Investment Magazine - August 2017 by Conexus Financial

INTELLIGENCE FOR INSTITUTIONAL INVESTORS

ISSUE 141

AUGUST 2017

BILL Shor ten

A STEP

to the left

If Bill Shorten is elected Australia’s next prime minister, his planned royal commission into the banks will turn up the heat on retail super funds

SEAN HENAGHAN THE CIO AND DIRECTOR OF AMP CAPITAL’S MULTI-ASSET GROUP IS A BRASH CRITIC OF PEER BENCHMARKING CHINA CONGRESS INVESTORS ARE WATCHING TO SEE HOW POWER GETS DISTRIBUTED AT CHINA’S FIVE-YEARLY LEADERSHIP RESHUFFLE AI & ETHICS FUTURISTS WARN THAT ASSET OWNERS MUST GRAPPLE WITH HOW THE RISE OF ARTIFICIAL INTELLIGENCE WILL RESHAPE WORK CHAIR’S SEAT VICSUPER CHAIR CHRISTINE STEWART UNDERSTANDS THE IMPORTANCE OF CONSENSUS DECISION-MAKING

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g r o u pi nsu ran ces um m it .com .au CONTACT Emma Brodie | emma.brodie@conexusfinancial.com.au | 02 9227 5708

CONTENTS AUGUST JULY 2017 2017

06 PROFILE

“There is a big risk to mandated super because people somehow think managing money is easy, partly because we haven’t effectively communicated what it is we do” – SEAN HENAGHAN – MULTI-ASSET GROUP CIO & DIRECTOR AMP CAPITAL

OUR NEXT PM? Bill Shorten outlines what a royal commission into the banking and financial services sector could mean for the superannuation industry.

MYRETIREMENT The government is in no rush to force funds to offer a CIPR. The need for innovation is urgent regardless, Patricia Pascuzzo writes.

EYES ON CHINA As China’s Communist Party readies for its five-yearly leadership reshuffle, global investors are watching to see who will wield power.

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COMPASSION Debby Blakey is pushing for victims and survivors of domestic violence to be allowed early access to their super on compassionate grounds.

AGRICULTURE As Asian demand for Australian agriculture booms, it’s time to get local institutional investors into the game, Stephen Anthony writes.

FUTURISM Ethicists urge investors to get to grips with what advancements in AI might mean for the future of work, investment portfolios and humanity.

GOVERNANCE APRA’s new powers designed for regulating banks don’t need to be applied to non-profit superannuation funds, Eva Scheerlinck argues.

CHAIR’S SEAT Six months into her role as VicSuper chair, Christine Stewart shares why she believes in consensus decision-making and trustee education.

GENDER DIVERSITY The 30% Club is struggling to achieve its goal of 30 per cent women on ASX 200 boards as a December 2018 deadline looms, Patricia Cross writes.

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\ FROM THE EDITOR

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

EDITOR

Sally Rose DIRECTOR OF INSTITUTIONAL CONTENT

Amanda White EDITOR-AT-LARGE

A LETTER from the editor

MYSUPER LICENSING SHOULD BE TOUGH

Simon Hoyle CONTRIBUTORS

Greg Earl Deborah Johnson Mark Story HEAD OF DESIGN

Kelly Patterson ART DIRECTOR

Suzanne Elworthy SUB-EDITOR

Haki P. Crisden

S WE WERE SENDING this issue to print, the Minister for Revenue and Financial Services, Kelly O’Dwyer, was readying to unveil a package of reforms to the MySuper licensing regime. The Australian Prudential Regulation Authority (APRA) will be given greater powers to crackdown on, and ultimately shut down, default superannuation funds when the trustee board is deemed to have breached its governance obligations. These changes will apply to all super funds with a MySuper licence, which gives them access to the $554 billion default market. It is widely accepted that governance standards need to be especially tight in the default sector, because it manages the retirement savings of people who typically never make an active choice to be in their particular fund. An ‘outcomes test’ is set to supersede APRA’s ‘scale test’, which has been in place since 2012 and has given the prudential regulator the power to force mergers of sub-scale funds or revoke the MySuper licences of those it finds are not up to scratch. This outcomes test is said to have been designed to expand APRA’s scope to intervene when it sees evidence of poor governance. It will force MySuper trustees to make annual written declarations that they made decisions based on their members’ financial interests above all else. With the caveat of not having seen the details of the new rules at the time of writing, this looks like a smart move that will help raise standards. If well designed and properly

AUGUST 2017

implemented, a tougher MySuper licensing framework, with the annual outcomes test at the heart of its ongoing registration requirements, should enhance consumer protections. This means protecting savers not only from overt examples of poor governance – including frauds, as exemplified by the Trio collapse, to which these changes are, in part, a response – but also from the far more widespread problem of incompetence and poor strategic planning. As at June 30, 2017, there were 116 MySuper funds in the marketplace. The quality and value these funds offer ranges from excellent to poor. And more than a few MySuper funds are reporting net outflows, with no credible plan in place to ensure their business model remains sustainable in the years ahead. In a pure free-market scenario, that might be fine, but the whole point of the MySuper system is to act as a vetting process to ensure all default members are in an appropriate, high-quality, reliable and good value fund. The Productivity Commission is due to unveil the final report from its Inquiry into Default Models for Superannuation before the end of August. How the government responds to the commission’s advice is tipped to overhaul dramatically the mechanisms by which employer groups and unions decide which super funds win default business. Whatever new model for allocating default funds we wind up with, a stronger MySuper licensing regime should ensure a better baseline outcome for the working public.

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ADVISORY BOARD MEMBERS Graeme Arnott, chief executive, StatePlus | Richard Brandweiner, partner, Leapfrog Investments | Peter Curtis, head of investment operations, AustralianSuper | Joanna Davison, chief executive, FEAL | Brian Delaney, global head of clients, QIC | Kristian Fok, executive manager for investment strategy, Cbus | Damian Graham, chief investment officer, First State Super | Sheridan Lee, principal, Shed Enterprises | Geoff Lloyd, managing director, Perpetual | Graeme Mather, head of distribution, product and marketing, Schroders | Damien Mu, chief executive, AIA Australia | Mary Murphy, chief digital officer, First State Super

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e q u i t i e ss um m it .com .au CONTACT Emma Brodie | emma.brodie@conexusfinancial.com.au | 02 9227 5708

\ CIO PROFILE

By Sally Rose + Photos Matt Fatches

AN OBSESSION WITH peer-relative benchmarking and a gross failure to build trusted engagement with members is endangering the Australian superannuation industry’s social licence to operate, argues Sean Henaghan, the chief investment officer and director of AMP Capital’s multi-asset group. Henaghan spoke to Investment Magazine about how his team is structured to eschew the peer-relative mindset in favour of a focus on meeting absolute targets, and how the industry must evolve to shore up trust. AMP Capital, which is the wealthmanagement arm of ASX-listed financial services giant AMP Ltd, has a total of $165.4 billion in funds under management. The multi-asset group that Henaghan heads up is responsible for $85 billion of that. Seven senior executives report directly to Henaghan, including well-known media commentators AMP Capital’s head of investment strategy and chief economist Shane Oliver, and head of dynamic markets Nader Naeimi. However, it is the multi-asset portfolio management team, headed by the more low-profile Debbie Alliston, that Henaghan describes as the “key source of competitive advantage” in the business. Alliston’s team has ultimate accountability for the performance of nearly all of the 45 funds in the broader multi-asset group, and the freedom to manage portfolios without the constraints of being benchmarked against a strategic asset allocation. There are still a handful of funds within the group operating under peer-relative mandates, mostly small corporate funds that remain as a legacy of AMP’s troubled takeover of AXA Asia Pacific six years ago. Still, the dominant multi-asset approach is quite rare within the Australian institutional asset management industry. “Our industry has always acted like picking the manager is the most important thing, but manager selection is just icing on the cake,” Henaghan says. “The most important decision we need to make is which idea or which market to invest in…How we then invest in that theme or market is second order.”

AUGUST 2017

Henaghan says the industry is endangering Australians’ compulsory retirement savings by clinging to its index and peer-relative benchmarks. To illustrate the problem, he recalls how AMP Capital outperformed its peers but ultimately failed to meet its objectives during the global financial crisis in 2007. “Everybody knew equities were overvalued,” Henaghan recalls. “We’d scaled back our active risk compared to the peer group...but we still went over the cliff with everyone else.” He fears the prevalent attitude that losing other people’s money is OK so long as a fund still outperforms its benchmarks will spell disaster in the next major market crisis, prompting another exodus out of large-scale, sophisticated, pooled-funds and into selfmanaged super funds. “What happens after something like the GFC is the member says, ‘Bugger you, I’m not paying 100 basis points to lose my money. I’m going to set up an SMSF myself,’ ” he says. “Well, the average SMSF has 40 per cent in Aussie banks and high-yielding stocks, 40 per cent in cash, and 20 per cent in international stocks and property. That’s a shocking portfolio and people are doing that because we as an industry have failed them.” Henaghan’s former boss, David Kiddie, who held the title AMP Capital CIO and head of the multi-asset group and specialised investment teams from 2009 to 2014, instigated the organisation’s reshuffle into its current multi-asset approach in the wake of the GFC.

