Taking a more active approach

Kristian Fok was appointed executive manager of investment strategy for the Cbus superannuation fund in October last year following a wholesale review of its investment processes.

The Melbourne-based fund, which manages the retirement savings of workers in Australia’s building and construction industry, has 655,000 members and A$21 billion ($22 billion) in AUM as at end-January. It plans to double this within seven years.

Q What is your return target and the breakdown of assets in your default portfolio?

A Our return target is inflation plus 3.5% per year measured over 10 years which, given where asset prices are at present, is reasonably aggressive and reflects the young age of our membership.

Our default portfolio is invested 31% in Australian shares, 18.5% in international shares, 13% in property, 11% in infrastructure, 10.5% in private equity, hedge funds and aggressive growth assets, 7.5% in bonds, and the remaining 8.5% in cash and fixed interest.

Q Cbus conducted a review of its investment strategy last year. What was the outcome?

A It was decided that the fund’s directors wanted to have better internal oversight of the portfolio and to be really aware of what our external managers are thinking and doing. We are now adding to the internal investments team and will take a more active role in asset allocation and setting risk parameters.

The team will identify new investment ideas, and conduct face-to-face meetings with managers. We will also have more oversight on tasks like transition management, where we can take advantage of our in-house expertise and save costs.

One of the objectives is to understand the recovery dynamics of the fund, so that if we experience a significant loss, we know how long it will be before we recover.

Q Why is it important to understand the recovery dynamics?

A Because it changes the attractiveness of certain asset classes. We want to be invested in assets that have good recovery characteristics and/or offer downside protection. This may include, for example, investing in warrants and options – securities that do not necessarily fit into an equities mandate or an alternatives mandate, but which have a place under our new approach.

Q Does this mean you want to manage assets in-house?

A Not entirely. Where we believe we have a comparative advantage we will handle investments in-house, but mainly we will continue to appoint external managers where we can find them.
Working with external managers has its advantages. If things aren’t working out with a particular manager, we can look for alternatives and make a switch. This is harder to do if you have a big internal team.

Q What asset classes do you have a comparative advantage in?

A We already own a property development company that operates at arm’s length with its own mandate and independent directors. Our members are in the construction industry, so it is a natural fit. We had some teething issues at first, but we have landed on a model that works.

Most traditional property funds earn a fee based on the amount of assets held in a portfolio, so there is little incentive to sell assets. The remuneration arrangement we have with our own fund is different. If they think they can sell an asset for a good price, they do it. This worked well in the lead-up to the global financial crisis when the fund sold quite a few assets at a profit and was able to buy new properties when valuations had dropped.

Another asset class that we manage in-house is a portion of our cash. We have a cash manager on our team that has had some good success with managing term deposits.

Q Have you changed the way you benchmark the fund’s performance?

A We have abandoned an explicit objective of ranking our performance against peers and instead have elevated the inflation-plus targets with appropriate risk measures.

On the equities side, we have reduced the emphasis of tracking error as a main measure of risk, and are more focused on finding managers that can perform consistently, particularly in bad markets.

Q Do you expect to continue using asset consultants?

A We will still maintain a relationship with our consultants as they will challenge our ideas to ensure they are robust, but we expect that their role will change over time. Instead of relying on them to write all of the research papers, we will write some of our own papers around asset allocation and risk, and work in conjunction with the asset consultants to construct the portfolio.

As the fund gets bigger we want to be in a position to negotiate our rights, not just in terms of fees, but in terms of our rights in complex investments, such as co-investment in infrastructure projects. We have a history of taking stakes in infrastructure projects.

Q Tell us more about your investment in alternatives.

A We have quite a large private equity programme, but over time we expect this will be redistributed to hedge funds or other opportunities where we can take advantage of market dislocation. Longer term, we expect to have 10% of our portfolio invested in these type of investments.

We will continue to invest in infrastructure where prices are cheap. Recently we have seen prices increase, and since it is an illiquid asset, we don’t want to be too aggressive.

Q What about your exposure to Asia?

A We have a fair bit of exposure to Asia through our global emerging market mandates and Australian equities mandates. Up to now we have participated in the China growth story mostly via resources stocks listed on foreign exchanges, but over time we would like to exploit the China story differently.

We are looking at ways of gaining exposure to the country’s rising middle class – not indirectly, but directly. Once we get a clearer picture of what our indirect exposure is, we will make this a higher priority.

Q How do you manage risks?

A This is done in many ways, but we will increase our use of scenario analysis. We run scenarios on where we think the current risks are and see how these impact the portfolio over short- and long-term horizons.

We have run scenarios around Europe’s recovery, a slowdown in Asia and the implications of a strong Australian dollar, for example.

Q Where do you think equities are going?

A We have had an overweight to equities, but we are talking about reducing that now. While there are good reasons to be confident about earnings, we think valuations are now full and it’s time to review our long-term allocation to equities.