclosed across the industry, Fitzpatrick said. Some funds have shown a minimal increase, while others have had a rise of about 100 basis points in the costs they report. “The average increase across MySuper products was 23 basis points, equating to about $115 a year in additional reported costs,” Fitzpatrick said. Members of these default super funds will see this increase in reported fees and costs on their next statement, even though they will not be paying any extra. This poses a challenge for the funds’ marketing and communication teams.

PLATFORMS IN PLAY

Groups such as AIST have been critical of RG 97 for providing an exemption for platform accounts, which often have thousands of investment products for individuals to choose from. Platforms are typically operated by the banks and other retail providers, such as AMP Ltd. Fitzpatrick sought to hose down fears that the new fee and cost disclosure rules would fail to provide people who invest their super via a retail platform with the same level of transparency as other super fund members.

“Contrary to some statements that have appeared in the media, there are no carve-outs for fee disclosures on platforms,” Fitzpatrick said. “To ensure that retail investors are not misled, [product disclosure statements on platforms] will need prominent statements, following our example, on annual fees and costs. The PDS will need to show what the fees and costs are related to the platform, as well as the investments on the list and that the additional fees and costs will be charged by the issuers of these products.” He said ASIC would like platform providers to show consumers a typical example of the combined effect of the fees for the investments themselves and the costs from the platform. “An example should be given in terms of its fees and costs and investment strategy for a major portion of the investments selected by the investor rather than the platform,” Fitzpatrick said. “We encourage platform providers to provide similar information with the cumulative effect of fees and costs for each investment in the list, taking into account the fees and costs of the platform and the fees and costs of the investments selected. This information should be based on what is known, ought to be known, and can be reasonably estimated. Marketing activities will need to ensure there are no unreasonable comparisons.” Many of the representatives from non-profit funds in the audience remained sceptical about how this would work. It would require a high level of engagement from consumers to read and understand the PDSs of all of the underlying investments they hold via a platform. But Fitzpatrick was emphatic that ASIC would seek to ensure that RG 97 was implemented across all players in the industry.

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REGUL ATION \

Left HELEN ROWELL Deputy chair, APRA GED FITZPATRICK Senior executive leader, investment managers and superannuation, ASIC

Below EVA SCHEERLINCK Chief executive, AIST

“I would emphasise that we are seeking to provide, via RG 97 and other reforms, a level playing field among all forms of investment,” he said. He also offered assurances that the regulator would not become obsessed with monitoring costs to the exclusion of considering net returns.

PERFORMANCE MATTERS

“We are very aware that fees and costs are not the only factors that funds should be considering in terms of what they are delivering to their members,” he said. “Asset allocation, investment risk and strategy are clearly also very important, as are elements of services. One area we are very interested in is that the focus should move to looking at net returns, and that if you have consistency and accuracy in terms of fee disclosure, then the focus can shift to net returns.” He said ASIC would be turning its attention to how to improve reporting of investment performance and he encouraged interested parties to get in touch.

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Australian Prudential Regulation Authority (APRA) deputy chair Helen Rowell also addressed the crowd, regarding the prudential regulator’s plans to ramp up its monitoring of super fund performance reporting over the coming months. “For the year ahead, APRA will be focused on strategic planning and member objectives,” she said. “Looking at business planning, how funds are delivering value for money for members and how they are going to be sustainable into the future.” Rowell noted that APRA would afford different weighting to different criteria in its assessment of a fund’s performance, to ensure there was not an unhealthy focus on costs. “Keeping fees low is a good objective, but it is not the be all and end all,” she said. “In fact, sometimes, having slightly higher costs that can provide the right investment performance and services for members is desirable.” She said APRA would be looking for evidence that funds had investment strategies in place that were well-suited to the needs of their membership, and warned against trying to compare the pricing of high-risk strategies with more conservative options. All trustees need to be thinking about how demographic and employment trends are affecting their fund in particular, and what that might mean for their investment strategy and other aspects of their operations, Rowell said. She warned trustees of funds with negative

cashflows to be mindful of the implications for their investment strategy and liquidity needs, and also to consider how this would inhibit their ability to invest in systems and technology. Funds with ageing member profiles must reconsider their strategic asset allocation as they move into negative cash flow, Rowell said.