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CIO PROFILE \

SEAN HENAGHAN, the chief investment officer and director of AMP CAPITAL’S $85 billion multi-asset group, doesn’t mince words about the CHALLENGES his fund and the industry face or the need for his COMPETITORS to be less concerned with comparisons and more amenable to collaboration.

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\ CIO PROFILE

CASE FOR LIFECYCLE PRODUCTS

Compatible with the philosophy of running funds without reference to a strategic asset allocation, AMP Capital’s default MySuper option is a lifecycle product, rather than the typical one-size-fits-all balanced fund approach. Henaghan uses a river-crossing metaphor to expound on why the lifecycle approach to default, where asset allocation is actively managed along a glide path as members approach retirement, is a “more fit for purpose” model than running a single balanced fund. “Imagine you are trying to help a bunch of people cross a river that on average is [a metre] deep, but there are pockets that are [2 or 3 metres deep]. Under your balanced fund scenario, 20 per cent of your members are going to drown. But hey, that’s OK because on average we did OK. No. We want to manage that sequencing risk to get everyone across the river.” One of the next projects for AMP Capital will be to develop a comprehensive income product for retirement (CIPR) to offer as a default option to retiring default members, as a complement to the lifecycle funds. Ultimately, Henaghan would like to develop a cradle-to-grave solution.

S e a n H e n a gh a n CIO AND DIRECTOR OF MULTI-ASSET GROUP AMP CAPITAL | Since 2014 PREVIOUS ROLES 2006 – 2013 1995 – 2006 1990 – 1995 1987 – 1989

AMP Capital Investors, investment director multi-manager and investment solutions. Watson Wyatt, principal Sovereign Insurance, investment liaison in actuarial office Merrill Lynch, middle office contractor

EDUCATION 1982 – 1984

University of Otago, bachelor of arts, mathematics and economics

2007

Macquarie University Graduate School of Management, executive certificate

2010

INSEAD, international executive program

A M P Capital m ulti- a sset group sen ior ma nage me nt AMP Capital multi-asset group (FUM $85 billion)

SEAN HENAGHAN

AMP Capital multi-asset group is a division AMP Ltd’s wealth-management arm AMP Capital (total FUM $165.4 billion)

DEBBIE ALLISTON Head of multiasset portfolio management

CIO and director multi-asset group

NADER NAEIMI

SHANE OLIVER

Head of dynamic markets

Head of investment strategy and chief economist

AUGUST 2017

TANYA DEBAKHAPOUVE Head of market solutions

JEFF ROGERS Chief investment officer, IPAC

LEANNE BRADLEY Head of tailored investment solutions

SONG HONG Senior business manager

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CIO PROFILE \

RETIREMENT SOLUTIONS

Henaghan is “deeply disturbed” by the trend for retirees to favour passive, conservative funds in the current lowyielding market. What retirees need is a portfolio designed to specifically target volatility, income, inflation and longevity risk, he says. The missing building block at the moment is the ability to manage for longevity risk, but Henaghan is hopeful that having made deferred annuities legal from July 1, 2017, the government will pursue further reforms to make them more compatible with the age pension asset test. He says that, along with offering retirees better products, the industry also needs to do a better job of communicating with superannuants as they approach retirement, so they are better prepared. “Telling members they’ve got a $100,000 balance is a wealth fallacy,” says Henaghan, who is an advocate for providing retirement income projections, rather than just account balances, on statements.

CANARY IN THE COAL MINE

With a history as one of the first big pension managers in Australia, AMP’s superannuation business has been under pressure in recent years as its client base has aged and started drawing pensions without a corresponding uptick in new young members, leading to net outflows. Henaghan doesn’t sugar-coat the challenge that presents to the business. “Absolutely that [net outflow] is a problem. That is telling us something. It is telling us that we are not relevant,” he says. “This is serious.” A challenging macro-economic environment also means the outlook for average investment returns over the next decade or so is set to be significantly lower

Your real IP is in your people, not in the stocks in your portfolio than consumers have grown accustomed to over the past decade, since the GFC. This raises the risk of waning public support for compulsory superannuation if the system can’t keep delivering results. “I think there is a big risk to mandated super, because people somehow think managing money is easy and I think that is partly because we haven’t effectively communicated what it is we do,” Henaghan says.

RADICAL TRANSPARENCY

In order to forge stronger engagement with consumers, the industry needs to push itself to become more transparent, Henaghan says. He lambastes those who have opposed incoming regulations to force all institutional investment managers to be far more transparent about their portfolio holdings on the grounds it would compromise their intellectual property (IP). “How arrogant,” he exclaims. “Anyone who reckons the rest of the industry would be just waiting to see their holdings to copy them is just kidding themselves.” He thinks the new rules, which were recently delayed for two years amid fierce opposition from the industry, are “brilliant” and plans to ensure his team is complying with them before the end of 2017. Henaghan predicts that as consumers become more digitally savvy they will demand more information about how their money is invested, rejecting institutions that refuse to provide it. Plus, he argues it is an outdated notion for funds to think about their IP as residing in

their research or investment records. “When I started in the industry 30 years ago, the theory went that your IP was only valuable if you protected it,” he explains. “Well the world has changed and now your IP is most valuable if you share it. Your real IP is in your people, not in the stocks in your portfolio.”

BUILDING AN IP NET WORK

In line with this, Henaghan wants to create an “IP network” based on building deeper relationships with other asset owners and managers. He credits Schroders, Wellington Management, T. Rowe Price, JP Morgan Asset Management and PIMCO as examples of global funds management firms that take an open approach to sharing IP with their clients. AMP Capital also shares IP with Australia’s $148 billion Future Fund. The sovereign wealth fund’s chief executive, David Neal, and Henaghan are old mates, having worked together at Watson Wyatt, where Neal rose to head of investment consulting. The personal connection helped set the stage for the collaboration, but it also helps that the two organisations are not in competition and share a multi-asset approach. Members of the investment teams from the two organisations meet to discuss their latest strategic thinking about everything from investment theory to front-office technology projects. Henaghan finishes our interview by offering an “open invitation” to any other funds that want to get together and talk.

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AUGUST 201 7

\ P OLITICS

BILL Shor ten

Th e

MAN

most AUGUST 2017

L I K E LY investmentmagazine.com.au

P OLITICS \

BILL SHORTEN wants to be the next prime minister of Australia and is IN WITH A FIGHTING CHANCE. Should he succeed in leading the Australian Labor Party to form our next government, one of the first things on his to-do list will be to establish the party’s promised ROYAL COMMISSION into the banking and financial services sector. By Simon Hoyle + Photos Andrew Taylor

HEN BILL SHORTEN first formally lobbed his threat at the big end of town back in April 2016, it immediately struck a chord with large swathes of the voting public. Support for Labor’s proposed royal commission into the banks has gathered steam ever since, seemingly prompting Prime Minister Malcolm Turnbull to respond with his own displays of getting tough on the sector. Polling day is probably still more than 12 months away. But with every passing day that the Coalition Government remains internally riven by factional divisions, the odds against an incoming Labor government shorten. Investment Magazine sat down with the opposition leader in his Canberra offices for an exclusive interview, in which he took aim at “fee-gouging” bank-owned superannuation providers and outlined the reasons behind his determination to launch the much-touted royal commission. The inquiry has been estimated to take two years and cost about $53 million. In comparison, the Royal Commission into Trade Union Governance and Corruption reportedly cost more than $46 million. Shorten says it would be money well spent. “We’ve tried just about everything else,” he says. “A royal commission is the king of all inquiries. It has the power to look behind… there are basically no excuses you can give not to give evidence. It has very strong powers.” And those powers are needed to address “a pathology” in elements of the banking sector and the financial services industry that creates a lack of accountability, he says. “Too many problems occur too often,” Shorten asserts. “And every time it does, we all get the mea culpas and they say it won’t happen again, until the next time.”

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As for what tangible outcomes might be gained from such a massive undertaking, Shorten says Labor would “have a serious look” at setting up a compensation scheme for victims of bank malpractice.

INDUSTRY VS RETAIL FUNDS

Labor’s plans for a royal commission were hatched amid the fallout from the current government’s Royal Commission into trade unions that turned a spotlight on alleged misconduct within the industry-fund sector. A Labor-instigated royal commission into the banks would ratchet up the already fierce partisan rivalry between the retail and industry superannuation sectors. “We haven’t finalised the terms of reference, so I wouldn’t want to say a particular issue in superannuation is a particular focus,” Shorten says. “But we’ll look at case studies where there have been problems across financial services and banking.” The political divide within superannuation is driven by fundamental differences of opinion and ideology, which Shorten says are embodied in the Coalition’s set against the industry funds. “I can’t think of any other sector of the Australian economy that represents literally hundreds of billions of dollars where the government wages such an ideological war,” Shorten says. “But industry funds, I think, are good competition for banks in superannuation: low fees, good performance.” The Turnbull Government has drawn the ire of the union-aligned industry-fund sector

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with moves to smash its equal representation board model and gut the role of the Fair Work Commission in arbitrating how employers select default funds for their workers. New rules around how funds must disclose their underlying portfolio holdings, and the fees and costs associated with those investments, have also been controversial. Shorten says he believes choice – of fund and investment options – is an important pillar of the superannuation system; however, he argues it should not cost “an arm and a leg” or be hindered by unethical practices. “If something is not performing, you should be allowed to pull out,” he says. “But choice is getting undermined, quite often, by life insurance products now. People reach a certain age and all of a sudden they’re stuck in a bank fund because they can’t get a comparable life insurance policy in another fund, but they keep getting gouged on fees.”

