Investment Magazine July 2017

INTELLIGENCE FOR INSTITUTIONAL INVESTORS

ISSUE 140

JULY 2017

Getting

DEALS DONE

Fresh from wrapping up another merger, Tasplan chair NAOMI EDWARDS speaks candidly about what

goes on in the boardroom

SCOTT TULLY THE HEAD OF INVESTMENTS AT COLONIAL FIRST STATE BELIEVES IN HELPING CLIENTS TAKE AGE-APPROPRIATE RISKS ROUNDTABLE LEADERS FROM THE SUPER, GROUP INSURANCE AND MENTAL HEALTH SECTORS AGREE THEY CAN LEARN FROM ONE ANOTHER SATYAJIT DAS 10 YEARS ON FROM THE GFC, THE FORMER BANKER AND CORPORATE TREASURER SEES NEW DANGERS SOCIAL IMPACT BONDS A NEW ASSET CLASS IS EMERGING, WITH THE POTENTIAL TO ATTRACT BIG CAPITAL TO ADDRESS SOCIAL PROBLEMS

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CONTENTS JULY 2017

06 PROFILE

“For our younger members, value factors have been a good contributor of return; whereas if you’re an older member you probably don’t want to have a large exposure” – SCOTT TULLY – HEAD OF INVESTMENTS COLONIAL FIRST STATE

10

CHAIR’S SEAT Tasplan’s Naomi Edwards used to think the chair was the boss of the board. Now she calls on her mentors for lessons in humility.

14

INFOCUS A recent survey of 194 global institutional asset owners showed demand for smart beta ETFs is on the rise. ESG investing could drive the next wave.

16

ROUNDTABLE Fourteen industry leaders from superannuation, group insurance and mental health met to discuss the potential for collaboration across sectors.

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20

INFOCUS In a challenging era for fixed income investors, more asset owners and managers are finding benefits in taking an absolute returns approach.

22

BROKEN MODEL Satyajit Das warns that 10 years on from the global financial crisis the post-war economic model is broken and the “whole world is a carry trade”.

26

MYRETIREMENT The Murray Inquiry recommended mandating that super funds offer CIPRs. Can the optional framework that government and industry favour succeed?

30

CHOICE OVERLOAD AIST boss Eva Scheerlinck believes too much choice in the superannuation sector is leaving consumers with decision paralysis.

32

SOCIAL IMPACT BONDS Global and local experiments are demonstrating the potential of these innovative finance structures. Now to get the big end of town more involved.

34

STRONGER SUPER Funds now have until 2019 to comply with new product dashboard and portfolio disclosure rules. Darryll Rogers warns that is no reason to dally.

J U L Y 201 7

04

\ FROM THE EDITOR

EDITORIAL EDITOR

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

Sally Rose MANAGING EDITOR

Keith Barrett DIRECTOR OF INSTITUTIONAL CONTENT

Amanda White

A LETTER from the editor

A

TOUGH CHOICES IN A PERILOUS MARKET

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

CHALLENGING MARKET environment presents chief investment officers with a major dilemma: either ramp up the level of risk they are prepared to take on in their portfolios or revise down their fund’s advertised return targets.

Most CIOs are reluctant to do much of either and are instead trying to beat a third path to success, via alternative sources of returns.

Traditional fixed income, cash and currency markets are not delivering the way they used to. Meanwhile, major equity-market valuations mostly look pretty full.

This has all led to an increased appetite for private credit, emergingmarket stocks and bonds, and unlisted asset classes such as global infrastructure, real-estate trusts, hedge funds, and private equity.

But as always happens when everyone has the same idea, those markets are getting crowded, too. There is a real danger that, unless superannuation funds take the plunge and lower their targets, the temptation for their managers to take unacceptable risks will prove too great.

That’s worth pondering as we mark the 10th anniversary of the start of the sub-prime mortgage crisis in the US, which precipitated the global financial crisis.

A decade on – and a colossal amount of bailout money and central bank stimulus later – a growing band of respected economists warn global markets are nursing an unsustainable “debt hangover” propping up asset bubbles that must inevitably pop, or

JULY 2017

at the very least deflate.

Former banker and corporate treasurer, turned consultant and author, Satyajit Das, goes as far as to warn that “the whole world has become one big carry trade” (see page 22).

July 2017 marks another, more positive, anniversary – it’s 25 years since the introduction of Australia’s compulsory retirement savings system. During that time, a cottage industry has grown into a $2.2 trillion behemoth, worth more than annual gross domestic product or the total market capitalisation of the local stock exchange.

The mandated inflows aren’t all that have driven that growth. A period of unprecedented domestic economic growth and falling global interest rates has supported a purple patch for investment returns.

SuperRatings data shows that in mid-June, Australia’s top-performing super funds were on track for another year of double-digit returns. But the warning that “historical performance may not be indicative of future returns” may prove more prescient than ever.

Beyond the short-term risks, today’s long-term outlook for interest rates – and thereby yields on major asset classes – could hardly be more different than it was when the superannuation guarantee was legislated in 1992.

Going forward, if local super funds want to stand any chance of meeting typical balanced fund return targets of CPI + 3 to 4 per cent, they are probably going to have to seek out more offshore assets and unlisted opportunities.

Happy bargain hunting.

CHIEF EXECUTIVE

Colin Tate

ADVERTISING BUSINESS DEVELOPMENT MANAGER

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karlee.samuels@conexusfinancial.com.au (02) 9227 5721, 0420 561 947 BUSINESS DEVELOPMENT MANAGER

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06

\ CIO PROFILE

FINE -tuned

default by

COLONIAL FIRST STATE has just completed the huge task of sorting its MySuper members into its12 FIRSTCHOICE LIFESTAGE PRODUCTS. Now head of investments SCOTT TULLY is focused on getting the RISK PROFILE RIGHT, for each age cohort.

By Sally Rose Photos Matt Fatches

COLONIAL FIRST STATE head of investments Scott Tully is a proponent of guiding disengaged default superannuation members into products with a risk profile appropriate to their stage in life. That belief informed the design of CFS’s MySuper product and is set to influence its approach to the incoming MyRetirement regime.

The 2011 Stronger Super reforms, which ushered in the MySuper licensing regime for default superannuation funds, gave providers the choice of either setting up a single balanced fund for all of their members or implementing a lifecycle fund model.

CFS was among the minority of providers that opted to offer a lifecycle-style MySuper product, which it called FirstChoice Lifestage.

This meant implementing 12 separate funds (segregated by age cohort), rather than a single fund for all default members.

Properly identifying and transferring existing members into the right product was a mammoth administrative task, which CFS finally completed in June 2017, just shy of the July 1, 2017, deadline.

Tully, a big believer in the importance of structuring more tailored default products

JULY 2017

for these “typically disengaged” default members, is confident it was worth the extra effort.

“In the short term, it would have been much easier to just stick everything in a balanced fund; but long term, we think it is much better for members to have this differentiation.”

He is “fairly confident” the lifecycle approach has already proven its worth.

Since inception, the FirstChoice Lifestage portfolios have consistently beaten their targets.

CFS is a division of the Commonwealth Bank of Australia’s wealth-management arm. It sources roughly one third of its asset-management services from related party Colonial First State Global Asset Management, but operates separately.

Tully’s 17-person internal team is responsible for the management of the FirstChoice multimanager, multi-index and Lifestage portfolios, as well as Commonwealth Bank Essential Super (a public offer Lifestage product marketed to employers looking for a default fund for their staff.)

S C OT T T U L LY COLONIAL FIRST STATE HEAD OF INVESTMENTS

Since January 2015

PREVIOUS ROLES January 2010 – December 2014 Colonial First State, head of investment services FirstChoice Investments, head March 2002 – December 2009 FirstChoice Investments, head April 2001 – March 2002 Commonwealth Investment Management, portfolio manager July 2000 – March 2001 Commonwealth Bank of Australia, VP institutional banking January 1995 – June 2000 Colonial State Bank, analyst/manager August 1992 – December 1994 State Bank of NSW, actuarial analyst January 1989 – August 1992 Mercer, actuarial analyst

investmentmagazine.com.au

CIO PROFILE \

It would have been much easier to just stick everything in a balanced fund; but long term, we think it is much better for members to have this differentiation

Overall, CFS has $40.2 billion in funds under management. The bulk of that, roughly $30 billion, is across products offered through the retail platform business.

Clients in the multimanager and multi-index platform products are typically over 50 and have seen a financial adviser, while clients in the default MySuper options – First Choice Lifestage and Commonwealth Bank Essential Super – tend to be younger and not advised.

FACTOR INVESTING

While the investment operations staff at CFS have been focused on finalising

investmentmagazine.com.au

MySuper compliance, the investment management team have been spending much time researching new factor-based investment strategies.

Since FirstChoice Lifestage portfolios were created in 2013, the entire equities component has been deployed according to factor-based strategies. Tully describes the philosophy behind his approach to factor-based investing as, “the idea that you can get active returns by decomposing a particular sector into different drivers of return”.

Originally, the entire equities portfolio was managed with a value factor strategy run by

CBA-owned quantitative manager Realindex Investments. Over the last 18 months, changes have been made to start diversifying the equities factor exposures.

“The very strong value skew in Lifestage was a bit of a negative at the end of 2015, but into 2016 it was a very strong addition to our return,” Tully says. “So, what we have done is reduced some of that value skew and brought in managers with a low-volatility approach.”

Tully says the degree to which the skew to value has been reduced varies across the different age cohorts.

JULY 201 7

07

08

\ CIO PROFILE

COLONI AL FIR ST STATE

One of the big questions is, ‘Where do interest rates go from here?’ … But we are not trying to make that call

KEY PEOPLE: Chair: Anne Ward Executive general manager: Linda Elkins General manager products and investments: Peter Chun Head of investments: Scott Tully NUMBER OF INVESTMENT STAFF: 17

“For our younger members, value has been a good contributor of return; whereas if you’re an older member, you probably don’t want to have a large exposure to value because it does tend to take a little while for that factor to play through.”

Tully and his team are now turning their attention to determining what other factors should be introduced to the FirstChoice Lifestage portfolios – such as momentum or small caps. They are also reviewing a number of multifactor strategies. Once these strategic decisions have been made, Tully won’t be sitting on his hands too long trying to time the entry point.

“If you think it is something that should be done in a portfolio, then you can finesse the timing a little bit but, primarily, you are looking to make that allocation, because we are investing long term.”

