Since 2005/06 the $8.6 billion LGsuper fund has moved away from peer benchmarks to a low volatility, low equity asset allocation – its board has sought greater diversification within the fund. Guy Rundle, investment manager, LGsuper, talks to Investment Magazine about why the fund has faith in alternatives.
The Queensland local government employee fund LGsuper is only a third quartile performer over one, three and five years and it is reasonably comfortable with this situation, as each option’s CPI+ objective has been met over all time periods.
Part of the reason is that it is a top quartile performer over seven and ten years and the skew of its investments means it is always likely to underperform when equity markets have rallied, but to do better when they fall.
Another reason is its MySuper option has a strategic alternative asset allocation of 25 per cent, much higher than its peers and one of the lowest equity allocations at only 46-47 per cent in equities.
A relatively mature fund, the decision has been taken to lessen volatility for members to avoid the situation in the GFC where some members get badly hit just before retirement. So the role of alternatives is to access investments that have less volatility than equities or uncorrelated returns. Guy Rundle, investment manager for the fund, states: “Our members want a more consistent journey, we are trying to smooth the path for them with greater downside protection.”
The change of stance prior to the GFC has meant a re-education of member expectations. A key part of this is to direct members who want greater equity upside to switch out of the default fund into a higher growth option and provide flexibility to DIY with single sector options. “It is what we are providing to our members that counts not short term league tables,” he rationalises.
LGsuper is increasing the amount in alternatives to bring it up to its full strategic asset allocation and it is currently seeking an insurance linked security exposure across a number of managers in a fund of hedge funds. Such hedge fund exposures are designed to add alpha as well as uncorrelated returns, they form one third of their alternatives approach, with infrastructure investments and alternative or specialist credit forming the other two thirds. Notably, the fund has looked at the option of smart beta approaches to equities that would provide the lower volatility the fund seeks, but they have preferred to go down the alternatives route, for now.
The fund is currently underweight its strategic allocation to alternatives due to the relative slowness of funding some managers, some taking three years to draw down all allocated capital. This under allocation could also be filled by opportunistic investments by its managers. “We can have a fast turnaround, as our board meets on a monthly basis,” says Rundle.
The third of the portfolio in hedge funds sits with the world’s leading hedge fund manager Bridgewater and with fund of funds manager K2 Advisors.
Bridgewater came first, but due capacity constraints they started returning money to LGsuper and so the mandate with K2 was established. In keeping with the reinvention of fund of fund managers as creators of bespoke portfolios, K2 matched 12 underlying managers to complement the risks taken elsewhere in the LGsuper asset mix.
“We provide them with our total portfolio,” explains Rundle. “They take their little piece of the fund and they model it within the total portfolio, to see how that complements all our other investments.”
The K2 mandate has been running for two and a half years and has “really paid off” says Rundle, who is passionate about the advantages of a bespoke hedge fund portfolio. “That old fashioned off-the-shelf hedge fund program should be redundant and you really should be looking for a bespoke mandate that complements your existing investments in your portfolio,” he says.
The relationship works so well, LGsuper is now in talks with K2 about building a broad portfolio exposure to insurance linked securities, a form of risk premia the fund is not yet exposed to. “We are looking at how we can make it dedicated exposure as a lot of the models show it reduces the risk of the portfolio and adds alpha as the investments are generally uncorrelated. It is just ensuring you get the right exposures with the right managers and timing in this sector is important.”
LGsuper do not believe a single exposure to a catastrophe bond manager, as some fund have, will be the most efficient way of accessing the ILS market. It is working with both its consultant Towers Watson and K2 on achieving this.
One of the hygiene factors for LGsuper in hedge fund investing is the transparency offered by K2. “They have very good relationships with these hedge funds and insist on having look through data on a weekly basis, so they know exactly how our portfolio looks, right down to the stock level,” says Rundle.
For good measure Towers Watson carry out similar analysis of these hedge funds for LGsuper and the results are similar, giving extra comfort that K2 are doing a good job. “Generally with any other fund of fund you have no idea what the underlying holdings are, you do not get that understanding of the assets you are exposed to,” says Rundle. “They do constant modelling on a monthly basis and can give detailed analysis on what our exposures are on that portfolio, which provides a huge level of comfort, knowing we have that insight into our investments.”
The alternatives portfolio takes up more time than the management of the other assets and directly owned infrastructure assets takes up the greatest amount of time.
The approach is exacerbated by pursuing a policy of avoiding trophy assets that attract worldwide interest from institutional investors. LG Super also prefers to invest outside of a pooled trust structure where possible, particularly in Australia. The sweet spot is an asset of $100 million for which they will take a $20-$30 million stake. Again ideally they will partner with an investment manager on such a purchase, their best relationship being with Palisade Investment Partners.
Rundle lists the extra work involved from this route as the investment thesis analysis, the tax and legal due diligence. “If you put in the work and the analysis it can pay off, certainly in the long run as you can hold these assets for years,” he says. The workload is shared by the LG Super team with input from the board and David Todd, the fund’s chief executive and former chief investment officer.
LG Super works with Palisade in Australia, where they have taken ownership chunks in the Port of Portland, Tasmanian Gas Pipeline and Waterloo Wind Farm. In Asia, they work with Equis who have a similar mid-market approach and in the US and Europe they have just appointed I Squared Capital to do the same.
Assets here are largely brownfield with a little development upside.
The fund is holding these low risk assets for the long term. “We look at these assets generating dividends on a regular basis. We could hold these assets for 20-30 years,” says Rundle.
The space where institutional investors have been able to provide capital for lending since the banks became restricted in their activities, has provided a couple of areas of high return in the last few years.
LG Super invests $142 million with Westbourne Capital in investment grade infrastructure debt which has brought returns of 10 per cent over three years, which Rundle is very happy with. “A lot of the return is not just the yield play it is also when debt is repaid early or refinanced,” he says. The key role of the investment is to provide diversification.
Another allocation that Rundle describes as not dis-similar to the infrastructure debt investment is in mortgage backed securities with Macquarie Bank – this has brought low volatile, consistent but “not huge returns”.
“On the back of the GFC, mortgage backed securities were out of favour so that has done reasonably well for us on a risk adjusted basis,” says Rundle.
The two other mandates cover emerging markets. The most intriguing is a specialist mandate with Stone Harbour that tilts between a fund for high yield debt and one for emerging market debt (both local and hard currency) as opportunities rise. This has allowed LG Super to move away from high yield as opportunities have declined and to re-emphasise emerging market debt as the range of opportunities has grown.
Finally, there is an opportunistic investment in emerging market currency with Rogge that the fund has held for just over three years as part of a DSAA 3-4 year tilt, has done very well for the fund.