AUGUST 2017

FEE GOUGING

However, the purpose of superannuation may ultimately be defined, “it wasn’t created to make the banks rich”, Shorten says, with a nod to the ongoing stoush over the exact wording of a proposed legislative definition for the objective of the mandated retirement savings system. In August, the Productivity Commission is due to deliver its final report on the allocation of individuals to default funds under the industrial award system and alternative ways of doing it, potentially that could open up greater competition between industry and retail funds. Shorten shrugs off the need for change, saying competition for default funds is already “not too bad”. “The government is just hung up on unions and industry funds, that’s [the root of] it,” he says. “It’s all politics. Competition for default funds is not a bad idea at all. But by the same token, people have choice [of fund] when they move around.” It’s true that most Australians are now entitled to choose their own super fund, but there are still about 2 million people who can’t, due to their specific workplace determination or enterprise bargaining agreement. Under Shorten, Labor has opposed the Turnbull Government’s push to change this. Shorten says super funds generally deliver “pretty good returns”, and communication with members about features and choice is improving. “I think that’s important,” he says. “The more control you give to individuals in their lives, the more granular quality you get in relationships.” Even so, a continued focus on minimising costs, and on ensuring fund members are getting value from service providers is needed. Shorten reserves particular scorn for a style of funds management that masquerades as active, and charges a fee accordingly, but delivers quasi-index returns. He is equally scathing of funds that charge high fees for individuals with “modest accounts, in vanilla investment products”. “If they’re giving you Commodore service, they shouldn’t charge you Rolls-Royce fees,” he says. “It’s a regulated, mandated flow of capital, and people are making a lot of money out of just indexing.”

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Women, on average, have much lower account balances. Paying women equally to men would be a good start

By 2001, Shorten had been elected AWU national secretary, a role that brought him to Australiawide prominence as a skilled negotiator and media performer during the Beaconsfield mine disaster in 2006. He parlayed the resultant profile into a political career that started in 2007 when he was elected to Federal Parliament. In 2010, he embarked on a nearly three-year stint as minister for financial services and superannuation and was elected leader of the opposition in 2013. During his time with the AWU, Shorten came to an understanding of what he calls the “43-year-old rule”: that until people reach the age of about 43, they are just not engaged with superannuation. “You start thinking about your next 20 years and what you’re going to have when you retire in your 60s,” he says. “There’s no science to it [but] at literally hundreds of workplace meetings, the young people, they’re interested in getting their house. The older people, they’re interested in what they’re going to get when they retire.”

SUPER’S SHORTCOMINGS

His advice to funds is blunt: “Charge less for doing the vanilla products, and always remember whose money it is. “It’s not the money of the trustees; it’s not the money of the people [working] in the funds. It’s the beneficiaries’. It’s the account holders’. It’s not the only factor, but if you don’t focus on costs, they’ll get away from you every time.”

THE ‘43-YEAR-OLD’ RULE

Shorten’s experiences as a union official and fund trustee have imbued him with a deep understanding of what superannuation means to working people, as well as an insight into how the industry works. He first joined the Australian Workers Union (AWU) as a trainee organiser in 1994. From 1998 to 2001, he was a director of AustralianSuper, the country’s largest industry superannuation fund, then from 2005 to 2007 he sat on the board of the Victorian Funds Management Corporation.

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When Labor introduced the superannuation guarantee under Bob Hawke and Paul Keating, it was designed to provide all working Australians with access to the sort of retirement savings system previously available only to well-paid, white-collar workers. But 25 years later, Shorten concedes that the system still doesn’t serve low-income earners or women particularly well. He proffers assurances that these shortcomings will be addressed by a series of Labor policies to be released before the next election. Shorten describes as “just hopeless” the current freeze on the rate of compulsory employer contributions under the superannuation guarantee at 9.5 per cent, with plans to reach the originally outlined 12 per cent delayed until 2025. One can assume, then, that he and shadow treasurer Chris Bowen have a plan to figure out how to finance fast-tracking that timeline. Addressing the system’s shortcomings as they affect women specifically will be an even more complex challenge. The Association of Superannuation Funds of Australia (ASFA) states that in 2013-14, the average superannuation account balance for

a man was about $98,500, while for a woman it was less than $55,000. “It’s a big issue…we’re working on our policies there. We see it as a gap in the current system,” Shorten says. “Women lose their super when they go on parental leave. The pay gap is real. In the public service, it’s 8.6 per cent; across Australia it’s nearly 20 per cent. Women, on average, have much lower account balances. Paying women equally to men would be a good start, because then the 9.5 per cent would be the same for everybody. Get more women into positions of power.” For all of the system’s shortcomings, Shorten still sees many more positives than negatives to compulsory super. One obvious marker of the system’s success is the $2.3 trillion pool of capital that has accumulated since 1992. “It’s created greater liquidity in our markets, and it’s meant that people have something to retire upon other than potentially just having their house. It’s diversified the asset base of Australians.” Shorten says Labor will continue to resist policies that conflate the purpose of superannuation with other objectives, such as the Turnbull Government’s First Home Super Saver Scheme, which allows first homebuyers early access to voluntary contributions, and earnings on those contributions, to fund a first home purchase. Labor took a much more radical and comprehensive plan to help address housing affordability to the 2016 election, pledging to reform negative gearing and concessional capital gains tax rates. The party has promised to stick with that proposal at the next poll. “The government needs to stop tampering with first homebuyers’ schemes, raiding superannuation. I don’t agree with that,” he says. One of Shorten’s key criticisms of the new First Home Super Saver Scheme is that it will not be any help to those who are least able to afford their own home. “It’s only going to benefit people who have the capacity when they’re young to put money in at a tax-preferred rate…not those people who are locked out of the housing market,” he says. “If there’s money sloshing around in the system, it doesn’t deal with supply…it’s [just] a price stimulus,” he says. “The point is, we’re now talking about housing affordability…and that’s not the purpose of superannuation.”

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AN INVESTMENT MAGAZINE INFOCUS REPORT, sponsored by PIMCO

ESG GAINS POPULARITY

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For fixed income investors wanting to incorporate ESG FACTORS, it is NOT ENOUGH to mimic the approach equity managers take. Demand is emerging for SPECIALIST PRODUCTS to meet the specific needs of fixed income investors.

Deborah Johnson

IN RECENT YEARS, it has become de rigueur for equity investors to incorporate environmental, social and governance (ESG) principles into their portfolios. Now, increasingly, fixed income investors are doing the same although, as analysis from the United Nations-supported Principles for Responsible Investment (PRI) shows, they have a lot of catching up to do. As the world’s leading proponent of responsible investment, the PRI encourages investors to use responsible investment to enhance returns and better manage risks. Each year, it scores how its signatories have performed in relation to implementation of the PRI’s six principles across various asset classes, and provides a median figure to enable peer comparison. The PRIs annual report card on how major asset classes are tracking on ESG, based on data provided by the group’s 1750 global signatories, shows fixed income portfolios are lagging. While median scores in the 2016 PRI assessments for equities were A’s and B’s, scores for the various fixed income categories ranged from C’s to E’s – an E denoting those not implementing responsible investment at all.

AUGUST 2017

“ESG in fixed income is catching up quickly but it will take some time before it’s as widely used as in the equity space,” PRI managing director Fiona Reynolds says. “Because it’s a newer area, best practice is still emerging but scores will increase over time as practice and tools develop.” PIMCO, a firm among the world’s largest fixed income management houses, introduced one of the first socially responsible investment bond funds in 1991. However, it wasn’t until April 2017 that its first dedicated ESG fund, the PIMCO ESG Global Bond Fund, was launched in Australasia. The fund is part of its global ESG investment framework, which was developed over six years by a firm-wide working group that included investment and client-facing teams and was led by Alex Struc, portfolio manager and head of ESG portfolio management at PIMCO. Struc says the group drew on the PRI principles in formulating the framework, which has three pillars: exclusion, evaluation and engagement. These are applied in the most relevant and meaningful ways to the different asset classes the firm manages. In its 2016 Fixed Income Reporting Module, the PRI cautions that although certain responsible investment activities can be carried out across both equities and fixed income, such as engagement and screening, the approaches are different. This is necessary because the differences between fixed income and equities pose unique challenges for each, Reynolds says. “Lenders have a contractual relationship with borrowers; they are not owners,” she explains. “Debt holders don’t vote at AGMs,

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Engaging collaboratively with companies in relation to ESG can influence long-term change. It provides us with an insight into the future and access to management can be relatively infrequent. Fixed income investors also have to deal with issues such as multilayered analysis (like yield spread and yield curve) and multiple issuer types (such as corporate, government, financial sector and supranational).” Even within the broad fixed income asset class, Reynolds argues, there’s a need for a specialist approach. “Widespread incorporation of ESG hinges on: a stronger consensus on which available ESG indicators give the most insights; more ESG research coverage for high-yield, emerging market and non-listed issuers; and a better understanding of how bondholders can manage ESG risks by engaging issuers.” The complexities of integrating ESG in fixed income and the related lack of available products have been cited as reasons for the relatively low take up among asset owners. Locally, of 115 products approved by the Responsible Investment Association Australasia’s (RIAA) certification program, only three are fixed income offerings. RIAA chief executive Simon O’Connor agrees that incorporating responsible investment and ESG across the various types of fixed income investments is not just a matter of replicating the approach used for equities. “ESG issues differ by sector, company and asset class,” O’Connor says. “Just as market trends affect different companies in different ways, all investments are exposed to varying levels of ESG risk. This complexity means there is no single method for assessing ESG and ethical risks.”

