Should super funds expand their middle offices as they grow, or is it more efficient for them to rely on an expanded range of services from custodians? Leading super fund chief financial officers, consultants and representatives of NAB Asset Servicing met in Melbourne recently to discuss this.
Philip Hope, chief executive of Morse Consulting, has noticed funds taking a “fundamental look” at their operating models and foresees a bigger role and recognition for the middle office in maximising performance efficiency. This would come from identifying leakage from the unintended consequences of different managers in a portfolio having different tilts. It could also come from measuring tax risks and exposures.
“There needs to be ownership within the funds of the exposures and their interpretation,” he says. “A service provider can do a lot in terms of providing tools, but you’ve got to be doing the analysis and the analytics. It gets very dangerous when you basically say, that’s the custodian’s responsibility.”
For Morse, the expansion of capabilities and staff in super fund middle offices would not undermine a custodian’s middle-office roles. “It’s not a question of one at the expense of the other,” he says.
Stephen Huppert, partner at Deloitte, sees part of the reason for the expansion of internal teams as providing a consulting function to the front office. “Previously there wasn’t the need to have that regular flow of data and be able to respond to questions as rapidly and with agility as now,” he says. “But investment people want to move, want to get information on a much more responsive basis. A lot of the older middle-office-type functions struggle to do that.”
From the discussion it emerges that some of the largest superannuation funds are on a path to greater self-reliance, while others are much happier to dial-up the services they use from custodians.
In this regard Kyle Ringrose, head of investment operations at QSuper, is intrigued by the self-reliance of the large Canadian funds. “Typically superannuation funds will look at their custodians as holding the source of truth and everything comes from there,” he says. “But if you look at the Canadian pension funds, they don’t do that; they don’t even give their custodian all the data. They have their own systems in-house that they regard as the source of truth, so they can get at the data faster. They have complete control of it.”
Douglas Clements, investment operations manager at Kinetic, sees the trend coming partly from the growth in independent directors with specialist skills coming on to super fund boards, and having better understanding and greater requests for services and capabilities.
For another of the large funds in the debate, First State Super, the limits of a custodian’s ability are forefront of mind. Michael Clavin, head of implementation at First State Super, questions their ability to fully measure a security’s attributes, not least because it would require various sources of information, not all of which the custodian would have ready access to. In this case he groups direct loans, over-the-counter (OTC) investments and assets held in trust structures for tax purposes. “It’s the trustee office that has to be the source of truth of what the fund holds. The custodian will not have the full picture any more,” he says.
Clare Tam, executive manager of member and employer services and chief information officer at VicSuper, agrees. “You will need specialisations,” she says. “And once we have that, you’re going to have different, multi custodians, as not all will be able to hold an OTC et cetera.” She adds that trustees will need concentration list aggregations and liquidity credit risks and look-through on multi-fund managers to have an informed view. Recalling a previous role at HSBC during the global financial crisis, Tam says: “At any point we needed to say what the exposure was on a line of stocks. If we could not have that in a real-time basis, it’s quite dramatic.”
This point is contested by Naresh Subramaniam, head of investment services at NAB Asset Servicing. He says that gathering information for unlisted assets and OTCs poses a challenge, but it is part of the service that they are expected to offer, to the majority of clients. “Our clients are telling us that they want us to give them the risk lens as well, not just the data,” he says. This includes stress-testing assets in a range of scenarios. “The larger clients have got that capability in-house, but there’s many clients who are saying [that] you, the custodian, need to give us that,” he says.
Middle office is a priority for NAB, which is investing in a dedicated middle office platform (Eagle) to capture accurate and rich investment data including security reference and trust look through. Subramaniam says custodians are ideally placed to provide the entire fund view of information, but that clients should ultimately take ownership of that information. Funds with their own middle office face the ongoing costs and staffing challenges associated with maintaining this. Engaging a custodian distributes the costs across clients. Custodians, says Subramaniam, are also able to attract and retain specialist middle office staff by being able to offer local and global career paths.
Huppert says funds are being presented with greater choice as to who they employ to provide analytics. “We’re seeing a lot of services now, and technology’s allowing you to do a lot more so that you don’t necessarily have to have a one-stop shop any more,” he says, pointing out that this could help a fund gain a competitive advantage.