TOUGH OUTLOOK

Tully got his start in the investment management industry in 1995 as an analyst and manager at Colonial State Bank, before it was bought out by CBA. Prior to that, he spent five years working as an actuarial analyst, having begun his career with Mercer.

Back in 1989, when he joined the industry, the official Reserve Bank cash rate peaked at 18 per cent. The outlook for rate moves over the next 25 to 30 years is entirely different, from a starting point of 1.5 per cent.

An obvious implication is that superannuation managers, including CFS, will struggle to deliver returns in line with historical averages.

“One of the big questions is, ‘Where do interest rates go from here?’… But we are not trying to make that call,” Tully says. “We have progressively taken money out of bonds over the last three to four years and allocated to less duration-sensitive assets. We still believe there is a space for bonds in a portfolio, we just don’t have as [many] as we did once upon a time.”

JULY 2017

Tully is also looking to allocate more capital in absolute-return strategies, across both equities and bonds. In recent years, CFS has allocated away from developed market shares and bonds into emerging markets and more alternative asset classes, such as global infrastructure and real-estate trusts. Tully expects this trend to continue and that these assets will be essential to generate the returns required to continue paying out large income streams to retirees.

MODERNISING PENSIONS

CFS is the second-largest payer of pensions in the country, behind only the federal government. In the last 12 months, the organisation has distributed $3 billion in private pensions to 165,000 retirees.

PORTFOLIOS MANAGED BY THE CFS INVESTMENT TEAM Portfolios

$ million

FirstChoice Multi manager multi sector

17,813

FirstChoice Multi-Index (multi sector)

6,150

FirstChoice Multi manager single sector FirstChoice Lifestage

6,088 7,537

Essential Super

2,573 40,161

TOTAL SOURCE: CFS

FIRSTCHOICE LIFESTAGE HISTORICAL PERFORMANCE – BALANCED (MYSUPER) OPTION

As at March 2017

FirstChoice Lifestage option

Investment objective

Minimum suggested timeframe

FirstChoice Lifestage 2000–04

CPI + 3% pa over rolling 7 year periods.

7 years

CPI + 2.5% pa over rolling 7-year periods.

6 years

FirstChoice Lifestage 1995–99 FirstChoice Lifestage 1990–94 FirstChoice Lifestage 1985–89 FirstChoice Lifestage 1980–84 FirstChoice Lifestage 1975–79 FirstChoice Lifestage 1970–74 FirstChoice Lifestage 1965–69 FirstChoice Lifestage 1960–64

CPI + 2% pa over rolling 6-year periods.

5 years

FirstChoice Lifestage 1955–59

CPI + 1% pa over rolling 3-year periods.

3 years

FirstChoice Lifestage 1950–54

CPI + 1% pa over rolling 3-year periods.

3 years

FirstChoice Lifestage 1945–49

CPI + 1% pa over rolling 3-year periods.

3 years

NOTE: Members who do not make an investment selection and who are born: • prior to 1945 will be invested in the FirstChoice Lifestage 1945–49 option.

• after 2004 will be invested in the FirstChoice Lifestage 2000–04 option.

• all investment objectives are after fees and taxes.

Colonial First State is a division of the Commonwealth Bank of Australia’s wealth-management arm.

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CIO PROFILE \

09

In principle, Tully supports the government’s effort to nudge super funds into offering a Comprehensive Income Product for Retirement (CIPR) as an alternative to a lump sum or account-based pension.

He thinks the new breed of retirement accounts, which the government has moved to re-badge as MyRetirement products, will help the bulk of Australians, who retire neither poor nor rich.

“For members with low balances, the age pension will always be the primary source of income, while at the other end of the spectrum, there are people who hit or come close to the $1.6 million transfer balance cap and talk to an adviser about how to structure their assets in a way that makes sense,” he says. “It is those people in the middle – who will have a reasonable sum accrued but have less access to the age pension, need some help and may not have an adviser – that the government is trying to help with CIPRs.” Tully sees “lots of work” to do on Treasury’s draft CIPR framework. “But I am confident that, with industry input, a solution will be found.”

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10

\ CHAIR’S SE AT

As smaller SUPER FUNDS across the country face mounting pressure to consolidate, TASPLAN chair NAOMI EDWARDS is uniquely placed to offer insights into how to pull off a merger.

Edited by Sally Rose Photos Peter Mathew

MASTER of

m e rge r s

JULY 2017

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CHAIR’S SE AT \

11

NAOMI EDWARDS has been the chair of $7.6 billion Hobartbased superannuation fund Tasplan since 2011. In that time, she has had oversight of the MERGER with Quadrant in December 2015 and the TRANSFER of the RBF Tasmanian Accumulation Scheme finalised in April 2017. In this Q&A with Investment Magazine, SHE SHARES HER TIPS for getting deals done and building a strong governance culture.

Q. WHAT IS YOUR ADVICE TO ANY TRUSTEES CURRENTLY ENGAGED IN MERGER DISCUSSIONS? A. Being clear about the business case is really important. As a first step in the RBF-Tasplan merger, the two funds commissioned a report into the likely impact of a merger on member fees and services. This showed a clear ability to reduce the fees paid by RBF accumulation members and Tasplan pension members. In addition, all members would benefit from reduced investment fees. Once the business case is established, all parties can see the benefits and issues like board seats become much less important. I have often heard boards use ‘different cultures’ as a reason not to merge, but I think this is overstated. A new and better culture can be formed out of the merged fund, taking the strengths from each fund.

No fund is ever wholly good or bad.

Q. WHAT WAS THE MOST CHALLENGING ASPECT OF COMPLETING THE DEAL WITH RBF? A. The RBF merger required passing an Act of Parliament through both houses in Tasmania. This meant negotiating not only with the two trustee groups but also with three political parties and independents in the upper and lower house. As it turned out, the legislation passed smoothly with tri-partisan support, but it was nerve-wracking not being in control of the timeframe. The other challenge was to keep the communication happening with the staff and other stakeholders. Staff were facing a very uncertain future, and even though there were very few redundancies, there was a lot of potential for stress. The more we communicated, the less stressed people became.

Q. ONLY A FEW YEARS AGO, TASPLAN EXCEEDED $2 BILLION IN FUNDS UNDER MANAGEMENT, NOW IT HAS MORE THAN $7.6 BILLION. AS YOU TRANSITION FROM BEING A SMALL TO A MEDIUMSIZED FUND, WHAT NEW ISSUES ARISE FOR THE BOARD AND INVESTMENT COMMITTEE? A. We recently held a strategic planning session, and the board and executive leadership group were very enthusiastically talking about the opportunities for more mergers. Perhaps we have become addicted to change, but I think we have seen the benefits that mergers can bring and are excited at the possibilities. Now that we have invested in bringing our administration and contact centre in house (using the Acurity system) we can generate great savings through future partnerships and mergers. Tasmania has many advantages as a shared services hub, thanks to our stable labour force and low rents, so we are not resting on our laurels.

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JULY 201 7

12

\ CHAIR’S SE AT

Q. WHAT PROCESSES DO YOU USE TO STRIKE THE RIGHT BALANCE BET WEEN KEEPING IN TOUCH WITH WHAT IS HAPPENING IN THE FUND AND NOT GETTING BOGGED DOWN IN THE DETAILS? A. Well-structured board papers should make it clear what the board is, and is not, being asked to form a view on. Keeping in touch with the vibe and culture of the fund means being close to the CEO but also forming some good relations with other staff.

Q. THE TASPLAN BOARD COMPRISES 40 PER CENT WOMEN DIRECTORS. DO YOU BELIEVE THIS CONTRIBUTES TO MORE ROBUST DEBATE AND DIVERSIT Y OF THINKING? A. The Tasplan board is blessed with some very strong women directors, including Roz Madsen, the president of Unions Tasmania, and Susan Parr, the chair of the Tasmanian Chamber of Commerce.

Their straight talk is a superb contribution to the board. But to me, diversity is also about mindset, life experience, age and socioeconomic background. The blending of the board from three funds (from public, private and local government sectors) has also helped ensure diversity.

Q. YOU HAVE LED THE TASPLAN BOARD FOR COMING UP ON SIX YEARS. DOES THE TASPLAN CHARTER HAVE TENURE LIMITS THAT DICTATE HOW MUCH LONGER YOU CAN STAY ON? IF SO, HOW DO THEY FIT WITH YOUR PERSONAL VIEWS ON APPROPRIATE TENURE LIMITS? A. Tasplan has a tenure limit of 12 years for all directors. However, as an independent chair, I think that a shorter tenure makes sense, so that you are bringing new ideas and experiences to the fund.

If I’m still there after 10 years, I’m pretty sure the board will be tapping me on the shoulder.

Q. HOW HAVE YOUR VIEWS ABOUT WHAT MAKES A GOOD CHAIR CHANGED OVER THE LAST SIX YEARS? A. I was appointed to my first chair role in 2008 when I was 40, at Australian Ethical Investments. In my younger days, I used to think the chair should be the boss of the board. Now I am realising the chair should be the servant of the board and that the best chairs are extremely humble. My fellow trustees would probably joke that this is still a work in progress, but observing great chairs in action has taught me heaps.

Q. WHAT IS THE MOST VALUABLE PROFESSIONAL DEVELOPMENT OR TRAINING YOU HAVE HAD FOR YOUR ROLE AS CHAIR? A. This will sound strange, but not withstanding all the Australian Institute of Company Directors and other courses I have attended, it was a ‘speed Buddhism’ course over one weekend that changed my concept of working with others and creating a compassionate environment. The course was attended by a lot of high-powered Australian directors, so it was nice to be on trend.

Q. WHEN FACED WITH DIFFICULT DECISIONS, WHOM DO YOU TURN TO FOR ADVICE? A. I have cultivated two very experienced chairs as my mentors: Rebecca McGrath, who is chair of OZ Minerals, and Brian Scullin, former chair of RBF and also chair of Hastings Funds Management.

Both are wise heads and exemplify the humble chair model I am trying to emulate.

Q. WHAT IS YOUR BEST TIP FOR HOW TO FACILITATE A CONSTRUCTIVE BOARD MEETING?

Q. YOU ARE ALSO A DIRECTOR OF THE TASMANIAN ECONOMIC DEVELOPMENT BOARD. DOES THAT ROLE DOVETAIL WITH YOUR INTERESTS AS TASPLAN CHAIR, GIVEN THE OBVIOUS BENEFITS OF PROMOTING THE ECONOMIC AND JOB SECURIT Y OF THE FUND’S MEMBERS?