THE THREE E’S OF ESG

Struc says the process behind the PIMCO ESG Global Bond Fund is based on the “three E’s of ESG”: exclusion, evaluation and engagement. Exclusion means corporate bonds issued

AUGUST 2017

by companies with business practices that are misaligned with sustainability principles are excluded. “We have a specialist group that meets monthly to discuss exclusions; these are split between a core list and a dynamic list,” Struc says. Evaluation means issuers are evaluated based on past and current behaviour. For every potential investment, PIMCO’s ESG team independently scores E, S and G factors, looking at the materiality of the risk to the balance sheet of that particular sector or company before weighting to generate a numeric ESG score. “For example, ‘E’ has a smaller relative contribution when assessing the ESG profile of banks compared to utilities,” adds Struc. We also identify best-in-class ESG practices by evaluating how an issuer’s ESG score compares with peers and whether it is improving over time.” Engagement, meanwhile, means interaction with companies. “Engaging collaboratively with companies in relation to ESG can influence long-term change,” Struc says. “Companies with aboveaverage ESG scores can be further improved through proactive influence and companies with less stellar scores may offer us the opportunity to really move the needle.” Struc adds that, as an equity holder, PIMCO’s ESG team takes quite a different approach. “We think like a treasurer, so as to assess a company’s ability to change, engage like a partner so as to unlock a company’s willingness to deliver results, and hold to account as a lender, to ensure a company’s progress,” he says. For sovereign bonds, PIMCO modifies its ESG framework. Sovereign bonds issued by those countries in the bottom 15 per cent of the global transparency index are excluded.

Evaluation takes place with a primary focus on governance but also incorporates environmental and social indicators. PIMCO has found that serious ESG issues can usually be correlated with the financial health of a country, along with its investment credentials, thus ESG plays an integral role in assessment of the investment opportunity. There is no formal engagement. Struc says: “With sovereigns, you are also investing in a global macro trade. US treasuries are not just about the US, they may be part of a ‘flight to safety’ trade in turbulent markets – a risk-off strategy.” The options available to fixed income investors have evolved from exclusionary screens through to specialist categories that are making a positive impact, such as green bonds. There are also several diversified fixed income funds that incorporate ESG.

MORE THAN SCREENING OUT

PIMCO’s ESG Global Bond Fund was designed to achieve returns consistent with other core bond strategies while also making a positive social impact. Its benchmark is the Bloomberg Barclays Global Aggregate Index hedged into Australian dollars, which reflects the aspiration to incorporate ESG without sacrificing performance. Struc describes it as “mobilising traditional fixed income capital for the purpose of change”. Reynolds calls PIMCO’s ESG Global Bond Fund a good example of how ESG strategies can be used across the fixed income sector. “For many investors, screening out undesirable investments does not go far enough,” she says. One such investor, the New Zealand Anglican Church Pension Board was a seed investor in the NZ PIMCO ESG fund. Its investment chief, Simon Brodie, explains: “It’s rare to find a global bond fund that meets socially responsible investment criteria. What PIMCO offers aligns closely with our investment strategy and the principles of our ethical investment philosophy.” The launch of PIMCO’s ESG fund is timely. The PRI states that fixed income is one of the fastest-growing areas of responsible investment activity for asset owners. It has already gathered more than $1 billion from large institutional and smaller retail investors. With more widely available ESG investment products, and greater interest from asset owners, a virtuous circle for responsible fixed income is formed.

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THE MAJORITY OF superannuation funds have no clear strategy for servicing the needs of retirees and pensioners, and there remains a scarcity of solutions on offer to allow members to better manage the various risks they face in retirement. Until now, the flow of people retiring with substantial balances has been barely a trickle. But with the population ageing and the super system maturing, that trickle is about to become a flood. To stimulate greater action, Treasury has been consulting on the development of a framework for comprehensive income products for retirement (CIPR), or MyRetirement products. It is not so much the accumulation of retirement savings but the income those account balances generate in retirement that counts. After contributing over the years, and in many cases making huge sacrifices, Australians deserve to know that they will have enough income to live securely in retirement. Treasury has consulted extensively on its preferred regulatory approach for CIPRs and its discussion paper flags a number of issues and alternatives for further consideration. BY It follows progress already made in PATRICIA PASCUZZO removing some regulatory impediments to product innovation, although we still await a decision on the social security Patricia Pascuzzo is the founder and executive director of the Committee for treatment of these products.

Sustainable Retirement Incomes.

TIME FOR ACTION

It is disappointing that the discussion paper hasn’t generated as much attention within the industry as it deserves, and certainly less than other superannuation reviews going on at this time. While the prevalence of small account

Trustees need to get pro-active on MyRetirement Too many SUPERANNUATION FUND TRUSTEE BOARDS are biding their time when it comes to DELIVERING next-generation retirement income products. investmentmagazine.com.au

balances is perhaps one reason for the underwhelming response, compounding factors are that the government has said it won’t force trustees to offer a CIPR and, if trustees do offer them, the government prefers that each fund provide a single, mass-customised product. There is some debate as to whether these approaches will lead to the best outcomes for members. Under the proposed rules, trustees may decide it is all too difficult and do nothing. Too many trustees are ill-prepared or simply believe they still have plenty of time to prepare for their members’ future retirement income needs. But trustees have a duty to act in their members’ best interests. As more members enter or approach retirement, funds will need to pay more attention to how they can deliver retirement incomes. Offering good retirement solutions will be critical for member retention. A prudent trustee board will have a systematic and regular approach to understanding members’ needs, including their retirement income needs.

THE MISSING PIECE

As it stands, the government’s CIPR proposal offers trustees the binary option of following specified product requirements or doing nothing at all. What is missing is an overarching framework that encourages trustees to make progress at an appropriate pace in helping members transition to retirement. An appropriate starting point is for trustees to consider the impact of demographic change on the movement of members into the retirement phase and the implications for the fund’s strategy and business plan. Trustees should develop a retirement benefit strategy for their fund that includes consideration of the needs of the membership, the retirement products and options to be offered, and whether they will be manufactured internally or by a third party. There is an important role for the industry to play in helping shape the market and support members. This includes setting industry product disclosure standards and guidelines relating to CIPRs. It is in the best interest of funds to take a co-operative approach to building the necessary confidence among their members, now and into the future.

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\ GEOP OLITICS

ALL EYES o n CHINA

As CHINA’S COMMUNIST PARTY readies for its five-yearly LEADERSHIP reshuffle, global investors are watching closely to see WHO WILL WIELD POWER and how they’re poised to manage the world’s second-largest economy as it faces up to its DEBT DILEMMA. By

Greg Earl

AUGUST 2017

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A TRULY GLOBAL CHINA

WHEN XI JINPING was settling in as China’s new president in 2013, an animated cartoon presenting his path to power as much more challenging than that of newly re-elected US President Barack Obama went viral. The message for Chinese viewers was clear: Xi had worked his way through 16 grinding jobs over a 40-year political career, while Obama had somehow emerged as a shooting star from a pugilistic system built on glib speeches and money politics. Later this year, Xi is set to join an elite group of Chinese Communist leaders who have had the chance to exercise paramount power for at least a decade, while the US is embroiled in speculation about the possible impeachment of President Donald Trump. How Xi’s rise is presented will say much about how he sees his place in the world. China’s five-yearly transfer of power within the Communist Party – which flows down through the central and provincial government ranks – is due to begin by the middle of October, although it could happen earlier if the opaque power brokers can reach a consensus. With Xi certain to retain his jobs as party general secretary, state president and head of the military, the main interest will be in which new people in the seven-member Politburo Standing Committee look best qualified – in terms of age, experience and factional ties – to take over as leader in 2022. The transition in the leadership has already been reverberating around the country over the last year, with a major turnover in senior financial regulators and shuffling of political jobs to pave the way for renewal of the roughly 200-member Communist Party Central Committee.

