Basis points matter, according to Andrew Spence, chief investment officer of the $6-billion Qantas Superannuation Plan, because the volumes of money in superannuation are “enormous.”
He is not talking about incremental investment gains on billions of dollars of invested capital. He’s speaking about saving money.
Specifically, the $1.42 million that the fund saved in the year to June 30, 2012 by taking control of foreign exchange transactions made for its $2.5 billion in global equity and alternative asset holdings. It’s the first of many net savings that Spence believes can be made for the fund’s 33,000-plus members by reducing the hidden costs of investing through “implementation efficiency” processes.
Working as a fund manager in London and Sydney for 20 years until 2005, then as an investment consultant to super funds until 2007, made Spence aware that investment processes incur implicit costs, or “slippage”, that are not covered by fund manager fees.
In 2009, about one year into his tenure as Qantas Super’s first CIO, he began analysing every foreign exchange trade made over two years by the global equity managers, who invest about $1.5 billion of the fund’s capital, and alternative asset managers, such as private equity firms, that oversee about $1 billion. Spence and his team measured the difference between the prices at which fund managers transacted and the best on offer at the time, called the spread. They always expected to uncover some expensive currency trades, “but you don’t really know until you do the work,” Spence said in an interview at Qantas Super’s offices at Sydney Airport on July 20. “Foreign exchange seemed to be the area that was most inefficient in trade execution. It’s a dark art.”
Their findings were striking. In currency trades totalling $1 billion over two years, managers paid six-to-eight times more than necessary. The results were consistent with industry research.
Special FX
Qantas Super found that most fund managers depended on custodian banks to execute currency trades, which in turn dealt with parent investment banks. Fewer managers transacted through internal trading desks and these processes were typically opaque. There was scant evidence that counterparties always sought optimal prices for currency trades made on the fund’s behalf.
Following due diligence, Qantas Super hired Russell Implementation Services (RIS) to take control of managers’ foreign exchange trading. A unit of Russell Investments, RIS seeks best prices from a panel of counterparties rather than being part of the trade. It is a “fiduciary agent”, Spence said, that fully discloses costs to Qantas by time-stamping each trade it made with 18 counterparties in the past year. Each transaction was externally audited to ensure that “best execution” was achieved.
“We’re turning implicit costs into explicit costs. Once you measure explicit costs, you can manage them,” Spence said. “If they do not become explicit costs, they are an unseen drag on members’ returns.”
Currency trading is just one investment process where slippage can be stopped. Portfolio rebalancing, tax management of stocks, securities lending and transition management are others. The $18-billion HESTA Super Fund measures how much tax its Australian equity managers incur and whether this can be minimised without compromising investment decisions. Qantas Super is now doing due diligence on whether it should seek similar discipline from domestic stock fund managers.
“Implementation efficiency is an important part of the value chain. What we’re trying to do is deconstruct the value chain and reconstruct it in a way that works for our members rather than another part of the industry,” Spence said. “It’s not a sexy area, but meaningful benefits are to be gained from it.”
RIS also manages Qantas Super’s currency hedging programs for developed and emerging-market stocks and alternative assets. It helps the fund limit the costs of shifting capital between fund managers, called transition management, by aiming to transact at the best prices.
Five people, one focus
At Towers Watson, Spence worked with David Neal as lead consultant to Qantas Super.
Like Neal, who is now CIO at the $77-billion Future Fund, Spence has ingrained a “single total portfolio” way of investing at the fund.
The investment team debates investment strategy, portfolio construction and risk management together. Each bears responsibility for decisions affecting the whole portfolio. None of the five people in the team focuses exclusively on an asset class and all are skilled in portfolio management, performance analysis, compliance and tax. Spence hires “people who are comfortable in the front, middle and back-office” departments of investment management, he said. “We’re building the internal capability to better manage the complete value chain. Not to manage the assets.”
Qantas Super’s focus on reducing the implicit costs of investing is not pursued at the expense of high risk-adjusted returns, or alpha. The fund will pay bigger fees to hire fund managers that it believes will provide strong returns without inappropriate risk. Such abilities are rare: the alpha-generating skills of managers are “cyclical”, meaning that they succeed at different times, “and are expensive,” Spence said. “Our focus is on getting value for money.”