A. Always leave space and headroom for some meaty discussions about strategic positioning, preferably at the start of the meeting.

Kick-off with an in-camera session and end with a quick meeting review. Make sure the room has plenty of natural light and good airflow. Now I sound like an architect, but I really think the space the board meets in can make a big difference to its functioning.

A. I feel very privileged to sit on both boards. Tasplan manages the super of more than one in two Tasmanians, while the Economic Development Board helps attract industries to the state and supports industries that are here. Tasmania is in a period of unprecedented optimism and growth, and I encourage anyone feeling the pinch on the mainland to think about moving down here!

JULY 2017

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DATA AND ANALYTICS TO TAKE ESG FROM NICHE TO NORM

The era of “ESG-aware� investing, whereby Environmental, Social and Governance (ESG) considerations are a part of investment and risk management decisions, has evolved from niche to normal. FTSE Russell has more than 15 years of ESG experience and provides data analytics, ratings and indexes covering thousands of companies worldwide.

ftserussell.com

14

\ INFOCUS REP ORT

BETA

SMART

is here to stay

By Deborah Johnson

NEARLY HALF OF all institutional investors globally are already using smart beta strategies, and the rate of adoption is tipped to skyrocket in the coming years.

Traditional smart beta strategies, such as those based on fundamental valuations, remain popular. However, there is also booming demand from institutional asset owners for smart beta products that will be used for multi-factor and sustainable investment strategies. This is tipped to turbo-charge inflows.

FTSE Russell recently surveyed 194 global institutional asset owners with total assets under management (AUM) estimated at more than US$2 trillion ($2.7 trillion) about their approach to smart beta.

A record 46 per cent of the investors surveyed are already incorporating smart beta strategies in their portfolios. While Australia was not singled out in the survey, the rate of smart beta adoption across the Asia-Pacific region was 48 per cent, well behind Europe, at 60 per cent.

FTSE Russell managing director of North America research, Rolf Agather, predicts that based on FTSE Russell’s survey, the uptake of smart beta among institutional investors will continue to rise in the coming years.

He says asset owners are embracing smart beta as more data and investor education become available and new products – such as multi-factor and environmental, social and governance (ESG) indices – hit the market.

“Smart beta is more than just a fad,” Agather says. “We expect growth in smart beta to continue at a robust pace, as, according to our survey results, the adoption expectations of asset owners currently

JULY 2017

Global asset owners hungry for risk-adjusted returns and searching for ways to improve the diversification of their portfolios are pouring into smart beta strategies. Increasingly, they favour a multi-factor approach, and ESG factors are tipped to be the next big thing.

AN INVESTMENT MAGAZINE INFOCUS REPORT, sponsored by FTSE RUSSELL

evaluating initial or additional smart beta allocations remains strong and satisfaction with smart beta among current users remains high.”

He believes smart beta’s appeal is that it offers investors additional choices beyond traditional active and passive approaches.

“For investors who like the transparency, low cost and discipline of an index-based approach but want to overcome some of the limitations of market cap-weighted indices, smart beta can provide a variety of options that are distinct from traditional indexes,” Agather says.

Smart beta is a catch-all term that covers a wide range of systematic, index-based investment strategies. Smart beta indices select and weight their constituents differently from the standard methodology of weighting based on market capitalisation.

The FTSE Russell survey shows the majority of asset owners that are using smart beta are typically using more than one strategy. Twothirds of those who have allocated to smart beta are using two or more smart beta strategies and 26 per cent are using four or more.

MULTI-FACTOR IN VOGUE

Nearly two-thirds of the smart beta adopters in the FTSE Russell survey were using multi-factor strategies, more than triple the 20 per cent using multi-factor in 2015. Among the new adopters (those who have had a smart beta allocation for less than two years), 71 per cent were using multi-factor strategies.

“Asset owners and consultants are harnessing the full spectrum of smart beta tools available,” Agather says. “If the trend revealed in our survey continues over the next five years, a substantial majority of institutional asset owners will have some amount of smart beta allocation.”

Many of the newly launched smart beta ETFs have been underpinned by multi-factor indices.

“The appeal of multi-factor is not surprising because it provides investors with a product that can be tailored to their requirements. They can choose their factors – typically three to five – and have the option of applying different tilts to each,” Agather says.

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INFOCUS REP ORT \

He predicts that, based on the FTSE Russell surveys and research, growing demand for ESG strategies is likely to be among the next big drivers of smart beta adoption.

More than 40 per cent of asset owners in the FTSE Russell survey that have, or are planning to evaluate, a smart beta allocation, indicated they anticipate applying ESG screens or factors to a smart beta strategy.

In Europe, the proportion is 60 per cent, increasing to nearly 80 per cent among asset owners with AUM greater than US$10 billion ($13.5 billion).

Considerations related to expected financial performance were the main reason given for adoption of smart beta strategies, and were also the primary motivations for selecting ESG factors. A desire to avoid longterm risks, such as climate change, was the most commonly cited reason. Regulatory requirements figured less prominently.

ESG FACTORS ON THE RISE

Around the world, a growing number of major institutions are acknowledging their exposures to climate-related risks. They want to ensure their portfolios build in some protection and secure some potential upside opportunities associated with climate change, such as growth of green industries.

Smart beta strategies incorporating relevant climate change parameters can be a useful tool to achieve this.

The trustees of HSBC Bank UK Pension Scheme adopted a climate change policy in 2015 and more recently implemented a climate aware fund for its defined contribution scheme equity default option, worth £1.85 billion ($3.2 billion). Legal & General Investment Management (which managed the previous passive default option) collaborated with HSBC, its asset consultants and FTSE Russell to create a new smart betabased fund with a focus on providing better risk-adjusted returns to members.

LGIM created its Future World Fund in consultation with HSBC, FTSE Russell and asset consultants.

The fund uses the FTSE All-World ex CW Climate Balanced Factor Index, which combines a climate change tilt with a smart beta multi-factor approach.

The index applies tilts towards four factors that have outperformed against a market cap weighted index since 2000 – value, low volatility, quality and small size. The three climate change parameters tilt exposure away from carbon emissions and carbon reserves

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and towards companies with revenues from green industries. Both the traditional risk-premia factors, as well as climate parameters in the historical analysis, deliver out-performance above the market cap-weighted benchmark.

“We believe this fund will offer our members a better risk-adjusted return, incorporate some climate change protection and deliver improved company engagement,” HSBC Bank UK Pension Scheme chief investment officer Mark Thompson says.

FUNDAMENTALS ENDURE

LGIM’s Future World Fund used by HSBC is just one example of how major investors are discovering more possibilities for employing smart beta.

While multi-factor and ESG strategies are driving increased adoption of smart beta, more mature styles – such as fundamentally weighted strategies – remain significant in absolute terms, particularly with investors who were earlier adopters of the investment style.

Among institutions that have had smart beta allocations for more than two years, 34 per cent have an allocation to a fundamental strategy, compared with 13 per cent of those who have had smart beta allocations for less than two years.

Among those considering making their first smart beta allocation, one-quarter are still considering a fundamentally weighted strategy.

SUCCESS STORY

BetaShares FTSE RAFI Australia 200 ETF (ASX code QOZ), a fundamentally weighted smart beta exchange traded fund, was one of the first smart beta ETFs launched in Australia.

It provides exposure to a diversified portfolio of Australian equities that are fundamentally weighted in a way that is reflective of the economic footprint – sales, cash flow, book value and dividends – of its constituent companies.

“We listed the fund on the Australian Securities Exchange four years ago as a better way to track an index without the shortfalls

of a cap-weighted index,” BetaShares director institutional business and national accounts Vinnie Wadhera says.

The product was launched with all market segments in mind – institutions, advisers and retail investors – but the strongest support has come from institutional investors. ”We have seen continuing strong growth in AUM since its launch. It’s not surprising when you look at the performance of the ETF and the underlying index,” Wadhera says.

Today’s AUM of $210 million compares with $60 million two years ago and $88 million one year ago. QOZ’s performance after fees compared with Australian active managers (using the Morningstar Australian Equity Large Growth and Australian Equity Large Blend categories), places it in the top quartile of all active managers. Over three years to March 31, 2017, it would have ranked 23rd out of 195 and, over one year, second out of 211 managers.

“Longer term, the FTSE RAFI Australia 200 index has outperformed the S&P ASX 200 index by an average 2.2 per cent per annum since its inception in August 2009. It all comes back to the index and its methodology, including annual rebalancing on fundamental weights,” Wadhera says.

BOOM TO CONTINUE

The global market for smart beta ETFs is booming and double-digit growth is forecast to continue. In Australia and overseas there has been a proliferation of smart beta ETFs with assets predicted to reach US$1 trillion ($1.35 trillion) by 2020, representing 19 per cent per annum growth from 2016, according to BlackRock.

Agather expects there to be continued evolution in multi-factor combinations, including increasing incorporation of ESG – particularly in Europe and other ESG-sensitive markets.

“There is also increasing talk and debate about the potential to time factors, so it is reasonable to expect an increasing number of dynamic factor strategies coming to market in the next few years,” he says. “We are also beginning to see interest in smart beta in other asset classes, such as fixed income.”

DISCLAIMER No member of the London Stock Exchange Group plc or its applicable group undertakings, which includes FTSE International Limited and its subsidiaries and Frank Russell Company, nor their respective directors, officers, employees, partners or licensors (a) accepts any responsibility or liability for any errors or for any loss from use of this article or any of the information or data contained herein, nor (b) makes any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of or suitability of the FTSE Russell Indexes. A decision to invest in any asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this article should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.

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\ ROUNDTABLE AN INVESTMENT MAGAZINE ROUNDTABLE, sponsored by AIA AUSTRALIA

TIME to put HEADS

TOGETHER A recent gathering brought together 14 leaders from the superannuation, group insurance and mental health sectors. The group IDENTIFIED A MAJOR OPPORTUNITY to improve collaboration and information sharing.

By Sally Rose Photos Matt Fatches

DAMIEN MU AIA Australia

JESSE KRNCEVIC Financial Services Council

FEW EXPERTS WOULD argue there is not great benefit, both social and economic, to be gained from supporting early intervention and prevention to combat mental illness.