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Once Xi has been formally elevated to the status of two-term party leader, he will be able to start comparing his achievements to those of Mao Zedong and Deng Xiaoping. There will be intense interest in how he faces up to mounting economic, demographic and environmental challenges that have at least partly been sidelined as he has been working on strengthening his political base. “This is the first party congress of a truly globalised China,” says British academic Kerry Brown, who argues that, for the first time, Xi and the other power brokers have to take account of how an uncertain world will view the regime’s new look. A year ago, Brown says, Xi might have been inclined to throw his weight around and ignore conventions on matters such as retirement age or the need for a potential succession plan. But now, amid rising global economic and political uncertainty, he will see a need and value in projecting a more calm and conventional approach. Linda Jakobson, chief executive of the Sydney-based public policy initiative China Matters, predicts this 19th Congress will be relatively smooth, compared with the delayed 2012 Congress, from which Xi emerged as leader after an unusually bitter public brawl with a populist regional rival, Chongqing party chief Bo Xilai. “There’s nothing that big on the horizon,” she says, but warns that, below the veneer of calm, even seemingly all-powerful modern Chinese leaders like Xi are consumed by a sense of “existential anxiety”. Despite their

success over the last 35 years, she says, China’s top leaders are “incredibly insecure” about how best to ensure the Communist Party stays in power. This insecurity may well become even more all-consuming during Xi’s next five-year term, as the Communist Party contemplates its 100th anniversary in 2021. Regardless of the new top leadership’s makeup, it will inherit a wide-ranging and sophisticated economic and public-sector reform program that was set out in 2013 but has been only modestly implemented, as Xi has concentrated on reinforcing his power, cracking down on corruption and pursuing a more assertive foreign policy. How the new leadership takes up the 2013 Third Plenum recommendations on issues such as state enterprise privatisation and the role of markets has become more critical for the Australian funds management industry with the recent decision to include Chinese shares in the Morgan Stanley Capital Index benchmark for emerging markets. Australian fund managers have, until now, tended to focus more on Australian assets with exposure to China or the impact of Chinese actions on global markets, rather than on direct investment in Chinese assets. However, in June, MSCI decided to add the shares of 222 Chinese companies to its emerging markets index gradually, after rejecting them three times before because of limitations on capital movement and opaque regulation. The country’s largest industry fund, AustralianSuper, has played a pioneering role in focusing on the rise of China. The fund opened a small Beijing office and

NON-FINANCIAL DEBT-TO-GDP RATIO

SOURCE: BIS

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MOST OF THE SENIOR CHINESE LEADERSHIP IS EXPECTED TO CHANGE AT THE PART Y CONGRESS

XI JINPING: the president will stay and may provide signals about whether he will remain in power beyond the next five years.

LI KEQIANG: the premier will almost certainly remain but seems to be losing power over economic policy to Xi.

WANG QISHAN: the anti-corruption chief may survive compulsor y retirement to play more of a role in economics.

Vice-Premier ZHANG GAOLI, Communist Party secretariat chief LIU YUNSHAN, National People’s Congress chairman ZHANG DEJIANG and People’s Political Consultative Conference chairman YU ZHENGSHENG are all set to retire. This will probably make way for two future potential presidents to emerge.

Watchpoint: The membership of the Standing Committee of the Communist Party Politburo was cut from nine to seven in 2012 and may be cut further to five.

C H I N A’ S n e w L O O K FOUR OUT OF FIVE TOP FINANCIAL OFFICIALS HAVE ALREADY BEEN REPLACED IN THE LAST YEAR, SUGGESTING THAT STABLE FINANCIAL MANAGEMENT IS SEEN AS CRITICAL TO LEADERSHIP CHANGE

People’s Bank of China: ZHOU XIAOCHUAN, 69, is the longest serving senior finance official after 15 high-profile years at the central bank, raising big questions about who will replace him.

Finance minister: Outspoken reformer LOU JIWEI was replaced last November, despite tackling local government finance reform. Replacement XIAO JIE is a lower-profile former tax official.

China Banking Regulatory Commission: GUO SHUQING, 61, was appointed in Februar y to clean up a debt-laden banking system without disrupting growth.

China Securities Regulatory Commission: Former central banker LIU SHIYU, 56, was appointed last year to avoid a repeat of the stock market disarray seen in late 2015.

China Insurance Regulatory Commission: Former head XIANG JUNBO was fired in April (and has not yet been replaced) after letting the sector expand too quickly, and is now under investigation.

Watchpoint: Debate is under way about a super-regulator to co-ordinate these issues.

AUGUST 2017

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appointed Stephen Joske as a China-based senior manager in 2012. That job is more about analysing China’s role in global markets than direct investment. But, as a director of another major industry fund told Investment Magazine, the long-mooted MSCI change will force funds to take a more formal position on whether and how much to seek direct exposure to Chinese assets. “Now, if you are in a leadership position in a fund, you need to think about what is happening in China,” says the director, who did not wish to be named. “The Australian economy and what’s happening in China was always there on our agenda. But I would now expect to see more visits by global equity teams.”

POTENTIAL DEBT BOMB

Another superannuation fund representative says the industry is underexposed to China but still cautious about direct exposure there because of debt concerns. In May, ratings agency Moody’s Investors Service bluntly defined the long-term economic challenge facing the incoming new leadership by cutting China’s sovereign debt rating to A1, due to concerns about the country’s rising debt burden. “While ongoing progress on reform is likely to transform the economy and financial system over time, it is not likely to prevent a further material rise in economy-wide debt,” Moody’s said at the time, warning about the economy’s dependence on stimulus measures. Many Western economists based in China say that while Xi came to office amid expectations he would be an economic reformer, he has now locked himself into unrealistically high growth rates and maintenance of a large state-owned enterprise sector, which means debt levels will continue to rise. This is one of the biggest challenges facing the regime. In June 2017, China’s debt surpassed 300 per cent of GDP, certain analysts say. Some economists interviewed for this

article believe the current rate of credit creation can be sustained for only about three to five years, which means a severe credit crunch will probably be one of the biggest challenges for the new leadership. Business advisory firm IMA-Asia noted in a recent outlook: “Since China’s massive debt-fuelled investment binge in 2008-09, it has become clear that the gains from its old growth model, which favoured investment and exports over household consumption, are diminishing. The rising credit intensity of growth and rapid build-up of debt are significant threats to the economy, should Beijing continue to resist slower growth.” Those expecting some form of credit crunch within a few years tend to think that after enforcing a more authoritarian political environment in his first term, Xi is unlikely to be able to shift back to more liberal economic policies in his second term. Other, more optimistic, observers say Xi’s flagship anti-corruption campaign, which has both rooted out enemies and restored some moral authority for the Communist Party, may now become less intense, allowing more focus on economic reform. UBS economist Tao Wang expects “improved policy implementation and co-ordination but not drastic changes in policy priority or direction”. National School of Development economist Yiping Huang wrote after the Moody’s decision that it highlighted past problems, rather than future risks, because the government was taking decisive steps to deal with debt. China Matters’ Jakobson says: “If Xi gets his own people appointed, he could well start genuinely reforming because he understands that is what is needed to keep the economy going. He wants to go down in history as a transformative leader.”

EXPERIENCED HANDS

Close observers of Chinese politics say up to 10 members of the current 25-member Politburo could win one of the four to five spots likely to be vacant on the Standing

If Xi gets his own people appointed, he could well start genuinely reforming. He wants to go down in history as a transformative leader investmentmagazine.com.au

Committee and be seen as future leaders. Jakobson says Xi may not show his hand on a succession strategy but if he does, there will probably be two competing candidates. “A lot can happen in five years,” she says, recalling the way former President Jiang Zemin emerged suddenly, from relative obscurity, after the 1989 Tiananmen crisis, to become China’s senior leader. Boston University professor Joseph Fewsmith says a key thing to watch at this Congress will be how Xi somehow paves a pathway to continuing to exercise power after his two five-year presidential terms end in 2022. Fewsmith predicts that Xi will try to write himself and his philosophy into the party constitution, to give himself a status similar to Mao’s and Deng’s. “He could continue to be the central force for 10-15 years without any problem,” Fewsmith says. But Brown says the most interesting thing to watch at this Congress will be how the Communist Party demonstrates it is responsive to public concerns despite the increasing centralisation of power around Xi. “The Communist Party wants people to participate at all levels of government, just not through voting,” says Brown, who was director of Sydney University’s China Studies Centre and is now professor of Chinese studies at London’s King’s College. “The leadership is…responding to the people without multi-party democracy. That’s the story of the Congress that probably won’t be recognised outside China.” That 2013 animated ode to Xi made a big deal about how his long training in city and provincial posts contrasted with Obama’s lack of previous executive administration experience. This is one of the littleappreciated strengths of the Chinese political system; while leaders go through an opaque selection process, they can be better prepared for government administration than many new Western leaders. Case in point, one of the youngest, most widely touted potential appointees to the Politburo’s Standing Committee, and a potential future leader, is Hu Chunhua. At the age of 54, he has worked as an administrator in Tibet, was China’s youngest ever governor in Hebei province 10 years ago, was then party secretary in Inner Mongolia and is now party secretary in Guangdong province, one of the country’s richest areas. This is the sort of administrative track record that will now be examined intensely around the world when the first Communist Party Congress of global China ends.

