sorts of risk, I think is going to continue.

 

Greg Bright: Does it have a natural cap on
it?

 

Craig Hughes: At
some point yes, because ultimately liquidity will come into play. So there is a
cap at some point. But it’s not a cap at 10 or 15 per cent.

 

Greg Bright: Would you hazard a guess at what
it would be for you?

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Craig Hughes: We’re
in a situation where we don’t have tremendous cash­flow.
We’re probably cash flow neutral in a medium-term sense… We could certainly
push towards 50 per cent in our unlisted securities.

Greg Bright: You don’t have to wor­ry about a
Chant West or SuperRatings rating, of course. Warren
Chant’s been vocal saying that with anything over somewhere between 20 and 30
per cent in alternatives and the fund won’t get a top recommendation from him.

 

Craig Hughes: No,
we don’t and obviously that’s something… We set a strategy and implement it.
We’re at advantage in that sense. But what we’ve seen recently, with the
volatility in these markets, won’t hold us back at all in a push for greater
focus on non-listed equity risk.

 

Greg Bright: Don, you’re the chair of a fund
that’s closed (State Super of NSW)…

 

Don Russell: We’re
closed but I think Craig’s made an important point that there is a scale
involvement in all of this – large funds can do some things, particularly in
the current market, that smaller funds can’t do. There are opportunities in the
direct space in an environment where large assets will get shaken out from
distressed sellers. So, if you are in a position where you can put up quite a
lot of money very quickly and if you have the internal expertise to do a good
job in terms of valuations, I think there are opportunities there which can
prove to be to the benefit of funds which don’t have that pressing liquidity
need immediately.

 

Amanda White: To what extent will the
changing demographics have anything to do with you looking where money’s going
to be moving from members?

 

Tim Hughes: I
don’t think the demographic is a particularly significant constraint for us
because the majority of members for our fund are staying with the fund
post-retirement. And they’ve got a very long time span after retire­ment in
which they need cash. So they still need growth investments.

 

Greg Bright: There are some people who
suggest that the illiquidity issue for some unlisted assets, such as infrastruc­ture,
is overstated.

 

Kristian Fok: The
thing about li­quidity is generally when you want it orneed
it that’s probably when you don’t have it. So you always plan on the basis that
you never want to be in a position where you’re forced to sell. And I think one
of the advantages that a lot of the Australian superannuation funds have had is
that cashflows have been a very big proportion of
investment. So even if you change your mind about the prospects of an asset
class you have the luxury of making current decisions with future cashflows to dilute that position. Over time that will
change as funds be­come mature and the average member balances become higher.

Some thought needs to be given to the types
of unlisted assets you have… There’s no one right asset allocation. Funds can
cope with some degree of switching, particularly if cashflows
are still 10 per cent of the fund and you can pay 15 per cent of the members
switch­ing. You can make a specific decision to redirect cashflows
over a year and try to win it back.

---

Charles Jacklin: I think there’s an aspect of illiquidity that is very relevant
for the defined contribution plans and that is that illiquid assets aren’t
necessarily priced accurately. If you have people leaving your fund, or even people
coming into the fund, and they’re coming in at prices that are question­able,
they can have a big impact. If you let a lot of people out of the fund and you
have a big chunk of illiquid assets and those assets are overpriced at the time
they go out, it’s going to hurt your return to the remaining people in the
fund.{sidebar align=left id=22}

David Stuart: The
listed market gives you a discipline on management. If you do badly and your
trust trades at a big discount to asset base, you can’t raise money. If you
trade at a premium you can raise money. So, good man­agement gets rewarded.
That’s not happening in the unlisted space. And I think that’s the issue:
there’s no market discipline. So, I generally agree that there are big problems
with the unlisted model. People give away the manage­ment rights,
which are actually worth an awful lot of money … and is unable to be
displayed.

 

Tim Hughes: To
counter that, we have had the example right now of an ABN AMRO private equity
fund where the manager has been removed by the investors.

 

David Stuart: There
are some exceptions. You’ve had another one recently with a Babcock and Brown
fund where management rights had been built up and sold for a substantial sum
of money, which is money that the investors had probably not realised they’d donated to anyone.

 

Amanada White: Is choosing the right partner or funds manager in
unlisted markets more important than in listed?