The group insurance sector, which provides automatic cover to about 8 million working Australians via their default superannuation fund, is uniquely placed to play a pivotal role in making this a reality.

Estimates from the Australian Bureau of Statistics indicate that 3000 lives were lost nationwide through suicide in 2016, more than twice the national road toll. But it is not just severe cases of mental illness that are affecting lives, reported cases of depression and anxiety are also on the rise.

Among Australians, 45 per cent will experience a mental health condition in their lifetime, meaning that, on average, 1 in 5 staff members in a workplace are likely to be experiencing a mental health condition at any given time. Every year, untreated mental health conditions cost Australian employers $10.9 billion in compensation and lost productivity.

Mental Health Australia chief executive Frank Quinlan stressed the urgent need to shift more focus to early intervention and prevention initiatives.

“Across government, across nongovernment, across workplaces, our focus has been on the crisis end and, slowly but surely, we need to shift it to early intervention and prevention,” Quinlan said.

Mental Health Australia is a peak body for large national organisations working in mental health, including various professional associations representing general practitioners, psychiatrists, psychologists, social workers and nurses, along with some research groups. The organisation’s core purpose is to understand the experiences of its stakeholder organisations and convert that understanding into cohesive and sensible policy advice to government.

AIA Australia & New Zealand chief executive Damien Mu said one of the insurer’s objectives in sponsoring the roundtable was to try to figure out how different players in the group insurance sector might better work together to share “the infinite amount of research and data” that they are all gathering individually.

“If we can collectively get some of our resources together…I feel optimistic that we can continue to make more of a difference, to improve the lives of millions of people,” he said.

A SPIRIT OF COLLABORATION

All the roundtable participants agreed that a stronger culture of collaboration between superannuation funds, their group insurance providers, the medical profession and mental health sector advocates could produce a much-needed body of evidence about what works.

“We are all working in a very disparate way, yet there is absolutely a fundamental

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ROUNDTABLE \

alignment around our purpose and objective, which is to help people get back to a healthier state of mind and back to a productive lifestyle,” Mu said.

AIA Australia, one of the largest providers of group insurance in the country, has gained valuable insights about which early detection and prevention strategies work for clients participating in its Vitality program.

Likewise, the insurer’s rehabilitation program, Restore, has helped it gain a better understanding of how different early intervention measures can help get people back to work.

Quinlan said it would be great to learn from the group insurance sector about how its early intervention and prevention programs work. He said that within the mental health carers’ sector it was considered “a general rule of thumb” that even for people with severe mental illness often only about 20 per cent of their recovery needs are medical.

“Secure housing, employment, social inclusion and intimate relationships – these are the types of things people seek help with,” he said.

Quinlan laments that a lack of big data sets about what types of psychosocial supports work makes it difficult to get the necessary investment from business and government. He said a major problem in assessing the success of different programs is the highly fragmented nature of mental health policy and funding between the states.

BIOPSYCHOSOCIAL APPROACH

SuperFriend chief executive Margo Lydon is enthusiastic in her support for the idea of fostering more collaboration between the group insurance and mental health sectors.

SuperFriend is an industry-funded nonprofit organisation (backed by 23 super funds and seven insurers) dedicated to promoting workplace mental health.

Lydon said that while the Diagnostic and Statistical Manual of Mental Disorders acts as a reference for diagnosing mental health conditions, there is no similar handbook for assessing the efficacy of biopsychosocial treatment options, which are those that focus on a combination of biological, psychological and social factors.

“I think there is a terrific opportunity for

the insurance industry to work in partnership with medical and allied health practitioners, and a range of other people with expertise, to build a single source of truth on best practice that every insurer in the country…could access to get the very best and most up-todate information about treatment options.”

Financial Services Council (FSC) policy manager, life insurance, Jesse Krncevic also saw merit in the push to foster closer ties between the group insurance and mental health sectors.

“I think we’re all aligned, there’s work going on in silos, but it’s smashing those walls down and bringing us all together and actually working towards a common goal,” Krncevic said.

UniSuper insurance and claims manager Amalia Faba said she would like to see better communication channels between the group insurance sector and the medical profession.

Faba highlights the need for a greater role for non-medical responses to people suffering from conditions such as stress and anxiety, while acknowledging that medical responses “obviously play a vital and critical role” for people with severe mental illness.

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\ ROUNDTABLE

PA R T I C I PA N T S SARINA AARONS

Head of insurance, First State Super MATTHEW BEARDMORE

Head of product, Commonwealth Superannuation Corporation JOHN BERRILL

Principal, Berrill & Watson KIM EAGLE

Chief operating officer and chief financial officer, National Mental Health Commission AMALIA FABA

Insurance and claims manager, UniSuper FIONA GALBRAITH

Director of policy, Association of Superannuation Funds of Australia JANE HUME

Senator for Victoria, Liberal Party JESSE KRNCEVIC

Policy manager life insurance, Financial Services Council CHRIS LOCKWOOD

General manager, industry partnerships, Cbus Super MARGO LYDON

Chief executive, SuperFriend DAMIEN MU

Chief executive, AI A Australia & New Zealand STEPHANIE PHILLIPS

Chief group insurance officer, AI A Australia FRANK QUINLAN

Chief executive, Mental Health Australia MICHAEL ROGERS

General manager, QInsure, QSuper

CHAIR SALLY ROSE

Editor, Investment Magazine

“As an industry, we rely very heavily on the medical model…and I think we have an opportunity to…take advice about how to use a more social approach and start demanding biopsychosocial recovery pathways for people on claim,” she said.

“I certainly believe there are many people who are misdiagnosed, over-diagnosed, and over-medicated…Disappointingly, mental illness is a very high-claims cause for [UniSuper’s] demographic, so it’s very high on our agenda.”

PRIORITIES FOR FUNDS

First State Super head of insurance Sarina Aarons said mental health is also high on that fund’s list of priorities, given that many of its members work in emergency services and policing, occupations that place people at high risk of experiencing trauma and distress. Meanwhile, the fund is also seeing a distressing rise in claims related to workplace bullying, she said.

Official statistics show young men working in construction are more than twice as likely to die by suicide as their peers in other industries. In response, a decade ago, construction industry super fund Cbus Super began supporting a range of mental health support programs for its members.

Cbus general manager, industry partnerships, Chris Lockwood has oversight for these initiatives, including Mates in Construction, which has been lauded for its

success as a peer-to-peer support network.

Lockwood’s advice to funds looking to launch similar initiatives is to empower their industry stakeholders to take a leadership role.

SuperFriend recently launched the SuperFit Mates program, which was inspired by the Mates in Construction model.

Commonwealth Superannuation Corporation head of product Matthew Beardmore said a more collaborative approach between super funds could go a long way towards attracting investment and support to scale up early intervention and prevention.

“We’re certainly not going to solve this one by one or individually,” he said.

Beardmore also suggested that super funds flex their collective muscle as investors to put more pressure on ASX-listed companies to demonstrate that they are taking action to foster mentally healthy workplaces.

LISTENING TO CLAIMANTS

QSuper last year became the first non-profit super fund in Australia to gain a licence to start its own life insurance division, QInsure.

The group has looked to best-practice examples from Canada to determine how to engage with its contributing employers to improve mental health outcomes among its members.

“Our program is entirely biopsychosocial,” QSuper general manager insurance Michael Rogers said.

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ROUNDTABLE \

As an example of how that is delivering results, he points to early successes QSuper has had in increasing the number of people on claim for depression who have been helped back to work.

This has been achieved by identifying when a person is on claim because they hate their job, and then providing them with access to an outplacement service to find a new role in which they are happier.

“Of course, the real challenge in implementing that kind of approach is that your claims managers have to become very, very competent,” Rogers said.

National Mental Health Commission chief operating and finance officer Kim Eagle said it’s important to listen to affected individuals about what works for them.

“Bringing consumers and their carers into these conversations is important because then you get good knowledge, advice and experience about what works, what’s effective and how you can get better outcomes.”

STEPHANIE PHILLIPS AIA Australia

FRANK QUINLAN Mental Health Australia

EARLY INTERVENTION WORKS

AIA Australia chief group insurance officer Stephanie Phillips said mental health is the third-biggest cause of all claims the group insurer receives.

She supports the idea that the industry needs to shift focus from just paying out claims to getting smarter about early intervention, education and awareness.

“For us, there’s a question of how we effectively better educate individuals and employers and super funds to intervene earlier to stop the condition from getting worse,” she says.

AIA Australia’s Restore program is designed to help claimants get back into society, which may mean going to the gym a few times a week or some other healthy routine, as a precursor to feeling ready to get back to work.

“We’ve got 50 per cent of [Restore participants] back to work, which is amazing…Some of them have taken 12 to 18 months to get there,” Phillips said. The program is optional for funds, employers and individuals.

Berrill & Watson principal John Berrill, a specialist lawyer and long-time adviser to the Superannuation Complaints Tribunal, argues that the group insurance sector needs to do more to standardise the forms they require claimants to get their medical providers to complete.

Phillips said there is room to improve the claims experience with more standardised language and definitions around the noncompetitive areas of group insurance, but that providers need to be able to distinguish themselves to compete.

We’re certainly not going to solve this one by one

Berrill said default group insurance is “an amazing” feature of Australia’s superannuation system that should be retained but it also needs reforms to strike the right balance between affordability and adequate coverage.

DON’T STIFLE INNOVATION

Association of Superannuation Funds of Australia director of policy Fiona Galbraith said it is critical that the new industry guidelines, and any changes to the prudential standards framework, leave enough flexibility in the system so fund trustees don’t face too many barriers to trying new approaches. She said the current regulatory settings around conditions of release need updating to allow innovation.

Krncevic said the FSC has been advocating for some time now for regulatory changes to allow life insurers to introduce a mechanism that will allow them to make special payments targeting early intervention measures.

“There are restrictions in the legislation that don’t allow insurers to provide payments at an earlier stage when they could help people get back to work and enjoy a fruitful life,” he said.

Jane Hume, a Liberal Senator for Victoria, said mental health is high on the government’s agenda for a number of reasons.

“Obviously, the most important [reason] is that a civilised society is defined by its ability to look after those who can’t look after themselves,” Hume said. “But also, on the other side of the ledger, this government is very focused on improving growth and productivity and, of course, the drain on the productivity that mental health in the workplace imposes is, I think, hugely underestimated.”