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\ COLUMN

WHILE HESTA SHARES our industry’s strong commitment to preserving superannuation for retirement, we also believe family violence is one of those rare situations where short-term financial needs are more compelling than longer-term considerations. That’s why, in June, we called on the federal government to change regulations related to the early release of super on compassionate grounds, to allow victims and survivors of family violence to access up to $10,000 of their super as a last resort. Family violence is no less compelling a need than existing grounds for early release of super. Superannuation may already be released early under a number of circumstances – including terminal illness – and on a range of compassionate grounds, such as the need to pay for a partner’s funeral, stop the family home from being re-possessed or afford medical treatment for a chronic or lifethreatening condition. More than 80 per cent of HESTA’s 820,000 members are women who work in the health and community sector. We could not sit back knowing every year, on average, at least one

BY DEBBY BLAKEY

Debby Blakey is the chief executive of HESTA, a $40 billion industry super fund for the health and community services sector.

Family violence victims deserve early access to super There is a compelling case for EXTENDING EXISTING COMPASSIONATE PROVISIONS to allow victims and survivors of family violence EARLY ACCESS to up to $10,000 of their superannuation. woman a week is killed by a partner or former partner. As a society, we need to do more about this and as a superannuation provider we believe we share in this responsibility.

THE ‘BEST INTERESTS’ TEST

For us, it is not enough to limit our action to being a good corporate citizen providing leave and other support for our own people if they experience family violence. Given the statistics, it’s likely that thousands, if not tens of thousands, of our members may be directly

AUGUST 2017

FAMILY VIOLENCE

If you or someone you know is affected by sexual assault or family violence, call 1800RESPECT (1800 737 732) or visit 1800RESPECT.org.au In an emergency, call 000.

affected by family violence. In addition, many HESTA members are on the frontline, delivering services to victims and survivors of family violence, and see every day the enormous social impact it has on families and individuals. As trustees, if we’re to act in the ‘best interests’ of members experiencing family violence, we need to consider their short-term need for safety from what could be a potentially life-threatening situation, and their longer-term recovery from this trauma. We know finances are among the greatest barriers to leaving an abusive relationship. Financial abuse and control are almost always present in situations of family violence, yet current financial support for victims is woefully inadequate. At HESTA, we strongly believe support for those affected by family violence is the responsibility of all levels of government. The superannuation industry cannot fill this gap alone. Nor should it be up to individual women, who already retire with only close to half the super of men on average. Urgent action is needed to provide more options for those seeking safety and a life beyond violence and abuse.

A CRITICAL LAST RESORT

Accessing super should be an interim measure and another tool to stem the tragic loss of life. Super should be accessed only when there are no other appropriate financial options available and in the context of specialist financial advice and counselling. If access to super can also help a victim or survivor of family violence recover, we think that’s going to be the best outcome for their long-term wellbeing, including their financial health. We know victims and survivors of family violence have a higher vulnerability to poverty, homelessness, disadvantage and mental illness. For our members, the ability to remain connected to work and earning an income is their greatest asset and will mean they’re contributing to and increasing their super. Finally, we understand that implementation of these measures requires careful consideration and appropriate safeguards. We are consulting with expert family violence service providers about the best way to achieve and implement change. We think it’s vital to bring together all levels of government, the superannuation industry and family violence and community groups to find the best way forward.

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Sow the seeds of local investment THE SUPERANNUATION INDUSTRY has typically shied away from investing in farms and other agricultural assets. However, as DEMAND from Asia for FARMLAND BOOMS, it’s time to work to overcome the hurdles to local investment in bush communities. WITH THE RIGHT mix of investment strategy and management expertise, Australian farming can deliver local asset owners stable long-term income, along with the diversification and inflation hedging benefits typically associated with agricultural commodities. Australian-based managed funds such as Laguna Bay, Macquarie Infrastructure and Real Assets (MIRA), Warakirri BY Agricultural Trusts and Queensland STEPHEN ANTHONY Investment Corporation have already invested, or committed, more than $2.3 billion dollars to local agriculture. Stephen Anthony is the chief economist Meanwhile, international players, at Industry Super Australia. notably a handful of major Canadian pension funds and the US Teachers Insurance and Annuity Association, have invested more than $1 billion in Australian agricultural assets since 2007-08. A sharp rise in foreign investment in domestic farmland since the global financial crisis is hardly surprising. Buyers are seeking to tougher and less predictable than in North secure prime land and assets in readiness for America – can affect farm outputs. surging overseas demand. To identify the performance of shortlisted Whilst these investments represent a assets relative to sector averages, extensive vote of confidence in the local industry, research and benchmarking is required. many asset owners remain inhibited about However, with research and due diligence, adding agriculture to their portfolio mix, decent returns from agriculture are possible given several high-profile failures in the past. for institutional investors. Opportunities aside, investors must always keep in mind that agriculture investment is FOR THOSE IN THE KNOW a long-term game and should be approached One prominent concern is the view that judiciously, with consideration to how it fits the low-return, low-volatility characteristics within the overall portfolio. of agriculture make the asset class less Investors must also consider whether they competitive than other investments with have the necessary expertise in assessing a similar risk-return profile. agricultural investment and under what model Secondly, because of the generally (direct operation, leasing, joint venture or fragmented nature of agricultural industries partnership) a farm asset should be operated. and the lack of broad, standardised Within the agricultural sector, property, performance data, investors must have water, timber and infrastructure assets all in-depth sectoral knowledge and experience offer different risk-return characteristics that before committing to it. require different expertise to manage. Finally, Australian climatic conditions –

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Scale is another important factor. Since the availability of large-scale farms is limited, investors may need to consider aggregating smaller farms to achieve similar benefits.

INVESTING IN THE BUSH

Agricultural production is an essential part of the food supply chain with tremendous potential for vertical integration and automation. Going forward, smart technologies can only enhance its efficiency and global competitiveness. The local sector must position itself to supply high-quality products to the burgeoning Asian middle class where the demand for protein and ‘clean-andgreen’ produce will rise. Our proximity to Asia and the recently signed free trade agreement with China should mean greater opportunity and access for Australian exports. The wider impact on rural communities of agricultural investment cannot be overstated. A rural post code is too often an indicator of social disadvantage. In addition to providing a diversified source of returns, greater institutional investment in Australian agriculture could also help provide jobs and build sustainable, healthy bush communities. Here are some steps for boosting super funds’ investment in the bush: 1 | Establish an independent survey of farm performance to measure rates of return across crop and livestock producers. 2 | Undertake an infrastructure audit of each of the major commodity supply chains to ensure the adequacy and competitive operation of transport, processing and storage facilities across regions. 3 | Establish Australian Competition and Consumer Commission regulatory arrangements to achieve effective price discovery and transparency in wholesale agricultural markets to neutralise the impact of big supermarket and international subsidies. 4 | Develop industry and trade policies to encourage domestic operators to form consortiums with local and foreign processors and distribution networks to reduce agricultural sales risk. 5 | Require the Commonwealth Treasury to take a more strategic approach to foreign investment rules. 6 | Establish a regional development bank to provide advisory services to rural producers and arrange long-term finance to intensify operations more efficiently.

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\ TECHNOLOGY

FUTURISTS AND ETHICISTS are urging superannuation funds to get to grips quickly with what advancements in ARTIFICIAL INTELLIGENCE might mean; not just for their portfolios and the workforce, but for the very idea of what it means to be HUMAN. By

Mark Story + Simon Hoyle

ADVANCEMENTS IN ARTIFICIAL intelligence (AI) and robotics are reshaping the institutional investment management industry from all angles. Over the last decade, high-speed automated trading has already revolutionised the day-to-day operation of financial markets and robo-advice has revamped the way wealth managers engage with clients. AI is upending the profit models of many companies in institutional investment portfolios. Within funds, many workers with repetitive and numbers-based jobs are set to be replaced. But the biggest fallout on superannuation and pension managers from the changing nature of work could be how it destroys the livelihoods of millions of their clients. Tesla chief executive Elon Musk made headlines worldwide in July when he declared AI a “fundamental risk to human civilisation”. But despite a number of respected voices issuing dire warnings, the systemic risks associated with the rise of AI may still be underappreciated. Centre for the Future founding executive chairman Dr Richard Hames believes most of the superannuation industry and investment community at large seems oblivious to the fact that the traditional way in which monetary value is extracted from what people do for a living – their day job – is crumbling right under humanity’s feet. As AI technology evolves into artificial super intelligence (ASI), it will erode many job markets, Hames warns. Not only unskilled jobs, but also white-collar jobs in fields such as medicine and law. Hames predicts this will eventually lead more nations to follow the lead of Finland and experiment with the introduction of a universal basic income (UBI) to avoid the pressures of maintaining a welfare system. And he says paying people not to work has great consequences for how society values human capital into the future. “It’s conceivable that Australia will have to start addressing these kinds of issues

AUGUST 2017

within five to 10 years, and given the likely impact on superannuation, the sector needs to start thinking about it now,” Hames advises. The futurist, philosopher, corporate strategist and author has been lauded by Forbes Asia as “one of the smartest people on the planet”. Since July 2015, Hames has headed the Centre for the Future, a think tank that aims to foster collaboration to improve the world for all of humanity without ecological damage.