 

Daniel Needham: It’s
always hard to assess returns in private equity, by defi­nition, because you
need to wait until they’re wound up the fund basing it on cashflow…
And then you have to adjust your return for leverage. On average you get market
returns, right? But the upper quartile outperforms significantly. The lower
quartile does much worse than listed markets …

 

Greg Bright: Given that manager selection is
more important in private equity and alternatives generally, why is it that the
major asset consultants are not as strong in that area? If you look at the
staff of the big Australian funds, most are devoted to the alternatives area.
The funds of funds have had a great run in private equity despite their extra
layer of fees because they have a large number of research staff.

 

David Stuart: You
can choose a highly rated equity fund manager and you can continue to provide
advice to clients who will generally, for a signifi­cant period of time, be
able to access that fund manager. You will poten­tially have a significant
proportion of your clients with that manager. But if you’re looking at
individual private equity strategies, or for that matter individual hedge fund
strategies, the problem is that it requires a lot of work and analysis to
properly rate them and then you’re likely to get very few of your clients
through the door at the time that that manager’s open…

You could say that’s an excuse and that we
should do better. I guess all the consultants have been building up their
alternatives research but we still find the problem of sustainability is a big
one.

 

Amanda White: Is there an option to change
the business model?

 

David Stuart: There
are certainly moves. I think some of the other con­sultants around the table
are makingmoves as well. The problem is that
traditionally we’ve been re­warded with retainers or some other kind of payment
which has been irrespective of funds under management. And that works well in a
scalable activity where, to be honest, providing the advice to a small fund may
not cost you very much more, or much less, than providing it to a big fund. In
these areas where capacity is extremely constrained and the amount of work
relative to the funds invested is significantly more you have to look at
something which is probably closer to a fund management style of fee. There
have been some moves towards that and that will probably continue.

 

Mark Delaney: What
they’re really aiming to do is to be an implemented consultant. And it’s by far
the most lucra­tive part of the consultancy business. You don’t see many
funds-of-funds people who aren’t affluent. It’s been a sur­prise to me that the
consultants have been slow to move into what looks like the most lucra­tive
area of the consulting task. I don’t know your business, but it’s surprising.
Other people have been operating in that space and making lots and lots of
money.

 

Kristian Fok: If
you look at private equity, first of all it was a fairly small part of client
portfolios. And secondly, once it became bigger, it’s not just about assessment
of manag­ers, it’s about actually getting into those managers, particu­larly in
some areas like venture capital. We wouldn’t be doing the right thing if we
weren’t able to actually put together a decent portfolio. But there are
components that make more sense. If you look at any asset class where you can
select qual­ity assets and get reasonable amounts away, then that makes more
sense for asset consul­tants to look at. Individual deals make more sense in
big­ger licks. So from our perspec­tive we’ve identified infrastruc­ture and
real estate as the areas it makes sense for us to do that. If we try to do
everything it would compromise our ability to deliver the other things that we
do. We don’t necessarily rush into every single alterna­tive asset class. We
just pick the ones that we think we can actually add value.

 

James Gruver: Many
funds consider peer risk. In par­ticular, I’ve heard several super fund CIOs
and CEOs say that if only they had had more in unlisted assets they would have
had a better shot at the league tables. Any comments on that?

 

Tim Farrelly: The peer stuff is really interesting. Everybody treats peer risk
as if it’s okay and often it’s just a massive conflict of interest where you’ve
got one group of people that don’t actually own the money looking after their
interests and not looking after the interest of the end inves­tors. And no-one
says this…

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Graeme Miller: It
seems to me that in the for -profit sector what peer risk does is it drives you
to mediocrity and it forces you to adopt ‘me too’ strategies because your most
valuable asset is the body of funds under management that you have; that’s what
generates your revenue stream.

I’m not sure that that’s true in the
not-for-profit sector. I think that what peer risk actu­ally does in the
not-for-profit sector, as a general rule, is itencourages
trustees to have the conver­sation about ‘how can we do something better for
our members?’ And peer risk comes up all the time in every trustee meeting and
every investment commit­tee meeting that I go to. But it’s very seldom in the
context of ‘we can’t afford to do X or Y because we’re going to be different from
our peers’. It’s much more in the context of ‘how can we add value …’.