Hume said “something has to give” or the cost of mental health to the taxpayer is set to “explode”. She encouraged her fellow roundtable participants to pursue their intentions to work towards more information sharing to promote best practice in early intervention and prevention.

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\ INFOCUS REP ORT AN INVESTMENT MAGAZINE INFOCUS REPORT, sponsored by FRANKLIN TEMPLETON INVESTMENTS

ABSOLUTE REWARDS on offer In a challenging era for fixed income investors, more managers and asset owners are finding there are benefits to taking an absolute returns approach.

By

SINCE THE GLOBAL financial crisis, the fixed income market has changed its stripes.

Ten years ago, investors were at ease with bonds delivering a decent income stream over an average of three years. High yields meant lower bond prices and a buffer against a downturn in the market.

Today, however, bonds offer a meagre income stream over an average duration of 5.1 years and growing. Bond prices are extremely sensitive to interest rate movements and, at the higher risk end, are behaving like equity, rather than a defensive security. Enticed by more attractive yields, investors have flocked to the credit market, only to squeeze valuations higher.

JULY 2017

Ben Falkenmire

In response, some fixed income managers are diversifying within the credit market or even taking a hedge fund-style approach.

At the more traditionally defensive end, others are consigning themselves to record low returns from a benchmark index.

“If you’re a traditional owner of the bond index and are looking to make a return, you are taking a big position that interest rates are going to decline,” Franklin Templeton Investments managing director of fixed income, Chris Siniakov, says. “If you’re putting all of your eggs into a credit-style strategy, you are adding risk to your portfolio.

Unfortunately, this becomes apparent only when times are tough.”

ABSOLUTE FLEXIBILIT Y

A middle ground for fixed income is an absolute return strategy. Franklin Templeton Investments has been running one for the last two-and-a-half-years with its Franklin Australian Absolute Return Bond strategy (FAARB).

The strategy adopts a flexible approach to handpick government and corporate debt with short durations and diverse yield positions. It targets local and foreign issuers in the domestic market known to Franklin Templeton’s 170-person global fixed income team, which collectively manages $400 billion in fixed income assets.

The idea is to offer investors the defensive qualities of bonds but with returns of 2 per cent to 3 per cent above the cash rate.

“We start with no duration and add it only where it’s rewarded with compelling valuations and yields in the right part of the curve. We then realise a profit when the bond moves back to a fuller valuation,” Franklin Templeton Investments director of fixed income, Andrew Canobi, says.

“In credit, we keep the average rating around the single A range. When we dip our toes into more interesting ideas, we’ll look for an undervalued bond and when we are happy to buy, we look for a profit and then move out.”

As an example, Canobi cites the March quarter 2016, when energy prices collapsed and the market feared the worst. High-quality issuers – like Rio Tinto, Origin Energy and Woodside – were experiencing substantial pressure on their bonds. Franklin Templeton Investments was able to buy in at attractive prices with 5 per cent to 6 per cent yields from strong global diversified miners. When those bond prices normalised, they sold out.

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INFOCUS REP ORT \

In the last 12 months, the $55 million FAARB has returned 4.24 per cent according to Morningstar, placing it in the first quartile for performance. As at June 2017, the portfolio yield is 3.2 per cent with a duration of one year, compared with the Bloomberg AusBond Composite Index’s yield of 2.3 per cent and 5.1 years. These figures suggest an absolute return strategy has merit.

Colonial First State has been using absolute return bonds for about eight years, since before they became popular. Senior investment manager George Lin says there are pros and cons to using them but the ultimate advantage is that they give portfolio managers the opportunity to buy the best priced bonds.

“A lot of bonds sit outside the traditional bond benchmark universe. We feel that some of those – like high yield, securitised and emerging debt – can be underpriced at times,” Lin explains. “These higher yielding type bonds tend to correlate with equity, so we do not necessarily want a structural allocation to them but prefer to give our managers the chance to pursue an active return strategy.”

GOING LONG ON INFLATION

One risk factor that has Franklin Templeton’s attention is inflation. Inflation-linked bonds give protection against rising interest rates but durations are typically long and if interest rates move too much, the benefits can quickly evaporate. This is where Siniakov and Canobi surgically target bonds.

“We consider inflation a bit of a sleeper in

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the longer term. We don’t expect the market will turn anytime soon in the developed world towards a disinflation or deflation outlook. The downside of owning exposure in inflation is limited, so we’re happy to leave that in the portfolio at the longer-term end,” Siniakov says.

According to Danica Hampton, head of investment specialists at Citi, global growth is moderately strong and is pushing inflation higher, with forecasts of 2.3 per cent and 2.2 per cent for 2017 and 2018. But she is quick to point out the world is heavily leveraged and a key indicator for inflation, wage growth, remains stagnant.

“The big question is what happens when these unprecedented monetary policies from governments around the world are unwound,” Hampton says. “Global wage growth is still relatively benign and a piece of the puzzle we need to keep our eyes on.

When wages increase, that will spark global domestic demand, and in turn inflation.”

Siniakov says that if the US and global economies continue to grow, wage growth will come on and move the world into an inflationary environment. But with some mixed signals in the market, he is erring on the side of caution, with preservation of capital front of mind.

“The US has reduced its unemployment rate significantly in the last three years.

Traditional relationships will tell you that we should start to see more significant wage pressures but that hasn’t come through in the data and everyone is trying to understand why,” Siniakov says.

GOING SHORT ON AUSTRALIA

While the US and Europe crawl forward, Australia appears to be inching closer to a slide in growth. Lin says when you take into account the downside risk to the Australian economy, the country’s bonds are not a bad prospect.

“We are still one of the only developing countries to offer bonds with relatively higher yields. What will be interesting to see is any change in the short-term interest rate differential between Australia and the US. If the differential declines further, hedging US bonds into Australian dollars becomes less attractive,” Lin says.

For 2018 and 2019, Siniakov is predicting Australian interest rates will be eased rather than increased, listing household consumption as a catalyst.

“Household consumption is almost 60 per cent of GDP but households are burdened by record levels of debt and low income growth. And now we have a central bank and regulators implementing policies to cool down housing market prices and activity. If they are successful, the flow-on effects could be significant,” Siniakov says.

In response, Franklin Templeton Investments is positioning itself at the short end of the yield curve. This means it is closely anchored to the cash rate. If that rate is moved down by the Reserve Bank, yields decline and bond prices rise, translating to a better return for their investors. Their long-term inflation position is there to pick up any growth in the market that will eventually come. It’s an absolute return strategy in action.

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\ MARKET OUTLOOK

TEN YEARS AFTER the global financial crisis, global growth is sluggish, inflation is hovering near record lows, and unprecedented experiments in global monetary stimulus have created the risk of asset bubbles. Put simply, current debt levels are unsustainably high and can’t be propped up forever.

That is the bleak assessment by Satyajit Das. He warns that with debt in many countries having reached three to four times gross domestic product (GDP), levels typically unseen since the Second World War, the continued ability of some sovereign issuers to keep paying back their debts is uncertain.

Das is an Australian-based former banker and corporate treasurer turned academic and author. His most recent book is The Age of Stagnation: Why perpetual growth is unattainable and the global economy is in peril.

Some of his earlier writings, from 2005 and 2006, proved prescient about the risks in derivatives that became more widely apparent in 2007. Given this past form, many investors are now listening carefully to Das’s fears about the global economy being over-leveraged.

To put his concerns about the build-up of debt into context, more than 20 countries now carry debt-to-GDP ratios above 200 per cent, with global debt having grown by $57 trillion, or 17 per cent of world GDP, since the GFC. Unsurprisingly, Das says, there is uncertainty over these numbers’ short- and longer-term impact on traditional financial markets and lending practices.

What’s arguably contributed to the financial market’s highly distorted view of economic reality, Das adds, is the longstanding fixation with using debt to buy existing assets, rather than to invest in productive businesses.

He explains: “Somewhere along the line, the world became one big carry trade. Here in Australia, people can buy anything they like with borrowed money, and everyone looks rich on paper. But finding a buyer down the track to realise the gain is becoming increasingly problematic.”

POST-WAR MODEL ‘BROKEN’

What we’ve been left with, Das says, is a world that continues to deny that the post-war economic model is fundamentally broken.

“While most [chief investment officers] continue to target historical returns of 6-8 per cent, or 4 per cent above inflation, it’s less likely that markets will resume delivering these outcomes at some future stage,” Das says. “Similarly, chasing higher yields

JULY 2017

WHEN THE

WHOLE WORLD IS A CARRY TRADE The world’s financial markets could again be teetering on the brink of catastrophe. Renowned author SATYAJIT DAS says that means fixed income managers need to get close to real income streams. without understanding the higher risks is like trying to pick up a gold coin in front of a speeding train.”

He says the key problem confronting institutional investors today is that there are many more unknown unknowns than at any time in recent history. As a result, investment chiefs now find themselves trapped in a world where they’re incapable of grappling with fundamental financial problems they’ve collectively created over the last three decades.

“CIOs are playing musical chairs, and when the music stops again, it will do so in a far more radical way than it did during the GFC,” he predicts. “Most growth generated over the last 30 years is due to excessive debt, financial imbalances, and a cycle of entitlement that appears impossible for policymakers to roll back; while companies have been more concerned about financial engineering than real engineering.”

What bothers Das just as much as the mounting debt levels is that the worldwide growth in equity prices since 2009 remains hugely uneven. For example, in the US, the S&P 500 has tripled since the nadir of the GFC; while here in Australia, the ASX All Ordinaries Index still trades about 16 per cent below its peak of 6873 points on November 1, 2007. Japanese equities are lagging even more, with the Nikkei Index trading slightly down on where it was back in 2000.

Das suspects growth and inflation will remain low and volatility variable, with sudden and unpredictable “melt-ups and meltdowns”. Within this environment, he urges CIOs to get better at tapping into the brains trust behind central bank policy.

MANDATED TRAPS

Unlike superannuation and pension funds, which are locked into particular ways

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MARKET OUTLOOK \

SATYAJIT DAS Former banker and corporate treasurer turned academic and author

reducing correlations to lower volatility.

In addition to looking beyond the traditional asset allocation approach, Kloss suggests investors look broadly across fixed income markets and sectors to create a multiasset class fixed income portfolio.

“This return stream should originate from differentiated sources of alpha across multiple fixed income asset classes, including currencies, sovereign bonds, investment grade and below investment grade credit, structured credit and bank loans,” Kloss says.

