John Pearce, chief investment officer of Unisuper, has a side bet with a member of his investment team that the Australian equity market is going to outperform the US equity market over the next year.
When most people are talking about the end of the Australian boom, uncompetitive labour costs, an expensive currency and a lack of momentum, Pearce stands this thinking on its head.
He points out that there is often a disconnect between GDP growth and share price growth. Australian GDP growth has been superior to the US, the US stock market has outperformed Australia.
The reason, he says, is that the US has benefitted from the tail winds of a lowly valued currency, quantitative easing, low interest rates and a slack labour market which have allowed historically high profit margins. But in Australia, these factors have been working in reverse, with relatively high interest rates being a drag on profits and a high currency valuation hitting trade.
“Arguably the US is coming out of that phase,” he says. “Interest rates are going to be a headwind for them and their currency is now starting to appreciate.”
Such thinking has led to UniSuper being one of a dwindling number of funds owning more domestic than international equities, the latter only makes up 40 per cent of its equity holdings. The strategic allocation for its balanced MySuper fund is 36 per cent Australian equities, 20 per cent global equities, 30 per cent cash and fixed interest, 9 per cent property and 5 per cent infrastructure and private equity.
He believes global macro indicators are also being overlooked when people state that equities currently look expensive.
“The people who talk about overvaluation of equities usually cite metrics like current versus historic price to- earnings Schiller adjusted,” he says. “It is typically based on some bottom-up analysis. What is completely missing is any reference to the macro situation.” He cites financial repression driven by quantitative easing in the USA, Europe and Japan as creating an insatiable desire for yield, which makes equities look cheap, even if the profit to earnings multiples are expensive historically.
The fund’s bullish stance on domestic equities has led it to build up a 10 per cent stake in Transurban. The toll road operator, along with AustralianSuper and Tawreed Investments, the Abu Dhabi sovereign wealth fund, purchased a big chunk of Queensland motorways in April for $7.05 billion, a figure that is around 28 times earnings. Pearce says UniSuper did not bid and raise its infrastructure allocation as it already gets its exposure to Queensland motorways through Transurban. He adds, the price was fair given that Transurban would not have to duplicate its operations in running the roads. “We believe there was a discipline where their cost of capital hurdle was still sufficient,” he says. “The market obviously agrees as the share price has done well.”
The large holdings in companies such as Transurban backs up Pearce’s third contrary view of equities. The fund does not have any explicit downside protection and it is currently not looking to add any, despite the talk about equityput options being cheap.
“We have this quality bias in the portfolio,” he says. “So, I have a degree of comfort our portfolios will outperform and in the event there is a sell off they will recover quicker. It does not mean their share price will not go down.”
This approach played out in the GFC, where he says the quality companies did not “miss a beat” on dividends and their share price recovered in a couple of years.
Pearce writes monthly investment bulletins, but is a stranger to domestic conferences, and not being a public offer fund, UniSuper does not make public utterances as per AustralianSuper. In this way, he has not seen the same hostile reaction senior executives of AustralianSuper received from some in the investment community, after they publicly explained their intention to manage more money in house. By contrast, over five years at UniSuper he has quietly built up internal management to 40-45 per cent of all assets.
The ability to bunker down and focus on maximising returns is what appeals.
“I did not appreciate how liberating working for a profit for members business would be,” he says. “Because we are a closed fund I do not spend much time at all on the marketing and sales front.”
Pearce has now spent five years as chief investment officer, which he seems surprised by.
“When I took the job I gave myself three years, some people gave me two years, but those five years have flown. I did not think I would love it as much as I do.”
This job satisfaction has been his sales pitch to team members too, who he describes as a team that “just love to manage money”.
“That is why I have been able to hire some top quality guys who arguably could command much higher salaries outside, but they are coming for the same reasons I am, they do not want to be distracted.” This love of their jobs must be strong as UniSuper does not offer its team the long term incentive arrangements found in fund managers. The pay-off is that they are running their own money, without the marketing and business spend of a fund manager and with no profit drag on returns.
Part of the logic for running money in house is that the best managers of Australian assets cannot be easily bargained with on fees. Many are at capacity and can be choosy about clients. “We can negotiate fees, but popular managers can look elsewhere,” he says. For this reason he foresees growth in managing large cap Australian equities inhouse, chipping away, as he puts it, from some of their existing managers in that space.
The other logic is to avoid what he describes as the rent seekers paradise of managers that add more and more funds to a strategy with a “relatively” fixed cost base and charge fees that rise in accordance with the volume of assets managed.
The in-house team manages domestic assets, from large and small caps, to infrastructure, fixed interest and property. Pearce expects the proportion of assets to grow in-house within these strategies. “If we put on another billion dollars of Aussie equities, our marginal cost base is zero, we are still paying the same team to pay an extra billion plus few bps in custody.”
There is no set target for this growth, however. “If I have a target I can reach it by simply reallocating, which I do not think is the right thing to do.”
He says in-house management is all “performance based” and that his “in-house guys” have to justify their existence. Once a year the in-house teams report to the investment committee about whether their strategies are a hold or a buy. Two strategies were dropped in 2013. “We sacked ourselves in two of our strategies as we did not believe it was performing to expectations,” he says, admitting that affected staff were disappointed. “No one likes having money taken away from them.” The money was diverted to other internal strategies and some to a new Japanese equities manager.
He is doubtful the in-house strategies will move into anything exotic. “We are not going to get to a situation where we say ‘how about we experiment by getting a team to manage global small caps?’. There are good managers out there that we cannot compete with, we do not have the resources.”
Domestic assets are chosen by the internal team for their quality and stability. Pearce reasons that they are managing life savings and it is different to how one would manage a discretionary managed fund. So large top 100 companies with strong balance sheets, sustainable and robust earnings are favoured.
This strategy has inadvertently led to a lower than average portfolio turnover and therefore lower than average management fees. “If the average portfolio turnover of the market is 30 per cent or whatever, we don’t say we want 15 per cent. We do not target that. It is an outcome.”
“If you are taking big positions in high quality companies, as long as they do not get to ridiculous valuations, you do not want to be turning these things over that much.”
This approach is why UniSuper have been “getting out of private equity for some time,” he explains. Moving away from high fee investments is another reason for the reduction in expensive alternatives. “We want to be a low cost provider,” he says.