 

Greg Bright: My contention is that super
funds’ in-house teams are at least challenging the traditional asset
consultants in terms of resources in their chosen areas. Does that skew the
recommendations from the in-house staff vis-à-vis the recommendations of the
consultant?

 

Graeme Miller: Greg,
you men­tioned the governance research that we published late last year and one
of the key conclusions of that was that the best-governed funds have got very
strong internal teams. And that that doesn’t preclude in any way the use of
external consultants. In fact, I share Kristian’s
view, we find that the clients who are able to extract most value from us are
those that have got strong inter­nal teams and that can actually utilise the sort of scale and resources we bring to them. I
think the thing that’s missed in this is that internal resources are seen as a
substitute for external advisors. They are not… The way the business model has
evolved has precluded invest­ment consultants from developing very deep
expertise. And it’s simply because there’s a rule written somewhere that says
fund managers deserve this amount of money and internal people and con­sultants
deserve that amount. Until we break down that rule I think that funds’ internal
teams and, indeed, consultants will face a giant headwind in terms of being
able to add a lot of value.

 

Tim Hughes: One
of the things that really surprised me when I moved from the fund management
side of this industry to the super fund side is just
how chronically under-resourced super funds are when it comes to their invest­ment
staff. There is a massive mismatch between value add, or potential value add,
and where the investment spend is.

 

Mark Delaney: I
think that’s worth looking at. We have a lot of measure­ments on how you
perform relative to your competitors. There are lots of surveys. But there’s
insufficient time spent on how much you’re paying for what you’re getting in
managing the portfolio. None of these portfolios need to be actively managed.
You don’t need asset consultants. You don’t need a su­per fund internal team.
You don’t need anybody pretty much bar the custodian. You could just have the
same asset allocation as everybody else and index everything. So, what you’ve
really got to do is you have to make money after fees above that. And we don’t
focus enough on the link between the money we’re making and the money we’re
paying. It just gets washed around the big pot. If it was a commercial business
you’d never get away with that behaviour.

Amanda White: Do you assume the value add in
setting an asset allocation and the time spent with asset consul­tants is more
than the after-fee value of funds management?

Mark Delaney: I’ve
worked out all those numbers and in broad terms manager selection accounts for
less than half of the value add over the last seven years, less than half. And
yet manage­ment fees account for 90 per cent of our fee bill.

Greg Bright: Getting back to the state of the
markets, I don’t know if I can hazard a guess at consensus within the industry
but people are starting to say that maybe this time next year there’ll be a few
more smiles on every­one’s faces.

Craig Hughes: We’re
still very concerned about the deterioration of the macro environment. So what
we’re talking about there is just basic econom­ic growth and a propensity for
inflation through basic commodities. Propensity for inflation to be above
targets globally. So what we’ve seen in the UK, what we’ve seen in Europe, what
we’ve seen in the US, those sorts of economic down­turns we haven’t seen for
some time and so the potential impact on profits we suspect has yet to come
through fully. So the markets have corrected, they’ve corrected a lot but
there’s probably still scope for further deterioration in earnings.

David Stuart: We’re
unashamedly sitting on the fence at the moment, which is not very comfortable …
If this was a normal recession, you’d be looking to buy equities by now. You
need to buy equities, clearly, before you see the upturn. But at the moment
this looks like an L-shaped recovery. And that’s not one which we that
confident that we’re going to be a standard recovery in equity markets at this
stage… Like Craig, and probably like a lot of the oth­ers, we are suggesting
that where people have gone underweight that they use cashflow
to get their equity weightings back to a long-term position. But we’re not yet
moving them overweight.

Amanda White: What’s the prog­nosis for the
US financial system?

Charles Jacklin: There are banks that are in trouble and they’re going to have to
sort through that. I think the Fed is more worried about the hous­ing market
grinding to a halt… And I think the Fed is more worried about the contraction
of credit than anything else. And they’re worried about banks only because if
they’ve got capital problems, then they’re not substituting for this in the securitised debt market. So they’re worried about Fanny Mae
and Freddie Mac and you have (Treasury Secretary) Paulson who’s worried about
introducing covered bonds so the banks will have a substitute way to finance
mortgages. But they’re worried about the contraction of credit more than
anything else, I think.