NEW APPROACHES NEEDED

of investing, courtesy of their mandates, family offices have successfully learnt from their past mistakes, Das says, to emerge amongst today’s best investors. What they’ve understood, he says, is that returns require getting close to real income streams.

As a result, what they’ve successfully done since 2008-09 is switch their previous 80 per cent exposure to public assets into private assets.

“The trouble is, CIOs, et al, can’t do that because their mandates simply don’t allow them to,” he says. “They’re fundamentally flawed because within this bi-polar macroeconomic environment, normal investing rules don’t apply.”

While dealing with the prevailing macroeconomic dynamics isn’t easy, Das recommends CIOs get better at capitalising on whatever conditions the market throws at them. While there’s no such thing as magic pudding, he says the onus is on CIOs moving away from public markets and renegotiating their investment decision rationale.

Within an environment where indices don’t make sense, he recommends moving more towards absolute returns and income than capital gains. “Assuming that CIOs’ hands remain tied and they don’t loosen their mandates, their focus should be on things they can do smarter and learning what they

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can live with,” Das says. “The alternative is to admit this is an uncertainty that you simply can’t manage and return money to investors.”

While few fund managers are considering such a bold move, a growing number share many of Das’s concerns about global debt levels and the challenges they pose to the outlook for fixed income markets.

FOCUS ON ABSOLUTE RETURNS

Apollo Advisors head of yield product development Seth Ruthen says that to be successful in the new environment – characterised by fiscal policy exhaustion, low growth, low inflation, low GDP and low interest rates – managers need to think about different types of risks than they are used to and develop strategies diametrically different to those that worked a decade ago.

Ruthen urges institutional investors to seek out managers who can create multidimensional opportunities beyond duration, credit quality and volatility.

“That also means moving into unconstrained environments more likely to deliver absolute returns,” he says.

Similarly, Brandywine Global portfolio manager and head of high yield, Brian Kloss, argues that an unconstrained holistic approach should help generate both absolute returns and a stable level of income, while

Beyond urging a move towards absolute returns and income, Das also recommends CIOs take steps to get on the right side of future M&A activity, and lower their exposures to sectors that will ultimately be killed off by disruption or regulation.

“Instead of overestimating future upside from either emerging markets or geopolitical risk, a much bigger issue confronting CIOs is how to be rewarded for funds under management, especially when ETFs are killing them on the fees [and sometimes on the performance] front.”

To create an environment where CIOs are considerably closer to free cash flow, Das recommends rethinking the investment process and the ability to preserve capital while also generating income and future capital growth. It’s also important, Das adds, that CIOs get better at developing strategies around what a protracted low-growth and low-inflation environment is going to offer.

But given there’s little room for rates to go much lower, Ruthen says expanding the opportunity set to include things beyond what is easily accessible or index-oriented – plus having the discretion to respond quickly across asset classes – has surpassed duration as the most important risk factor.

“That means being able to buy debt off other people’s balance sheets, creating debt within the right parameters, using illiquidity in a prudent manner and getting paid for it in the right way,” Ruthen says. “If CIOs don’t have the skill set to reorient the business around new opportunities, they’re at a real disadvantage.”

SAT YAJIT DAS will deliver the opening keynote address at the Investment Magazine Fixed Income, Cash and Currency Forum in Healesville, Victoria, July 25-26, 2017.

For registration enquiries, contact Emma Brodie: +61 2 9927 5708 emma.brodie@conexusfinancial.com.au

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\ COLUMN

WOMEN CAN’T AFFORD another two decades of inaction on the gender pay gap, and neither can the Australian economy.

A little over a year ago, the Senate Economic Committee’s inquiry into women’s economic security in retirement, which I chaired, handed down its final report. That inquiry benefited greatly from contributions from the financial services sector.

Our final report made a number of recommendations about how we could make our superannuation system more fair for women. However, a key finding of that inquiry was that the gender gap in super outcomes is largely symptomatic of a much deeper issue. Women are retiring with less than men because women earn less over the course of their working lives.

LITTLE PROGRESS ON PAY GAP

BY JENNY MCALLISTER

Jenny McAllister is a Labor senator for NSW.

The issue was referred to the Finance and Public Administration References Committee to be the subject of a follow up inquiry into gender segregation in the workplace and its impact on women’s economic equality, which I also chaired and that recently wrapped up.

There is much to be done. When I entered the workforce about 20 years ago, the gender pay gap was 17 per cent. Today, official data from the Australian Bureau of Statistics shows, it is 16 per cent. Those two decades brought some of the strongest economic growth in our history. Despite that, we have not found a way to fix what is an unfair economic outcome for women.

Addressing the gender pay gap should be of particular interest to superannuation funds, as it disadvantages roughly half of their members. And of course, it also affects professionals working in the sector as individuals and employers.

A national plan for closing the gender pay gap is overdue Income inequality is the key reason Australian women retire with roughly half as much in superannuation as men.

An inquiry has recommended a POLICY FRAMEWORK FOR PAY EQUITY as part of the solution.

JULY 2017

The financial services sector has the highest gender pay gap of any industry in Australia.

This should prompt funds to take a closer look at their workplace structures and practices.

The gender pay gap may also have broader implications. The latest monthly Melbourne Institute – Westpac Institute Consumer Sentiment Survey found that consumer sentiment dipped 1.8 per cent between May and June, with all of the deterioration in confidence coming from female respondents.

One wonders whether women’s flagging confidence is connected to their accurate perceptions that their own fortunes do not mirror their male peers.

IMPACT OF SEGREGATION

It is a common misconception that the gender pay gap results from simple discrimination – a firm hires two accountants and pays the man more than the woman. Although this is a part of the gender pay gap, it is not the whole story.

Today, the second-biggest driver of the gender pay gap is occupational and industrial segregation. In Australia, 60 per cent of industries are dominated by one gender or another. Social and structural factors direct women into ‘pink ghettos’ with lower pay and fewer opportunities for advancement.

The finance sector is not immune to these drivers. During the Senate committee hearings, we heard from women in finance who were told, “we do not do part time in business banking,” or “we do not do part time in financial planning. If you want to work part time…you can come back to work as a teller”.

Businesses have enormous opportunity to actively tackle these structural problems, and in the process deliver a much fairer and more productive workplace.

These issues are not going to go away on their own. During the recent inquiry into gender segregation in the workplace, we heard from academics and employers, unions and working women. What became clear is that gender segregation and the gender pay gap are complex problems requiring a co-ordinated solution.

That is why we are calling for the government to set up a national policy framework for pay equity. It is no longer enough to measure the gap. We need to take steps to close it.

For two decades, the pay gap has barely budged. Unless government makes pay equity a priority, we will be in the same place two decades from now. Neither women nor our economy can afford that.

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26

\ PENSION REFORM

MyRetirement

REGIME

FACES RESISTANCE By

As industry responses to Treasury’s consultation paper on COMPREHENSIVE INCOME PRODUCTS FOR RETIREMENT trickle in, a clear objection is emerging to making the products a mandatory offering for all superannuation funds.

MAKING IT OPTIONAL for super funds to develop and offer the new breed of pension-phase products contradicts the recommendation of the 2014 Financial System Inquiry, led by David Murray, which proposed the new framework for the drawdown phase of superannuation.

“CIPRs should be offered as a preselected option to all members of Australian Prudential Regulation Authority-regulated funds – not only to MySuper members,” the Murray Inquiry found.

It was that recommendation that prompted the federal government’s December 2016 discussion paper on Comprehensive Income Products for Retirement (CIPRs). In it, the government also proposes re-badging CIPRs with the snappier title ‘MyRetirement’ products. The deadline for submissions in response to the paper is July 7, 2017.

However , as Treasury confirmed to Investment Magazine, at this stage there are no plans to make it compulsory for trustees to offer a CIPR.

JULY 2017

The proposal is that MyRetirement products be developed as an alternative option to a lump-sum payout or accountbased pension for retiring super fund members. The government has proposed MyRetirement products be manufactured with three main design features in mind: income, risk management and flexibility.

It was Murray’s intention that CIPRs, or MyRetirement products as they will henceforth be known, should include an annuity or “annuity-like” component to combat longevity risk. This element of the regime is also open for feedback.

But before getting into the stoush over what should or shouldn’t be mandatory in a MyRetirement product, it is worth stepping back and looking at the arguments for and against making them a requirement for all funds, both MySuper and Choice providers, to offer them. Note, it was never Murray’s intent to force retirees to select them.

The Actuaries Institute has made a submission to government arguing against making it compulsory, at this stage, for all funds to develop MyRetirement products.

“We do not believe it should be compulsory to offer any particular type of retirement income product until we have had a chance to observe how this development progresses,” the institute’s statement reads.

Roger Balch

KPMG made a similar argument in its submission. When asked whether MyRetirement products should be compulsory, KPMG director Katrina Bacon replied, “No. I think that comes down to a fund choice.” Bacon said some funds would remain focused on the accumulation phase.

Founder and director of the Committee for Sustainable Retirement Incomes Patricia Pascuzzo also argues against forcing all funds to offer MyRetirement products to retiring members.

“Before jumping in and making CIPRs compulsory, I suggest that the government has other mechanisms at its disposal to encourage trustees to offer them. The important thing is to ensure that trustees are planning strategically for how they are going to meet the retirement benefit needs of their members and acting accordingly,” Pascuzzo says.

CALLS FOR SOFT LAUNCH

One reason for the financial services industry’s reluctance to embrace the compulsory offering of MyRetirement products is the argument that it would be less risky to develop the market and introduce the regime gradually.

“It will take some time for products to come out that will build up scale.

We don’t want to be left with a whole lot of subscale products [that] then technically fail because they haven’t got sufficient scale,” says Catherine Nance, a partner at PwC and a member of the Actuaries Institute’s retirement strategy group.

A Mercer survey of fund executives (The Mercer Super Fund Executive Report)

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PENSION REFORM \

indicates many funds will simply wait to see how the market unfolds. In what the survey calls “a glaring omission” in super funds’ strategies for how they plan to service their retiring member base, 55 per cent of funds reported that they had no clear strategy for managing post-retirement members.

“Unfortunately, meeting the needs of the post-retirement market looks to have been put into the ‘too hard basket’,” the Mercer report found.

Pascuzzo says the industry can’t be expected to resolve all the complex issues associated with developing a CIPR framework overnight. However, she also acknowledges the danger of taking a waitand-see approach.