This view is challenged by John Rodd, former chief financial officer of Equipsuper, who has a belief that the organisation that holds the core data can expand its range of services. On this theme Ringrose picks up on a technical issue around derivatives. He says APRA regulations specify superannuation fund assets must be custodially held and he questions whether that is practical any more, not least because a derivative is a contract rather than an asset.
Choosing your model
One thought springing up from this debate is that super funds need to make a conscious decision about the size and the role of their middle office and how much they are prepared to invest in that. Hope says that how much a fund insources or outsources would be a driver in terms of their investment strategy and the asset classes they hold. Another issue is managing complexity. Hope says he knows of one client that was running more than 200 separate strategies, which posed difficulties in reporting. Rodd says one of the factors for a fund in building their middle office is deciding whether they need information daily, weekly or quarterly.
How can middle-office capabilities help to meet APRA guidelines on data security, transparency?
Christine Bartlett, executive general manager of NAB Asset Servicing, cites the work of the Australian Custodial Services Association in working with APRA to find ways of making new reporting regulations easily implementable and pragmatic. “By default we’ve sort of ended up with Ausmaq in terms of being a service provider to many custodians in providing that look-through data,” she says. “So rather than having seven or more custodians asking fund managers for the data, we’ve got a single point through Ausmaq to do that, so hopefully that’s going to drive simplicity and more efficiency.”
Rodd says that middle-office functions should help trustees meet the primary responsibility to APRA of demonstrating a full understanding of the risks and accountabilities. “It is important you’re no longer just relying on the outsource consultant to tell you that,” he says. He adds that for trustees, the integrity of information is another priority. “It’s not only what you’re reporting to APRA but what you’re reporting on your product dashboard, on your website, which is the ASIC requirement which actually puts the onus and a penalty on the fund for making sure that the information is consistent,” he says. On this theme Ringrose calls for greater help from custodians in providing greater data mining to help meet the new APRA requirements.
Where are we in measuring performance in life-cycle or cohort funds?
The growth of cohort and life-cycle strategies is posing new conundrums for superannuation funds. These make it difficult to measure performance relative to other funds and to judge the success of investment teams.
This is a question QSuper is wrestling with, and Ringrose says the focus will ultimately be on whether the fund is on target to deliver an adequate income stream in retirement for pensioners. Huppert is seeing this shift of focus in many funds, with many asking if performance is about measuring against their peers or about them maximising outcomes for members.
It is felt that determining what level of risk is right for the member will be a factor in measures of success or failure. Rodd proposes that such risk profiles should be going into APRA PDS’s.
Another ongoing challenge discussed by the group is the prospect of being able to offer members a consolidated view of the assets they hold both within super and on a member-direct platform. The challenge comes from combining data from different administrators and deciding whether this service should be among the trustees’ responsibilities; and if so, how should this be costed – across the whole member base, or just to member-direct platform members?
Data disclosure a headache or an opportunity?
For John Dyer, chief financial officer at UniSuper, such portfolio disclosure is a headache, not least because his fund’s analysis already goes deeper and is more detailed. “We look at the mandates in so many different forms and get quite innovative. For example, on global shares in Asia you’re looking at where the source of the revenue is,” he says. Though he concedes portfolio disclosure will lead to funds finding out different things about their data.
Tam cites the importance of having this information to hand. “When the Fukushima disaster happened a client called and said, what is my Japanese exposure? We had to go through and say, well you’ve got everything in trust. He said, well that’s no good to me, I need to know today.”
Clements notes that prior to APRA upping the frequency of reporting, funds had the luxury of looking back six to eight months at those underlying exposures, but now they have only 28 days to get that information out. Dyer says such demands have been one of the reasons that UniSuper has reduced the amount and variety of its private equity holdings, which have been hard to analyse and measure.
Christine Bartlett executive general manager of NAB Asset Servicing
Philip Hope CEO of Morse Consulting
Stephen Huppert partner at Deloitte
Kyle Ringrose head of investment operations at QSuper
Michael Clavin head of implementation at First State Super
John Dyer CFO at UniSuper
Clare Tam executive manager of member and employer services and chief information officer at VicSuper
Naresh Subramaniam head of investment services at NAB Asset Servicing
John Rodd former CFO of Equipsuper
Douglas Clements investment operations manager at Kinetic Super
Justin Howell head of strategy and projects at First State Super
David Rowley editor of Investment Magazine