Michael Stachan, chief investment officer, Equipsuper refers to his team as investment managers and risk managers, whose job is to preserve its $6.5 billion
fund as much as add value.
“One thing about running money is that you are scenario testing all the time, you are implicitly managing risk. It is hard enough making money so you do not want to lose it,” says Michael Strachan, chief investment officer of Equip, a mature, cautioous fund with over half its members aged over 40 and with relatively high balances.
“You will not see us being caught up in hubris or getting caught up into fads, such as portable alpha and more recently smart beta” he says. Indeed, he has a good many phrases and anecdotes to back up the wisdom of a cautious investment approach, which is partly formed by the fund’s experience of managing a mature defined benefit scheme.
“If things sound too good to be true they invariably are,” he says of his pride in not buying into any sub-prime investments, prior to the GFC.
“How can you take something that is BBB rated and make it AAA? We are very cynical and pragmatic investors; if we do not understand it we do not go there,” adding “I am scientist by training I want to see the facts.”
The fund did not buy into the arguments on hedge funds prior to the GFC either.
“Investment consultants have a bit to answer for. They said that hedge funds have the volatility of bonds and the return of equities, well that is just not true. If you can get us 8 per cent net of fees you are taking risk out here,” he says, gesturing widely with his hands. He notes long short equity managers generally underperformed domestic and global long only managers. Not surprisingly, he credits the fund’s experience at the time as “relatively good” considering everyone’s investments fell.
“We want to add value consistently and sustainably,” he says. “We are going to be protected in the GFC, but we are unlikely to be top in boom markets.”
The fund is not only cautious but wise, according to Strachan, he points to the average 15-16 years’ experience in its seven strong investment team. While averse to wild promises from fund managers, the Equip team are certainly not endorsers of the passive approach floated by the Grattan Institute. Strachan sees active management as a key process in risk management. “People think of passive as cheap and secure it is not. A passive fixed income manager buys more of the most indebted nations,” he says. “Active management is close to risk management.”
Good investors, he adds avoid the blow-ups. He cites Bell Resources, Bond Corporation and Qintex as classic examples of companies which have all gone to the “corporate graveyard” after the 1987 share market crash, having featured prominently in indexes in the late 80s, but subsequently imploding due to over expansion, high debt and insufficient revenue. More recent examples, post the GFC, include ABC Learning, Allco and Babcock & Brown.
One of the ways Strachan risk manages the portfolio is in its active asset-allocation stance which takes 18 month to two year views on how far it can veer from its strategic asset allocation as either a means to add or preserve value where it perceives a mispricing between asset classes.
Strachan sees the average 30 bps of value added each year for eight years (i.e. around $20m for the fund last financial year) through its calls on the market as a vindication.
The results would have been higher if not for its call in 2012 to go underweight on global bonds, which initially rallied after increased concerns regarding the sovereign debt crisis in Europe; however, this call has since been correct with significant value added over the past two years. The fund is still underweight fixed interest, overweight global equities and neutral on Australian equities.
Strachan lists company healthy balance sheets, a good reporting season, a US recovery and better yields than cash or fixed interest as the obvious reasons for being overweight in equities. However, he also acknowledges the illogic of the position when valuations are in historical terms high. He argues there are special circumstances today.
“In terms of historical valuations we are in a different environment, no one has ever done QE on this scale before and now as we begin to pull out it could take longer than market expectations.” And he takes confidence from indications from the Federal Reserve board that the halt to QE will be gentle.
“What is quite clear to us is that [the Fed] are not going to do anything premature that is going to put the recovery at risk,” he says. “So for them they would rather go later in terms of raising interest rates.” Strachan has a good picture of what the equity markets will look like if they have to get out. “The final phase is a lot of M&A activity and everyone getting euphoric,” he says.
He rationalises yields on bonds are only likely to go in one direction and that purchasing bonds at yields of 3.4-3.5 per cent is locking up real returns of 1 per cent for 10 years, which is unlikely to meet the retirement income aspirations of members.
Such diversions from the strategic asset allocation are taken with sobriety. They are not traders who are in and out of markets quickly, he emphasises. “We take a view and do a risk assessment and in every investment committee meeting we explain in detail the basis of our views,” he says. “If you started seeing things we did not like in our markets between investment committee meetings we could move with the express permission of the chair of the investment committee.”
A third of all assets at Equip are managed internally and the fund has done so for over twenty five years with a significant component in Australian equities. The companies it purchases must have cash flow, have low to moderate debt levels and the ability to service them comfortably, this gives the fund assurance over their valuation and has led to a circa 16 per cent annual turnover for the internal equity portfolios, compared to 25-30 per cent for Equip’s average mandate, a figure Strachan is sure is lower than the industry average.
This approach is viewed as common sense. “Why sell a lot and reinvest at 85 cents in the dollar if you have held for less than 12 months,” he says. “We are very tax aware and conservative in how we run money.”
This low turnover approach is also desired in the managers Equip hires.
It sees its in-house equities as its core and looks for high conviction managers to sit around this. “We want people who understand capital preservation as well as making money. We do not want someone who is going to blow the lights out one year and have us in the depths of despair the next,” he says. “We would rather do internally what we can do well and use our risk budget to managers where we do not have sufficient expertise such as a benchmark unaware concentrated manager. What we can’t do well, we will outsource.”
The investment team works with an investment committee made up of directors, Andrew Pickering (chair), John Azaris, Bruce Beeren, Robin Jervis-Read and external consultant, Andrew Cooke on decisions such as active asset allocation, manager selection and selecting unlisted investments. The main board delegates investment decision making to the investment committee, but must approve any strategic asset allocation changes. The chief investment officer’s main responsibility is to manage the internal portfolios and make recommendations on active asset allocation, manager selection or termination and unlisted investments.
The fund uses its asset consultant JANA for advice, but it is not a traditional relationship. Equip has its own manager database it consults as well as using JANA’s research when choosing managers for further due diligence for a particular mandate. Strachan says: “It is a partnership model. We all sit round the table and compare thoughts and work it through. They have greater reach than we do, we are only a team of seven people, but we have experience in areas they have not, it works very well.”
On two or three occasions, the investment team and JANA have come to a disagreement over a manager or an asset class that has had to be resolved by the investment committee. In this situation, each side writes its own papers and the committee takes a view. However, they agree, “if you thrash around the ideas you ultimately come up with the right answer”, says Strachan.
A second way the Equip team is unconventional is in its bid to have all team members multi-skilled, rather than focusing on single asset classes. Strachan says that there is otherwise a danger of information being missed when making asset allocation decisions. He cites the funds decision to move out of equity markets in 2008 as a good example of the multi-skilled approach, citing how team member Darren Rosario, who has a fixed income background, was able to point out the problems in mortgage back securities in February 2008 that the equity market did not recognise. Similarly, Strachan uses feedback from its unlisted property trust investments to see early trends in sales and consumer behaviour.