“If too many funds decide to do nothing, the scale and diversification needed to make pooled longevity products work will not be achieved,” she says.

MYRIAD OTHER CHALLENGES

There are several other obstacles to the introduction of MyRetirement products that go some way towards explaining the reluctance within the industry to mandate their offering.

From July 1, 2017, it will be legal to sell and purchase deferred lifetime annuities, which are expected to form a key component of many MyRetirement solutions. However, there are calls for the government to clarify

how these deferred lifetime annuities, and other new types of pooled risk products, will be treated under the age pension eligibility assets test.

This will probably be a key to their popularity, given about 70 per cent of retirees currently receive either a full or part age pension at some point.

“No one’s going to buy a product – no product issuer is going to put a product onto the market – without understanding…how it will affect the age pension,” Nance says.

Another concern, which goes to the heart of the need for MyRetirement products, is that some are challenging the Murray Inquiry’s assertion that incomes from them could be 15 per cent to 30 per cent higher than those achieved from drawing down the minimum amount from an account-based pension.

KPMG’s submission states the Murray Inquiry’s assumptions about what CIPRs could deliver “may not play out in practice, meaning achieving higher income may not be realised for some retirees”. To address this, it recommends that disclosure requirements “identify areas of uncertainty and convey the potential implication if reality differs from assumptions”.

Given the risk of products making false promises, a key message of KPMG’s submission is that it welcomes “a safeharbour design feature that supports trustees

in considering the best interests of a cohort of members”.

Management of consumer expectations is another obstacle to the smooth and speedy introduction of MyRetirement products.

“The historic experience is various funds have tried to introduce this type of product that has some kind of longevity protection in it, but it’s been hard to communicate and, therefore, the take-up’s been low,” Bacon says.

PwC’s Nance agrees. “It’s very hard to know what the promise is, I think the lesson that’s been learnt globally is that you have to keep it simple, you have to be clear,” she says.

URGENCY FOR REFORM

Real though all these obstacles may be, the industry should be subject to serious questioning if it insists on dragging its feet over the implementation of a framework.

A flood of Baby Boomers are now finishing their working lives with sizeable super balances. This demographic shift creates a growing urgency to ensure people’s super savings translate into adequate income during their retirement years. That’s important for individuals but also necessary to ensure that the costly tax breaks afforded to superannuation savings allow the system to achieve what it was set up to do. That is, to shift much of the burden of supporting retirees from taxpayers to individuals.

The important thing is to ensure that trustees are planning strategically for how they are going to meet the retirement benefit needs of their members and acting accordingly

investmentmagazine.com.au

JULY 201 7

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\ COLUMN

SINCE THE INTRODUCTION of compulsory super 25 years ago, the Australian defined contribution retirement system has developed into one of the world’s best. People are now retiring with a meaningful amount of superannuation, but retirees are still either taking a lump sum or using an accountbased pension to manage their spending in retirement.

Unfortunately, neither of those approaches is as efficient as it could be. While investment risk and inflation risk are important and need to be considered, the biggest risk retirees face is longevity risk. Retirees are concerned about running out of money before they die, and because they don’t know how long they will live, most live more frugally than necessary by drawing down their account-based pension at the minimum level.

The Actuaries Institute supports any effort to change the underlying narrative away from a focus on the accumulated lump sum at the time of retirement to providing an income throughout the retirement years. This starts with a communication plan to educate members about how much superannuation they will require in order to meet their

BY ANDREW BOAL

Andrew Boal is chair of the Actuaries Institute’s retirement strategy group. He is also regional head of Australasia at Willis Towers Watson.

Get the new MyRetirement framework right The Institute of Actuaries of Australia argues deferred lifetime annuities should be exempt from the age pension asset test to encourage more retirees to take them up, either as standalone products or as part of a ‘MyRetirement’ SOLUTION OFFERED BY THEIR SUPER FUND. spending needs in retirement, including benefit projections provided to all members during the accumulation phase and expressed as an expected amount of income in retirement.

We also need financial products that help retirees manage longevity risk more efficiently.

The good news is that, from July 1 this year, the regulatory environment will be much more supportive of product innovation, including for deferred lifetime annuities (DLAs). The one remaining piece of this regulatory puzzle is how DLAs will be treated for the age pension

JULY 2017

means test. Given the behavioural biases against pooled longevity products, there is a good argument that the means test treatment of DLAs should be mildly attractive to encourage their uptake. For example, given the insurance nature of a DLA, its capital value could be 100 per cent exempt from the assets test.

TRANSITION TO RETIREMENT

Finally, we need all superannuation funds to have an appropriate framework to help manage the transition of their members into retirement. Amongst other things, a retirement income governance framework should meet the government’s requirements for a comprehensive income product for retirement (CIPR) as outlined in Treasury’s consultation paper released in December 2016. It needs to provide the flexibility to meet the varying needs of different members, generate a broadly constant level of income for life, and provide a level of income above what a retiree would get from taking the minimum amount permitted from an account-based pension.

It also needs to consider the role pooled longevity protection products can play in giving members the confidence to draw down on their capital throughout retirement, rather than preserving it as a safety net. However, offering longevity protection products does increase the level of complexity and members will take some time to become properly informed about their benefits and risks.

In addition, the product landscape is still immature, and the volume of assets in the decumulation phase is relatively low.

IF NOT, WHY NOT

There is public interest in ensuring that any changes introduced meet members’ needs in retirement, including by taking into account their changing eligibility for a part or full age pension as they draw on their assets. A failure could seriously damage consumer confidence, which is why the Actuaries Institute recommends that we adopt a cautious approach to the introduction of the new CIPR (or “MyRetirement”) regime.

It should not be compulsory to offer a particular type of retirement income product until we see how the market develops and how members and their advisers respond.

Instead, an ‘if not, why not’ approach could be introduced, in which funds would be required to justify the appropriateness of their retirement income products for their members and, in particular, why longevity protection products have or haven’t been included.

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30

\ COLUMN

More choice isn’t always a good thing Banks and other retail providers of superannuation products are exploiting the phenomenon of ‘choice overload’ TO THE DETRIMENT OF CONSUMERS. BEHAVIORAL PSYCHOLOGISTS HAVE long known that too much product choice can cause buyer paralysis.

Back in 2005, a now famous study found that shoppers were 10 times more likely to purchase a jar of jam when the number of varieties available was reduced from 24 to 6. The study’s authors concluded that the more options people have, the more time BY and effort they need to invest in making EVA SCHEERLINCK a choice – and that most people are not

prepared to do this work.

Eva Scheerlinck is the chief executive This phenomenon – known as of the Australian Institute of choice overload – has been observed Superannuation Trustees. across a host of product categories, She was formerly a from ice cream, to speed dating, to practising lawyer. financial services. Choice overload is more severe when the products are complex.

In this context, it’s interesting to reflect on consumer behavior in our highly complex superannuation system. Estimates from the Australian Prudential Regulation Authority show that there are more than of the entire super savings pool.

20,000 investment options across the Many of these members had their fund Choice sector. By comparison, there recommended to them by either a financial are roughly 130 licensed funds in the planner or staff member of the bank or other MySuper sector. retail provider that manufactures it.

The Choice sector is dominated by When it comes to the Choice sector, there offerings from the banks. An estimated is less regulatory oversight, less disclosure, six out of every seven members of retail and less publicly available performance data. funds have their super invested in a Choice In terms of transparency, it’s like pea soup. product. This amounts to $900 billion in Poor disclosure across the Choice sector funds under management, almost one-third makes it virtually impossible for the average

Poor disclosure across the Choice sector makes it virtually impossible for the average consumer to compare products JULY 2017

consumer to compare products. Even experienced finance journalists struggle.

Reporters ring us up at the Australian Institute of Superannuation Trustees complaining they don’t know where to start, which often means the stories that should be written about rip-offs and dismal performance don’t get written because they are simply too hard to research.

Where ratings agencies have managed to compare at least some Choice products on a like-for-like basis, the results are damning for retail funds. A 2017 SuperRatings report that examined the fees, investment returns and assets of more than 600 investment options across both MySuper and Choice found that, on average, retail funds underperformed across the board. Within the Choice sector, profit-to-member funds out-performed retail funds over one, three, seven and 10 years in nine out of 11 different investment options.

SAME PRODUCT, HIGHER FEES

Perhaps the most blatant examples of Choice retail products failing members are instances when the fees for balanced investment options in the Choice sector are significantly higher than fees for a similar product (those with almost identical asset allocations) in the MySuper sector.

Overall, members of retail funds in the Choice arena have paid more for less. If this is competition at work, it’s not working for Choice members.

When it comes to consumers having to make decisions in this complex, competitive market, it is concerning that poor disclosure in the Choice sector puts millions of working Australians at risk of sub-optimal retirement outcomes.

The poor performance of the Choice sector also has relevance in the current default fund selection debate. Default members do not exist in isolation. As long as fund members can switch out of one fund into another, the Choice sector and the default sector remain inextricably intertwined.

In a compulsory super system, it is not appropriate simply to dismiss poor disclosure in Choice as a “buyer beware” issue. No matter what super fund members invest in, be it in the Choice or default sector, they need to be confident that they are buying into a quality product that can be easily compared and that the trustees of the fund are keeping their best interests front and centre. Super should never be money for jam.

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32

\ ANALYSIS

SO C I A L

SECURITIES

KYRN STEVENS recently completed a thesis on social investing for his executive master’s of business administration at the University of Wollongong’s Sydney Business School.

He is a corporate affairs and marketing professional in the community health sector and a non-executive director of the Fairy Meadow Branch of Bendigo Bank.

A 2016 REPORT by Impact Investing Australia estimated the value of the Australian impact investment market at $32 billion, with private equity, venture capital and pay-for-performance instruments the sector’s most frequent vehicles.

The most common type of pay-forperformance instruments are best known internationally as social impact bonds.

These instruments, which are often labelled social benefit bonds here in Australia, are an exciting emerging asset class to watch.

Already, a handful of institutional investors, including HESTA and QBE Insurance, are supporting the nascent market, while the country’s three biggest banks – Commonwealth Bank, Westpac and NAB – have worked on assembling the structures.