POTENTIAL GOOD, TOO

Shara Evans, another futurist, who is the founder of technology analyst firm Market Clarity, wants super fund executives to remember that despite a barrage of dire

predictions about AI, it has the capacity to add as much good to the human condition as it does to destroy it. Given the pace of change, however, Evans warns institutional asset owners that they can’t remain agnostic on the pros and cons of these new technologies. She recommends funds quickly establish a framework for evaluating the capacity of emerging technology either to enhance or disrupt an industry or specific company. Evans says super industry executives and trustees lack a good understanding of the massive impact job disruptions will have on their investment portfolios. “They need a better understanding of how AI and robotics are being used by the assets [in which they invest]” and must

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Assuming most companies are serious about reskilling, there’s no reason dire predictions of AI, robotics and digital technologies replacing 40 per cent to 50 per cent of the world’s jobs within 20 years have to become a reality, Evans argues.

REDEFINE BEING HUMAN

The existential

CHALLENGE

AI of

adapt their investment plans accordingly, Evans says. “Super execs should share an ethical responsibility to use their leverage as shareholders to agitate for companies to behave in a certain way when deploying these technologies; for example, [pushing for them to] invest in reskilling workers whose jobs are displaced by automation.” Ahead of the imminent arrival of Amazon in Australia, everyone is talking about how the company and its robot pickers and delivery drones will spell the death knell for less sophisticated local retailers. But the often-overlooked aspect of applying these technologies to reduce costs, Evans says, is impact on staff. She stresses that they can be reskilled and redeployed, instead of laid off. Domino’s Pizza is trialling delivery

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bots and drones to help meet its 30-minute delivery target, while removing the need to use a 2-tonne vehicle to deliver a 40-gram product. While this may have reduced the pizza chain’s need for drivers, she says it’s also arguably enabled the company to hire more staff through its new-store launch, and there are no known plans to lay off any of its current delivery drivers. “Clearly, the issue of whether AI and robotics are good or bad depends on how they will integrate into the workforce,” Evans says. It’s a pertinent comment, given Domino’s made headlines earlier this year when it was revealed the Fair Work Commission was investigating the fast-food giant for widespread underpayment and exploitation of staff.

Hames and Evans both spoke to Investment Magazine ahead of addressing the annual FEAL National Conference in Melbourne on August 3, 2017, about how AI is set to reshape the investment and operational landscape for superannuation funds. At another recent industry gathering, how financial services organisations might respond responsibly to the challenges AI brings was a major theme. Attendees of the Banking and Finance Ethics Conference, in Sydney on June 8, 2017, heard from a range of speakers about the need for finance and investment professionals to think deeply about how AI is set to reshape their own businesses and those in which they invest. The executive director of the Ethics Centre, Dr Simon Longstaff, said this might mean re-examining employment. “Maybe the future is not about securing work, or at least employment, as a potential source of meaning, so much as redefining the way in which human beings [develop] a sense of validity and purpose in their lives, which may be unrelated to work,” Longstaff said. The founder of strategy consultancy 2nd Road, Tony Golsby-Smith, said the rise of ‘thinking’ machines has an impact beyond the economic and is already becoming a political story, which presents uncomfortable ethical issues as jobs are killed, reimagined and moved around the globe. “The question is, are we facing Armageddon – the death of jobs? Are we systematically destroying jobs?” More profoundly, the integration of humans and machines raises the fundamental question of what it means to be human. Golsby-Smith AI may be creating a Frankenstein’s monster. “The artificial intelligence community can say trust us, it’s all right; well, I don’t know about you, but my trust is always a little bit mixed,” he said. “More importantly, deep, deep, down underneath it, there’s something more fundamental, which is the battle to be truly human. Just how smart can machines get, and are we smarter than machines?” As machines get smarter, perhaps professionals will be forced to rely less on their intelligence to distinguish themselves and more on their personal ethics.

AUGUST 201 7

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IF CULTURE STARTS at the top, so does accountability. Too often, when bad behaviour occurs in the corporate environment, we’ve seen senior executives and directors escape any serious consequences while more junior employees are shown the door. The need for a greater degree of accountability among top executives and directors in the banking sector was recognised in May’s federal budget. Treasurer Scott Morrison announced a suite of additional powers for regulators, including the authority to make direct adjustments to the banks’ remuneration policies and enforce new obligations on bank conduct with costly penalties. The majority of the proposed new measures relate to banks and not superannuation funds. But a measure to strengthen the Australian Prudential Regulation Authority’s existing power

In fact, the power to disqualify already exists under the regulator’s ‘fit and proper’ regime, which covers senior executives. Perhaps it is the rarity of disqualifications in our sector, credited to our strong governance practices, that allows us to forget that sometimes. In contrast, disqualifications occur frequently in the SMSF sector.

STRONG PROTECTIONS

The Australian Institute of Superannuation Trustees (AIST) will not oppose the new measure that strengthens the regulator’s power to disqualify directors and responsible persons where clear shortcomings have been identified. The right to review a decision APRA makes under these proposed new powers remains. We are, however, less comfortable with suggestions that some of the other

There is already ‘nowhere to hide’ APRA has been granted a number of new special powers. In applying them, it’s important to remember that TRUSTEES AT PROFIT-TO-MEMBER FUNDS ARE ALREADY HELD ACCOUNTABLE to a much greater degree than bank executives and directors. to remove and disqualify executives and directors is intended to apply to all APRAregulated entities, including super funds. Under existing legislation, the APRA already has the power to apply to the Federal Court for the disqualification of directors or “responsible persons” of any supervised entity. Similarly, the Australian Tax Office can also disqualify directors or trustees of self-managed super funds. The change announced on budget night would allow the APRA to remove individuals from banks, super funds and insurers without first applying to the Federal Court. Removing the need for APRA to go to Federal Court to seek director disqualification may result in quicker action but we don’t expect to see great change in the profit-to-member super sector.

AUGUST 2017

budget measures applying to banks be extended to superannuation funds for no other reason than to align regulation across the financial services sector. More clarity is needed on these new measures and how they are intended to work in practice. Meanwhile, it is important to recognise that current prudential standards provide a robust framework for the regulator to supervise and monitor super funds and require them to adopt the necessary systems and behaviours that meet best-practice governance obligations. The duties and obligations now imposed on super fund directors are already much higher than those for banks or insurance company directors. These legal obligations were heightened in 2013 as a result of the Stronger Super reforms.

BY EVA SCHEERLINCK

Eva Scheerlinck is the chief executive of the Australian Institute of Superannuation Trustees. She was formerly a practising lawyer.

Harsh penalties apply to super fund directors who breach their obligations, and rightfully so. They can be held personally liable for the payment of monetary penalties and, in extreme cases, end up in jail. Underpinning these obligations, trust law requires super trustees to take extra care as fiduciaries of others’ money.

NEW GOVERNANCE CODE

As a third layer of accountability, AIST has developed a new Governance Code that our member funds (which include industry, public-sector and corporate funds) will be required to adopt from July 1, 2018. The code, which some AIST member funds are voluntarily moving to adopt for this financial year, includes requirements around the appointment and renewal of directors above APRA’s current standards. As our industry grows and changes, AIST recognises that there is a collective need to review the way we govern ourselves, to preserve those good things that distinguish us and to further develop those areas where we can improve. In terms of accountability, directors and executives of profit-to-member super funds already have nowhere to hide. And this is exactly how it should be in a compulsory system where we act as stewards for people’s hard-earned retirement savings.

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AIST’S FLAGSHIP EDUCATION OFFERING

TRUSTEE DIRECTOR COURSE BUILT BY THE INDUSTRY FOR THE INDUSTRY

Australia’s first super-specific director course is AIST’s Trustee Director Course. Join the superannuation industry’s most experienced directors on the Enhance your Excellence program. Enhance your Excellence has been specifically developed for those in the superannuation industry with a focus on strategy, investment and board governance, decision-making and leading board discussions, which are critical to acting collectively in the best interest of members.

COURSE DATES MELBOURNE VIC October 2017: 11th, 12th, 13th, 19th & 20th SYDNEY NSW July 2018: 11th, 12th, 13th, 19th & 20th

Facilitated by AIST and leading industry experts, this unique program is delivered via a combination of interactive case studies and practical experiences that recognises an ever-changing superannuation and economic environment. Graduates will receive 40 CPD hours and use of the prestigious post-nominal GAIST (Adv.) upon completion of the program. Be recognised as a leading trustee director with up-to-date knowledge across all the required fields. Enrol now for AIST’s flagship educational offering.

MELBOURNE VIC October 2018: 10th, 11th, 12th, 18th & 19th Other states based on demand. Express your interest in 2017 by sending your contact details and preferred state via email to training@aist.asn.au.

