Local Government Super (LGS) has converted a passive mandate to an enhanced passive mandate with State Street in a move to increase its active risk. The fund has awarded the manager a $780 million active Australian equities mandate.

Chief investment officer Craig Turnbull told IM online the fund is giving State Street “more scope” on its existing relationship of an index mandate in Australian equities, which was tailored to fit LGS’ sustainability guidelines.

“That was going very well for us, and we were happy with it, except that when we were doing a review of our Australian equities sector, there was a view put forward by our consultant, [which] was accepted by the investment committee, that really we weren’t taking a lot of risk in our Australian equity portfolio.”

The portfolio is about $1.4bn in size, in a slightly larger than $7bn fund, with a little over half in passive and the other half in active management.

“But when you put all that together, it had a tracking error of around about 1 per cent, so a low-risk portfolio. And it was put to us that we had room in our risk budget to increase that.”

Turnbull said there were a number of approaches the fund could have taken, but it was decided to convert the passive mandate to an enhanced passive mandate. The fund also considered other managers, based on recommendations by its consultant Jana, but didn’t go out to tender.

“In the end we were happy with the proposal State Street put forward to really tailor a mandate for us that had the tight tracking limits on it but gave them some scope to try and beat the index,” Turnbull said.

Turnbull said the sector has been “going okay”, but the fund has had some issues on the active manager side.

“There was a replacement there, one manager was taken out and replaced with another. This move to State Street was part of a whole sector restructuring, but it was one of the important outcomes of the sector review – we could take a bit more risk … and balancing off risk and return, this could be a good way to maybe boost the returns just a little bit.”

The fund has already moved down a similar pathway with its international equities, putting in place an enhanced passive mandate with Hermes, when it reviewed the sector about a year ago.

“In that case we retained Vanguard as passive manager, so we really got a large core of passive plus a smaller allocation to enhanced passive as the core in that situation. But that gives us the flexibility to change that mix over time if we desire.”

LGS’ general structure in investment is to have a core of passive with more concentrated active – tilted or style – strategies around that.

“In all the large sectors we apply that. Certainly would be in international equities, also to some extent on the bond side and even in things like our absolute returns sector.”

Turnbull said it’s a common structure the fund uses, which is about the enhanced passive portfolio taking on the core role within a sector.

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