It is in the interests of institutional investors to collaborate with government and the social service delivery sector to ensure this market can grow. It would help communities, take pressure off budgets, and develop a new institutional asset class

JULY 2017

As the global market for SOCIAL IMPACT BONDS gathers steam, local experiments are demonstrating the POTENTIAL of these innovative finance structures. However, they still need collaboration and government support.

By

Kyrn Stevens

offering a highly diversified source of returns.

Social impact bonds are not actual bonds. They are transactions that enable the government to attract investors to social interventions that would otherwise have a higher upfront cost to the taxpayer. The government uses those savings to repay the investors, including a dividend based on predetermined outcomes.

The first social impact bond was the United Kingdom’s Peterborough Prison bond, launched in 2010, aimed at reducing recidivism among 3000 short-term offenders over six years.

A 2015 review of the first five years of social impact investments, by The Brookings Institution in Washington, DC, found 44 had been issued in advanced economies.

One year later, 96 were implemented or designed in such economies. The Brookings review found the issues typically raised between US$2 million and US$5 million, with one raising US$24 million.

Globally, returns on social impact investments have ranged from 3 per cent to 7.5 per cent, with most returning about 5 per cent. Payments often increase over time and with better success at achieving a particular outcome.

These investments are transforming how governments fund service provision. However, to date they are mostly small and targeted at philanthropic family trusts and endowments.

THE AUSTRALIAN EXPERIENCE

In Australia, New South Wales was the first state government to back social benefit bonds, launching two in 2013. One was to support families of children who might be at risk of going into care (the Newpin bond) and another was to divert children from out-ofhome care (the Benevolent Society bond).

To date, Newpin has delivered a 12.2 per cent return to investors, restored 130 children to their families and helped 47 families prevent their children from entering care.

Also, 61 per cent of children referred to the service provider have been returned from out-of-home care.

New South Wales is now supporting the development of more social impact bonds to finance programs aimed at managing mental health hospitalisations and early-childhood education, and helping vulnerable young people transition to independence.

The Queensland Government has issued an Indigenous-focused Newpin bond, and in June 2017, it announced its second bond, Life Without Barriers, for youth aged 10-16 with ‘high to very high’ risk of re-offending.

Queensland is now also looking at areas such as families with young children experiencing housing instability, young people exiting statutory care at risk of homelessness, and chronic illness.

Social Ventures Australia announced in March 2017 that it had raised $9 million to

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ANALYSIS \

fund the South Australian Government’s Aspire Program, which aims to build the independence and resilience of people experiencing homelessness in Adelaide.

Investors include Coopers Brewery Foundation, HESTA and Future Super.

Up to 600 people in the program will each be supported for three years, with accommodation, case management, pathways to employment and life skills development.

Meanwhile, the Victorian Government has announced it is examining investments for drug and alcohol treatment programs and young people leaving out-of-home care.

CANBERRA LATE TO PART Y

The Australian Government has been investigating social impact investment models since 2011. The Senate Economics Committee has held an inquiry into the sector that is focused on options available for developing a mature capital market for the social economy in Australia and the barriers in the way.

The inquiry’s main recommendation was to establish a Social Finance Taskforce, which the government supported in principle but has not established. The committee also found that company directors, senior managers, investors and financial advisers should undertake training to become more aware of social investment opportunities.

The 2014 Financial System Inquiry, led by David Murray, noted that there is no inherent conflict between fiduciary duty and making social impact investments. The inquiry recommended the government provide more guidance to superannuation trustees and update the rules for private ancillary funds investing in social impact bonds.

In response, changes announced in the May 2016 federal budget allowed private ancillary funds more opportunity to invest in social impact bonds and to make, or

guarantee, loans to charities.

For super funds, however, trustee fiduciary ‘sole purpose’ duty to maximise returns to members is still often seen as an impediment to investing in these assets.

Treasurer Scott Morrison described a social impact investing discussion paper released this year as “the next step in implementing the Financial System Inquiry’s recommendation to explore ways to facilitate the growth of the social impact investment market”.

The Turnbull Government’s response to the paper – the consultation closed in February – should help frame government action around barriers to impact investing.

Overall, the federal government has been slow to move on efforts to support the social impact market and risks impeding maturation of this growing opportunity.

BRINGING MARKET DISCIPLINE

Despite a pressing need to attract institutional capital to help solve social issues but there remains a supply side problem too. The lack of offerings coming out of the social sector is not least because not-for-profit organisations (NFPs) face many challenges becoming ‘investment ready’.

An NFP looking to develop a social impact bond offering must identify an existing program or service that is generating a positive social outcome. The program or service should focus on one outcome to make it more readily measurable. This program should then be independently evaluated to determine its benefits.

Based on this review, the program may need to be redesigned and expanded to maximise the benefits and then operated for a period (typically two to three years) to gather data on its impact and cost.

Philanthropic funding may be sought for this.

That data can be combined with information on the potential client/

Overall, the federal government has been slow to move on efforts to support the social impact market and risks impeding maturation of this growing opportunity investmentmagazine.com.au

beneficiary base to calculate the possible savings to government. The organisation and private funder are then well placed to take an unsolicited proposal to government.

A key risk for NFPs is that outcomes-based funding could lead to ‘cream skimming’ or ‘cherry picking’ by service providers, in which beneficiaries close to the outcome necessary for a payment are prioritised.

Service providers may also be inclined to ‘park’ certain projects – working only with beneficiaries most likely to achieve the outcomes that trigger payment.

Tiered payments – differential pricing for outcomes in different subgroups – are a way to limit cherry picking and parking.

Under this approach, higher rates are paid for outcomes achieved for harder-to-help groups.

Partners can also minimise these practices by agreeing on clear metrics and strong goal alignment early in contract design. Robust performance management and independent evaluation, which the private sector can bring to partnerships, also helps.

The legal fees paid for framing agreements are another big challenge to the development of pay-for-performance mechanisms.

The development of one bond in the US reportedly involved writing 27 contracts and more than 1100 hours billed for legal services.

A ROLE FOR PATIENT CAPITAL

A broad concern for social service providers is that the role of these bonds lies in individual interventions and may have minimal impact on the social determinants of the issues being tackled. While initial investments may target the acute problem, investors and governments could look at secondary bonds that are more preventative.

These, however, would probably require much longer lead times to achieve measurable results. Such investments are most likely the domain of capital with a higher risk tolerance and a longer horizon.

This is an area where the $2.1 trillion superannuation sector could play a role.

Investors should look for not-for-profit partners that have a good capacity for data collection, sound governance and financial controls. A record of managing large projects, organisational longevity and strong growth are also good indicators of capacity to enter into social benefit bonds. One bond service provider has its own research team and three former investment bankers on its staff. NFPs and investors may want to consider specialist intermediaries, at least during start-up.

JULY 201 7

33

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\ COLUMN

BY DARRYLL ROGERS

Darryll Rogers is chair of the Australian Custodial Services Association’s regulatory compliance working group and was previously the chair of the ACSA Stronger Super taskforce. He is a senior executive at NAB Asset Servicing.

ON JUNE 1, 2017, the Australian Securities and Investments Commission (ASIC) announced it had further delayed the start dates for the final two components of the Stronger Super reforms.

Superannuation funds now have an additional two years to comply with the new product dashboard requirements for Choice offerings and expanded portfolio disclosure rules. The start dates for these last pieces of the Stronger Super reforms have been moved to July 1, 2019, and December 31, 2019, respectively.

ASIC is also allowing registrable superannuation entities’ licensees to continue to provide their latest product dashboards via a website address in their periodic statements, rather than requiring them to provide hard copies to members.

In some corners, the deferrals will be a welcome reprieve from the consistently changing regulatory landscape, as many are still grappling with the implementation of the fees and cost disclosures in ASIC’s

Delay in Stronger Super a chance to show initiative The corporate regulator has delayed the deadline for compliance with new disclosure reforms until 2019, but funds shouldn’t take that as an excuse to dally.

Regulatory Guide 97. Others may be feeling the effects of long-term reform fatigue as the period between the initial Stronger Super consultation in early 2011 and the final ‘go live’ date grows to just shy of a decade.

Over the next two years, the updates to legislation and regulations will provide additional clarity, but due to the complexities and sophistication of superannuation fund investments, it is unlikely that they will be able to address every variable or data point that can occur within a product.

JULY 2017

INDUSTRY COLLABORATION

In many cases, it will be superannuation funds and their service providers, such as administrators and custodians, that will be in the best position to determine what is the most appropriate, pragmatic and meaningful level of disclosure to their members. This is especially the case with portfolio holdings, where the right balance needs to be struck between providing a long list of individual holdings, potentially thousands of lines long, and a more contextual disclosure that is meaningful to the desired audience.

The Australian Custodial Services Association (ACSA) has worked closely with regulators throughout the Stronger Super implementation and the collaborative experience with our relevant industry subject matter experts has significantly aided the formulation of workable solutions to disclosure requirements.

The most optimal implementation of new regulatory disclosure requirements occurs when ACSA is able to apply the spirit of the law to a given situation or investment type. In such cases, the solution is more pragmatic and closely aligned to the original aims of the regulators.

Portfolio holdings disclosure can be quite a sensitive issue for many superannuation funds, as the prospect of either not complying with regulations or, alternatively, providing more information to the market than their competitors, is an unwelcome one.

AMPLE TIME

In working towards an industry approach to minimising this concern, ACSA is continuing our earlier work and collaborating with those super funds that have already begun disclosing their portfolio holdings so a baseline disclosure view can be formulated. This view needs to be detailed enough to provide adequate transparency but grouped and presented in a way that is meaningful for members.

The additional time ASIC has provided is more than adequate to complete this if industry participants take the initiative to work through and solve the challenges.

This will also greatly increase the likelihood that the Stronger Super reforms result in outcomes that benefit members, whilst at the same time minimising the ongoing compliance cost to the industry.

investmentmagazine.com.au

A VOLUNTEERING DAY YOU CAN PUT YOUR HEART INTO The Wayside Chapel invites you and your colleagues to spend a day in Kings Cross learning about life on the streets and lending a helping hand to the most vulnerable people in our community. Come to hear about lived experiences of homelessness, learn about local social issues, and cook and serve a lovingly prepared meal.

You’ll leave with a different perspective of the people you pass in the street, and a whole lot of love.

an AWAYSIDE day A TEAM EXPERIENCE LIKE NO OTHER

FOR MORE INFORMATION AND BOOKINGS: EMAIL: groupvolunteering@thewaysidechapel.com PHONE: 9581 9101

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