VicSuper is about to launch a scientific, analysis-driven approach to enhance its dynamic asset allocation. The project, which has been one year in the making, is pooling sources of information on its investment holdings into a data warehouse.
It will use this superior information on the risks and opportunities it faces, to help better inform the scope of its asset tilts. It will also inform its strategic review on how it manages investments on a three to five year time horizon.
Oscar Fabian, chief investment officer for VicSuper, talks of how this will help the fund enter a new dynamic phase, that takes advantage of its sweet spot in scale at $14 billion – it is large enough to be sophisticated, but not too large to make money from smaller market positions.
“The philosophy in the early days was to be indexed and have low costs,” he says. “The board is now more focused on value for money and being more willing to be dynamic.” And he sees this as a sign that MySuper is not leading to a low fee, passive approach as many had feared.
He describes how quickly the DAA model can jump into action. “If the market is down x per cent overnight, we will have a plan which will be implemented fairly quickly,” he says. “So in doing our risk budgeting we make sure we have the ability to capture more of the alpha.”
Data warehouse
The first step in this journey has been collecting all data sources into one data warehouse. This information comes from its fund managers, market information providers, custodian and from the risk management system supplied by BlackRock.
The warehouse uses straight through processing and will thereby help pay for itself by cutting down on pricing errors in information that has been typed into spreadsheets. The system, which uses Sonata software provided by Bravura, will also create a much simpler audit trail.
“The objective is efficiency, straight through processing as distinct from a whole bunch of spreadsheets, with all sorts of different sources and the potential for error,” says Fabian.
To do dynamic asset allocation you need timely information and good implementation as well, so, VicSuper hired Citi as implementation manager to help make the transition of money, to and from fund managers, smoother and more efficient. One way Citi will achieve this will be through the use of futures and derivatives to ensure the fund can take up positions quickly.
“At the moment if we get a $100 million inflow, we put it through transition if it is big and complicated enough, or we do it ourselves by basically buying and selling stuff. With the implementation approach (from Citi) we can move quickly.”
Core satellite
VicSuper runs a core and satellite approach, but its core is made sophisticated by including enhanced passive approaches such as low volatility global equities. The core is there for stability – $2 billion with Vanguard – and downside protection. While the satellite portfolios, “very concentrated and benchmark unaware” is naturally there for alpha.
VicSuper appointed Analytic, a Los Angeles based fund manager, to run low volatility $416 million (3 per cent of the fund) in global equities with the aim of gaining above benchmark returns with 30 per cent less volatility. It has achieved this since launch in May 2014, but its main role is in downside protection. Such moves involve a mindset change away from benchmarks. “People have been talking about this low vol for decades, but not doing anything about it,” says Fabian. “You cannot use your standard metric of tracking error. You cannot use the information ratio, you have to use the Sharpe ratio.”
He adds of Analytic: “We are giving them the freedom to exercise their investment judgement, within their constraints.” Despite the returns and the greater downside protection, it will remain fairly limited due to relative extra expense compared to passive equities.
The success has encouraged the fund to look at running the same low volatility approach for emerging market equities and Australian equities. Though, due to the already imperfect nature of emerging markets the reduction in volatility would only be around 20 per cent.
VicSuper has a core approach to just 25 per cent of its emerging markets equity portfolio due to the general inefficiency of the market. One of the recent additions here is an emerging consumer fund mandate run by AB (formerly Alliance Bernstein). Run by Tassos Stassopoulos from London, it does not just focus on the emerging middle class, but targets consumers down to the lowest level. Fabian describes it as a “very interesting approach that is back to the old days of fundamental research for Bernstein”. Research consists of visiting parts of the world such as rural India, talking to the consumers to see what they are purchasing. “We did a lot of work and research on the fund and we are comfortable that it is going to add value,” says Fabian.
Global equities
VicSuper is eyeing a gradual reduction in Australian equities in favour of global equities. This would not be too notable, but for the fact that it has only a third of total equities in Australian equities and a much larger proportion in global.
“We are probably the other way around to most super funds of our size,” says Fabian. “If anything we will see that increasing rather than decreasing.”
Partly this is due to a decline in the commodity cycle stage for Australia, but some of it is for structural reasons, particularly the growth of internet based services, which will lead to disruption to traditional businesses and unemployment.
“There is a structural problem with unemployment going forward. It will stay high because many people have the wrong skills going forward,” says Fabian, who even envisages pruning back the 18 per cent allocation to Australian equities even further – global equities makes up 32 per cent of the fund with 11.5 per cent in emerging equities.
Fabian attributes the bias partly to not having any defined benefit liabilities, which need to be hedged to the domestic currency. Even with an 18 per cent allocation, this still represents a home country bias, points out Fabian.
Unlike many forecasters, Fabian is not alarmed unduly by the impact of US rates on equities. “We are not in the camp of trying to predict the exact date of the Fed hike and then trying to be out of equities by then. We are going to take a measured approach and see how we go,” he says. “If the Fed does finally hike it might not be so good for bond market, but why is it bad for equities?”
Similarly, the fund is looking to global property rather than Australian REITS. “It is a global asset class and should be treated as such,” he says.
In spite of its growing international asset base, VicSuper continues to run a passive currency exposure, with 50 per cent in total hedged through a program run by BlackRock. “We have looked at the possibility of active, but it is very period specific. It is hard to make a case over the really long time, so at the moment we are agnostic,” says Fabian.
He is confident with the global bias and points VicSuper’s top quartile performance in the Chant West survey as evidence – to the end of September 2014, VicSuper’s MySuper fund is positioned third over one year, fifth over three years and twelfth over five years.
Alternatives
If VicSuper is making smart decisions around listed asset classes, it hopes to get even smarter on unlisted assets by hiring a manager to run a dynamic program of alternative assets across many elements and strategies. Such a program it hopes will give it the confidence to increase its current 6 per cent weighting to alternatives. The money will come from organic growth at the fund, which is cash flow positive.
The goal is a diversification of its equity risk, with the objective of making nominal returns of 8 per cent. There are several managers in the frame which already run a range of alternatives in house and the proposition is soon to go to the board.
Fabian explains the appeal of such a move, compared to building an alternatives program in-house. “We are not eclectically hiring a hedge fund guy and a commodity trader and putting them together,” he says. “Then you have the problem of what proportions do you use and what proportions do the asset allocations change.”
Elsewhere in alternatives, VicSuper is focused on mid-market infrastructure deals. “We are trying to get away from the really large top end. The big assets are bid up to high. We are looking more at mid-market.”
