Seeking higher-quality assets

UniSuper is the retirement fund for Australia’s higher-education sector, with A$42 billion ($37.3 billion) in assets under management and 450,000 members. As CIO, John Pearce oversees about 35 investment professionals across all asset classes both domestically and globally.

He has been with UniSuper since July 2009. From 2006 to 2008 Pearce was head of global asset management at Chinese insurer Ping An. He also held several senior positions at Australian fund house Colonial First State from 2000 to 2006, including chief executive and general manager of investments.

Like most of its Australian peers, UniSuper offers a range of investment portfolios with different return targets. There are seven pre-mixed options ranging from conservative balanced to high-growth, and 10 sector options, mainly single asset-class portfolios.

Q Can we get some insight into your investment strategy?
A We stay away from asset class classifications – instead we look at risk classifications, across high, moderate and low risk. For example, we’d have property in all of those buckets. In the low-risk bucket, you’d have real estate with low leverage and stable tenants, such as a government department. At the high-risk end there is property with a lot of development potential.
So we’re fairly agnostic as to the asset types in each category. In the moderate risk bucket, infrastructure and property are competing for the same risk allocation. It just depends which is the better deal at the time.

Q Are you looking at different assets to boost returns, given the current low-yield environment?
A We are not really fans of alternative assets. For example, since I joined we’ve been divesting our private equity assets, and we’ve got the allocation down from $2.5 billion to about $500 million.
This is a function of the caps we’ve imposed on taking on illiquid assets. We believe illiquidity has not been properly priced in the market, and that super funds and others have not captured a premium for investing in illiquid assets.
We’ve got to ration our limited capacity for illiquid assets to those that not only give a better fit for our liabilities but also a better risk/return profile. And for us, that’s been property and infrastructure rather than private equity.
QDo you allocate to hedge funds?

A No, for two main reasons – one is lack of transparency and the other is the fees. I understand that the transparency issues are being resolved in many cases, with hedge funds becoming far more ready to disclose holdings on a timely basis. But the fees are still a hurdle.
You can argue that you shouldn’t be looking only at costs but at returns, and that is a fair point. But the reality is that when you’re positioning yourself as a low-cost provider, as we are, hedge fund fee structures are problematic.
And let’s face it, the value proposition offered by hedge funds in the past few years hasn’t been stellar.

Q How much do you invest in foreign assets?
A When we go offshore, we restrict ourselves to the listed markets, whereas onshore we’ll do both listed and unlisted. The amount of international allocation depends on the asset class. For example, in the balanced-option portfolio about 35% of our listed equity exposure will be offshore, while the bulk of our infrastructure and also fixed income investment will be onshore – 86% for each.
Some 15% of international equity exposure was in Asia ex-Japan stocks as of June, down from 21% two years earlier, in the balanced option.
Our website gives details of our offshore allocations, as well as the exposures to different asset classes. For example, the strategic asset allocation for the balanced option as of August 31 was infrastructure and private equity 5%, property 9%, international shares 20%, cash and fixed interest 30% and Australian shares 36%.

Q Do you ever do single-country Asia mandates?
A Yes we’ve made an allocation to [UK manager] Baillie Gifford for a pure Japan mandate. We were an underweight position on Japan and now we’re square. Around 7% of our offshore equity exposure was in Japan stocks as of June.

Q Aside from reducing your private equity exposure, have there been any other major changes to the portfolio?
A The major change is philosophical. We have the mantra that superannuation is someone’s life savings, and it is their biggest asset after their primary home.
So we have a huge focus now on upgrading the quality of our portfolios. For example, we’ve spent the last few years selling non-core property and investing very heavily in quality retail in prime locations.
The same is true of infrastructure – we’ve divested minor stakes in some infrastructure, but we’ll take big stakes in quality infrastructure. We’re the biggest owner of Sydney Airport and Transurban and own 50% of Adelaide airport.
For the same reasons, we’ll stay away from complex structures and frontier markets. We wouldn’t invest money in Africa, Pakistan or some eastern European countries, for instance.

Q Do you do much in the credit space?
A We’ve got two high-yield mandates – both US high yield – with Oaktree and Shenkman. We invested at attractive spreads, but we hit our target and got out at levels above where they currently are, so we have a bit of seller’s remorse there. But it just seemed to us that when you hit your target and things are looking pretty expensive, it’s time to lighten the weight.

Q Do you invest in emerging-market debt?
A No, because we’re not comfortable taking emerging-market currency risk, and EM debt is basically a currency play. And Australia is a reasonably high-yielding developed market anyway.

Q How much investing do you do in-house?
A We do a lot of in-house management, but we outsource too. For example, most of our Asian assets are managed by teams based in Hong Kong – such as BlackRock, Schroders or T. Rowe Price. All our managers are listed on our website.
We manage about 40% in-house and outsource 60%. Five years ago we were outsourcing everything, but we’ve been gradually in-sourcing more. So it’s been a pretty rapid buildup [of in-house-managed assets].
But the team hasn’t really exploded in size, though it has changed in terms of composition, and the capability is certainly different. So we have people on board now that have pretty deep experience in terms of managing money rather than just allocating money.
We’ve had around six new investment staff join over the last five years.

Q What do you use external asset managers for?
A We’re aware of our limitations, so in-house we restrict ourselves largely to the generic asset classes in Australia: domestic large-cap equities, cash and fixed interest, and property. Once we move to the higher-beta, sector-specific or region-specific assets, we go external.
We don’t have the capability to do high yield, and even for global credit portfolios we go external. There isn’t really an Australian high-yield market, and we tend only to do domestic investment-grade bonds in-house. We have some domestic sub-investment-grade – which is not necessarily high-yield – and that’s done out of house.
We will always run a hybrid in-house/external model, because we always want to have optionality.
And we have to be realistic about the skills set we can hire and the size of the team that we want.

Q What are the main issues that are keeping you up at night?
A If you think about a black swan event, it’ll probably be inflation because the whole market is worried about deflation. But there are no signs of it at the moment.
The other one for me is China, which is inextricably linked to Australia. China is always going to be our single biggest risk.
The slowdown there has quantifiably hit the iron ore price. BHP Billiton [mining firm] was trading at A$50 before the global financial crisis, now it’s trading at A$34, whereas a lot of the industrials have recovered to their pre-GFC highs.

Q Have you made changes to your portfolios as a result?
A If you think of the world, the US is everyone’s favourite [right now] and Asia is at bottom of the pecking order, which is reflected in the valuations. There will be a time to get back into Asia and raise the weighting again. We’re grappling with that question right now.

Q Do you buy pooled funds or only use separate accounts?
A We’re always in separate accounts – our minimum mandates are A$200 million. n