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

JOHN BRUMBY CHAIR, MTAA SUPER

Not sure whether Enhance your Excellence is right for you? AIST can offer personalised advice on the best program to meet your needs. Phone AIST Education Manager Sally Graham on 03 8677 3840. For more information, go to: www.aist.asn.au/education

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In the boardroom, as in the classroom, the LOUDEST VOICE isn’t always THE ONE TO HEED. Recently installed VicSuper chair CHRISTINE STEWART, a former teacher and long-serving deputy secretary of the AUSTRALIAN EDUCATION UNION, is an ADVOCATE for ongoing trustee education and consensus decision-making. Edited Sally Rose + Photos Matt Fatches

CHRISTINE STEWART WAS promoted to chair at VicSuper in January 2017. The $19 billion default superannuation fund for Victorian public sector employees is recognised for its commitment to socially responsible investing and leadership in offering an innovative retirement income solution to members. In this Q&A with Investment Magazine, Stewart reflects on lessons in decision-making, communication with fund managers, and the fund’s strategic thinking around mergers and acquisitions. Q. SIX MONTHS INTO YOUR TENURE AS VICSUPER CHAIR, WHAT WOULD YOU SAY IS THE BIGGEST CHALLENGE THAT COMES WITH THE ROLE? A. Having been on the board since 2009, and chaired a range of committees over the years, I already knew all the people around the table and how the board worked so there have been no real surprises. I think the biggest challenge in being chair rather than a director is the responsibility for time management. It is important to ensure that there is adequate discussion and all views are canvassed on important issues. But once people start repeating themselves it is time to move on. Q. THE FUND LAUNCHED ITS SOCIALLY CONSCIOUS OPTION IN FEBRUARY 2017 AND AN ESG FOCUS IS AN INCREASINGLY STRONG PART OF THE BRAND IDENTITY. HOW IS ESG THINKING INTEGRATED INTO THE WAY THE BOARD WORKS? A. The focus on ESG has always been there for us, having been absolutely crucial to founding chief executive Bob Welsh when he set up the fund in 1994. It is an important part of our heritage and our members expect us to be good corporate citizens. When we got out of tobacco production

AUGUST 2017

in 2013, the reaction from most of our members was, ‘We thought you would have done that years ago.’ Their shock was a reminder of the high expectations our members have. More recently, we have talked more publicly about the way our management and investment committee work with our fund managers on ESG issues. The board also recently spent some time looking at our proxy voting arrangements to ensure our votes were being cast in line with our principles, and it was good to be reassured that they were. Q. IN JUNE 2015, VICSUPER BECAME ONE OF THE FIRST SUPER FUNDS TO LAUNCH ITS OWN VERSION OF A COMPREHENSIVE INCOME PRODUCT FOR RETIREMENT (CIPR). WHAT IS YOUR ADVICE TO OTHER TRUSTEES ON DEVELOPING NEW POSTRETIREMENT SOLUTIONS? A. Michael Dundon, our CEO, was one of the first to recognise that accumulating super savings is only half the story. Half our assets are held by people aged over 50, mostly public servants and teachers. We began with a research project breaking the membership down into different demographics, based on age, balance size, and expected time until retirement based on their industry. That allowed us to look closely at who our members were, what they needed, and what we could do for them. Management then led the work of examining a number of different options before we settled on offering an account-based pension with an annuity component. My advice to any trustee not sure what approach their fund should take to building a CIPR is to begin by having a very detailed look at the demographics and characteristics of your particular members. Don’t just follow what others are doing, it has to suit the profile of your members.

Q. WHAT IS YOUR BEST ADVICE TO INVESTMENT MANAGERS FOR IMPROVING COMMUNICATION WITH TRUSTEES? A. Remember that directors aren’t investment experts. Be mindful of the jargon, and take care to really explain things clearly. As a director, I want to understand clearly what makes [a manager] different, how that complements and adds value to our investment strategy, when they will outperform the benchmark and even more importantly when they won’t. It’s very important to manage expectations. Investment managers addressing a board need to realise that even though we might not all be investment experts, we are all genuinely interested in learning and are the people with the capacity to analyse, question and then sign-off. Q. HOW DOES THE VICSUPER BOARD WORK TO INCREASE ITS UNDERSTANDING OF COMPLEX INVESTMENT ISSUES? A. Internally, we openly discuss issues and are good at recognising where we need help and immediately getting it. Most months, we will have a one-hour training session immediately before or after our board meeting. Usually if the board is considering making an important investment decision, we’ll get some specific briefing that allows us to get a much deeper understanding of that particular asset class. The thorough processes of our investment consultants and our CIO and CEO ensure that each recommendation is thoroughly substantiated, with the investment committee openly discussing the merits of the recommendation and how it will help achieve our investment objectives.

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CHAIR’S SE AT \

Q. WHO HAVE BEEN YOUR MENTORS OR MOST IMPORTANT INFLUENCES AS A TRUSTEE? A. The first time I experienced genuine consensus decision-making was years ago when I was part of a Victorian Board of Studies Year 12 curriculum committee chaired by Elida Brereton. At the start, a lot of the men were complaining about her style – that the meetings took too long, that the discussions weren’t focused enough. But I quickly realised she was actually very focused at leading us through the concerns around the issues we didn’t agree on. The end result wasn’t a compromise but something the whole committee was genuinely happy with. I also learnt a lot about leadership from working with [AEU then-president] Mary Bluett during my time as deputy secretary of the Australian Education Union. She had little time for hecklers or people being abusive and would cut them off, but always had plenty of time for those people who just wanted to discuss the issues. At the moment, if I want any advice, not about issues but about process, I usually turn to former VicSuper chair Barbra Norris. Q. VICSUPER RECENTLY FORMED A MERGER STEERING COMMITTEE. WHAT IS THAT ABOUT AND WHAT IS THE MOST IMPORTANT LESSON THE BOARD LEARNED FROM THE 2012 MERGER TALKS WITH VISION SUPER THAT DID NOT PROCEED? A. We established a merger steering committee a few months ago, so that in the case of any future merger discussions, it would already be in place. At the time of the talks with Vision Super, we didn’t have a formal merger committee, not that I think that would have made a difference to the outcome. In terms of lessons learned from that experience, I would say the big one is that in merger talks, both parties should go in from the outset with a statement of their core values and really lay out early what the deal-breakers would be for them. There also has to be a clear business case where everyone’s members are set to benefit, if not in the immediate term then in the near-tomedium term. We are not in any detailed merger talks at the moment, although we are always open to options that are right for our members.

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LEADING STARTS with LISTENING AUGUST 201 7

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WHEN THE AUSTRALIAN chapter of the 30% Club launched in May 2015, I was hopeful we could reach a target of 30 per cent female directors on ASX 200 boards by the end of 2018. But today, with just under 18 months left to achieve our target, I am deeply concerned that we are not on track to make it. The 30% Club is a movement with proven success at increasing the number of women on boards in the United Kingdom and I was certain it could do the same here, especially given the strong advocacy and direct support of the Australian Institute of Company Directors. Our calculations showed we needed only to lift the running rate of appointment from 30 per cent women to 40 per cent and we’d easily get to 30 per cent total women on boards by 2018. That didn’t seem so hard, just a dial-up in the appointment rate from one woman for every two men, to two women for every five men. In Australia, 2016 was a great year for female appointments, with the average monthly rate right on target at about 40 per cent. Unfortunately, 2017 has been a disappointment so far. We are struggling, with the running rate languishing at 33 per cent and only 15 female appointments to ASX 200 boards over the first third of the year. As a non-executive director of several companies, and as the chair of the Commonwealth Superannuation Corporation, it is my duty to ensure that

BY PATRICIA CROSS ___

Patricia Cross is chair of the Australian chapter of the 30% Club. She is also chair of Commonwealth Superannuation Corporation and a non-executive director of Macquarie Group and Aviva.

I and my fellow directors are focused on sustainable long-term wealth creation.

THE TIME IS NOW

Over the 20-plus years I’ve served as a listed company director, we’ve come a long way. In some ways, Australia is now a paragon of

ASX 200 must get on board for gender diversity Three years ago, THE 30% CLUB set what looked like a very achievable target – to have WOMEN occupying 30 PER CENT of all ASX 200 board seats by the end of 2018. But without serious SUPPORT from major asset owners, that goal is set to slip out of reach. AUGUST 2017

virtue in terms of corporate governance and stewardship, compared with international markets. So I think it’s time for the beneficial owners of our largest listed companies to begin to flex their muscle on the diversity agenda to advocate for meaningful and sustainable change. There is a great deal of research espousing the benefits of diversity – whether it’s by gender, race, age, background or experience – and its contribution to increased company performance. There is equally compelling research regarding the dangers of groupthink and employing individuals with the same frames of reference and viewpoints. Unfortunately, many players in the equity markets focus insanely on the short term. Prime time news every night gives daily share price movements, as if individual investors should be day traders. Super funds still obsess about short-term performance. How can this be congruent with long-term stewardship? For our portfolio companies to compete globally well into the future, we need diverse individuals sitting around their board tables, challenging management and one another to perform at a higher standard. Diversity, of course, is about more than gender, but how can we achieve diversity in a broader sense when our top boardrooms bear no resemblance to 50 per cent of the population?

I urge all directors to consider their selection and appointment processes carefully to ensure they are appointing diverse directors who bring unique skills to their boards. Company directors should ask their recruitment advisers what their success rate is in appointing women to boards and get the data in fine detail. I also call on investors to have difficult conversations with those boards at their portfolio companies that don’t exhibit gender diversity and ensure these directors understand that their institutional backers are focused on long-term performance. Investors can also show their support by signing onto the 30% Club’s Statement of Intent, pledging their support for discussing gender diversity in their engagement with chairs and non-executive directors. We all have a role to play to make sure our largest listed companies are performing to the best of their ability and incorporating the abundant female talent that is available to them.

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