Most large superannuation funds are looking to increase the amount they manage in-house, but Cbus is resisting the trend and thinks it has found a smarter approach.
As a $30 billion Cbus moves up fund size from medium to large fund over the next five years, it is finding greater complexity in achieving further economies of scale.
The traditional slide down fund management fee scales as the fund becomes larger begins to break down. Kristian Fok, executive manager investment strategy, at Cbus, sums up the problem: “When you are smaller you can give larger amounts to the managers you have a higher conviction in; you have a fee scale in place that reduces the percentage fees you pay.”
“You then hit a wall where the managers are limiting how much money they accept and then you are forced to add managers. The consequence of that is that you are now not receiving more fee reduction because you are just replicating the same structure with more managers. And you are starting to introduce lower conviction managers, so therefore the net of fees outcome declines and the fee rates remain static.”
Cbus is already seeing some of the above problems creep into its portfolio and it only foresees it getting worse. From chatting to larger funds about this experience, Fok concludes that the biggest danger is at around the $50 billion size, which is a few years off yet, but he is starting planning for the event now.
While for many large funds the most obvious solution is to manage a proportion of assets in-house, Fok believes this approach is too blunt. He sees internal teams dedicated to a particular asset class as potentially locking the fund into a strategy that might not always suit its interests.
“It would be putting the cart before the horse if we said, ‘we need to put strategies in-house’ when we have not had the time and capabilities to think about what is required to manage them.”
David Atkin, chief executive of Cbus, concurs with Fok on avoiding managing assets in-house for the time being.
“We are interested in what other funds are doing, but we have some reservations about how much additional risk that would bring internally into our environment,” he says.
Atkin describes the risk of having an in-house team as creating inflexibility which would limit the fund from maximising returns in certain investment cycles.
A third way
The alternative proposal from Cbus is that it builds up its investment team with people able to collaborate with fund managers to create more tailored mandates.
Atkin describes this process as improving the level of strategic thinking in the investment team and ensuring optimal performance from the back and middle office.
While Fok describes it as managing the portfolio in a smarter way, identifying where the biggest risk exposures and opportunities are and generally thinking about the portfolio more granularly. He predicts more alternative beta type strategies which will provide flexibility to overweight the fund to a particular sector or risk exposure during investment cycles.
“In the first instance, we would be investing in resources around how we best manage the total portfolio and then we can look at whether there are elements of investments that we should think about taking internally,” he says.
Fok says it should be possible to design portfolios to target certain risk factors and work with others to assist in the execution.
He says: “If there are external parties able to implement this in a cost effective way, it makes sense for us to get them to do it. This keeps our time free to keep generating ideas.”
The strategic thinking to help design such portfolios is in part going to be carried out by the stock analyst Cbus is hiring that will focus on some of the fund’s largest company and sector exposures. This would give Cbus some of the same insights achieved by funds that manage equities in-house.
“One of the things fund’s mention as the benefit of in-house management is having your own company views that allow you to think about risks more holistically,” says Fok. “It also allows you to have a different dialogue with the fund manager.”
As well as strategy insights for its equity portfolios, internal expertise will also help in exercising its shareholder rights on its largest equity exposures.
Another area of enhancement is in quantitative analytics.
“If we take those ideas and robustly test them, we could then ultimately translate that into a strategy for an external provider to implement,” says Fok.
In infrastructure, Fok sees greater scope for coinvestments as the fund increases in size. He is also looking at a “much bigger, more structured way of managing cash”, some of which could be taken in-house with projected savings of around $500,000. This exercise is being undertaken in the middle office run by Trish Donohue, executive manager investment management. This will involve centralising liquidity management across parts of the portfolio. Fok admits that if there is a single fund that he takes inspiration from then it is the Future Fund’s way of working.
“Certainly, I have had some discussions with the Future Fund and there is a lot of attractions around what they have built out and there is a similar emphasis around thinking about strategies and portfolios.”
Increasing the expertise in the middle office is all part of this strategic transformation. Donohue is also growing her team to achieve greater understanding of risks and opportunities, particularly around liquidity and to ensure greater post-tax investment outcomes.
She says: “We are measuring our managers on an after tax basis, but we are now looking to introduce tax propagation, which is bringing together our tax parcels for the underlying managers and optimising what is actually bought and sold to minimise that after tax outcome.”
Donohue cites the appointment of JP Morgan as its custodian in 2013 as also helping it on this path to greater sources of portfolio returns, including securities lending and cash management. She also noted that Cbus has been receiving revenues from class action involvement for many years.
More recently, Donohue has hired an in-house lawyer. Of the appointment she says: “It is part of a risk management process, which enables Cbus to centralise its commercial and legal views and have a view that is consistent across our portfolio. It will also lead to more efficient management of legal costs.”
The changes that are coming to Cbus have put a greater focus on how these investment decisions are governed.
“We have set up some additional internal structures to streamline some of our decision making” she says.
Donohue describes the communication from the board’s investment committee to the year old internal investment committee and then on to the investment team as a “really strong delegation framework” that allows the investment team to be more nimble. In addition Cbus has an investment management group, monitoring the portfolio and making implementation decisions.