PRICE OF REFORM

Both Rowell and Fitzpatrick acknowledged funds are dealing with a large volume of regulatory change, but said it was all designed to foster a stronger industry. A number of conference delegates complained the regulators did not seem to have considered how the expense of implementing more stringent fee and cost disclosures might, itself, contribute to higher costs. Both regulators said they were aware of this potential conundrum, and encouraged funds to provide more detailed feedback on their compliance burdens. “The challenge we often face is getting good cost information from industry,” Rowell said. “We do ask in our consultation papers, and maybe people ignore it because it is a standard section, but we very rarely get any meaningful information and that means it is really hard for us to do a rigorous cost/benefit analysis.” Fitzpatrick said ASIC would also welcome more detailed feedback on the cost of regulatory compliance.

OCTOBER 2017

\ COLUMN

WE HAVE ALL heard the exhortations about the power of positive thinking: the glass is always half full; no negative thoughts allowed; train your mind to see the good in every situation; and my personal favourite, when you change the way you look at things, the things you look at change. Well, no matter how hard I looked at them, the concrete walls and steel bars of my cell in Cairo’s Torah Prison were still just walls and bars, and I struggled to ‘see the good’ in the list of terrorism charges that my interrogator had just read out. Solitary confinement in an Egyptian prison is a solid place to test the utility of positive thinking, and after two weeks in the cells, I was beginning to discover that it doesn’t always work as well as its exponents claim. In recent decades, a whole industry has developed around the power of positive thinking, along with rows of bookshelves groaning with titles like You Can if You Think You Can, and Think and Grow Rich. Those books have their place, but they can look a little hollow when they bump up against the brutally harsh realities that life just happens to lob in our faces from time to time. One of the features of Western thinking – and an assumption that underpins the ideas behind positive thinking – is the cult of agency. This is the notion that we are in complete control of our lives, and we have the power to do whatever we want as long as we work hard enough. Winston Churchill encapsulated it nicely when he said, “A positive thinker sees the invisible, feels the intangible and achieves the impossible.” Implicit in Churchill’s quote is the idea that his own remarkable success was because of his capacity to see the bright side of things. This idea neatly brushes aside the accident of his birth. Undoubtedly, Churchill had an

Recognise the role that chance plays in both success and failure, and understand the limits of our own power to control things extraordinary mind, but the former British prime minister was also born in the incredibly opulent Blenheim Palace as the son of Lord Randolph Churchill, himself a former chancellor of the exchequer, and a member of the aristocratic Spencer family. If anyone ever had a silver spoon in his mouth from the get-go, it was Winston Churchill.

BY PETER GRESTE

Peter Greste is an internationally acclaimed Australian-born journalist who spent 400 days in an Egyptian prison on false terrorism charges. He is an advocate for press freedom.

Positive thinking has its limits Realising when no amount of looking on THE BRIGHT SIDE will make things better can be EMPOWERING in its own right.

OCTOBER 2017

A danger with much of the literature about positive thinking is that it implies it is our own fault if we have not achieved the impossible – and let’s face it, generally most of us haven’t. It often suggests we have not been positive enough, and that if only we could squeeze a little more cheeriness out of our souls, all would be perfect. This denies the fact that if things are lousy, it might just be because the economy has gone south, or a few of our cells have gone rogue and given us cancer, or a storm has just wiped out our crops. The Buddhist nun and writer Pema Chodron offers an alternative idea. She says we should toss out all the blithe affirmations stuck on our fridges and replace them with just one: abandon hope. Chodron is not arguing that we simply give up and dump our ambitions. Rather, she is advocating for a clear-eyed look at what is really going on in our lives, without living for some non-existent future that we might hope for but never attain. She is suggesting we recognise the role that chance plays in both success and failure, and understand the limits of our own power to control things. For me in prison, that was an unexpectedly and profoundly comforting notion. My colleagues and I were not responsible for being stuck in the cells, and thinking our way out was a fool’s errand. Instead of denying the walls, we turned them into canvases, plastered them with the strips of foil that our food often came wrapped in, and created big, glistening murals. If we were going to be stuck there for a while, we thought, we might as well accept it and make life a little less bleak. Peter Greste was a guest speaker at the Conexus Financial Group Insurance Summit 2017, held in Sydney on August 29, where he shared his perspectives on the topic of resilience and mental health.

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