While most superannuation funds grapple with member retention and growth, SAS Trustee Corporation is coming to grips with the opposite issue: how to manage a closed fund, in negative cash flow, with a membership nearing retirement and a long tail of defined benefit pension liabilities.
SAS is trustee for four funds that collectively go under the brand name State Super: State Authorities Superannuation Scheme (SASS), State Superannuation Scheme (SSS), Police Superannuation Scheme (PSS) and the State Authorities Non-contributory Superannuation
As at June 2016, State Super had assets of about $42 billion and a total membership of about 110,000, including 65,000 defined-benefit (DB) members. About $34 billion is managed for DB members, who on retirement receive lifetime pensions, determined by the terms of their employment contracts and unrelated to the performance of investment markets. State Super is one of the largest providers of lifetime pensions in the country.
Only about $8 billion of the fund’s total assets are managed for defined-contribution (DC) members, who must take a lump sum and leave the fund by age 70. However, the age members typically depart the fund is 63, and the average member age sits at 55 – just eight years away from retirement.
Unlike most super funds, which have the benefit of operating a business model fuelled by mandated contributions, State Super is in managed wind-down phase, working towards turning the lights off in about 2080.
These peculiar constraints have forced State Super chief investment officer Richard Hedley and his five-member investment team to become trailblazers in dealing with the next crop of challenges the bulk of the industry will face as the Baby Boomers retire.
“We’re highly cognisant of that,” Hedley says. “In a sense, we’re right at the forefront
of what the industry is going to face when it moves into that de-accumulation phase: How do you deal with the fact that investment horizons have shortened for an individual member, who may have only two, three, four, five years left in the fund? How do you manage the portfolio for that person?”
Amid the industry debate on the merits of the government’s plan to implement comprehensive income products for retirement (CIPRs), State Super is an enthusiastic voice on issues such as managing longevity and other risks. This is despite it being unable to offer post-retirement products to its DC members, under the terms of its constituent legislation. Instead, it refers them to StatePlus, the financial planning business the fund sold to
First State Super for a reported $1 billion in 2016, a project Hedley led.
Hedley’s main responsibility is setting the broad investment strategy and strategic asset allocation, and defining objectives for investment options, keeping in mind the profile of members.
The actual investment function is outsourced. NSW Treasury Corporation (TCorp) handles the DB component, overseen by Hedley’s team. A number of State Super staff transferred to TCorp when it won the mandate in mid-2015, ensuring deep understanding of the fund and its members’ needs continued. The DC portfolio is spread across 35 external managers, selected with guidance from asset consultants Frontier.
‘Noses in, fingers out’
Of every dollar State Super spends on investments and services to members, about 95 cents goes to external suppliers.
Hedley says the trick to managing service providers is to set precise and detailed objectives and then let them get on with it, with careful monitoring of results.
“It’s noses in, fingers out,” Hedley says.
It also means being prepared to take action when suppliers are failing to deliver or not behaving appropriately.
For the DC component of the fund, Hedley says, Frontier provides the investment resources that the fund itself lacks.
“They can get out and see so many more people in the market than we can, to help us identify who is the best manager out there to implement the strategy we’ve set,” he says.
Hedley, in a previous role, worked for one of the managers State Super employs, Deutsche Asset Management, specialising in infrastructure and private equity. He joined State Super in August 2015, initially as head of unlisted assets and alternatives, before being appointed CIO in October 2016.
He says he got two surprises on joining the organisation. A pleasant discovery was the level of investment knowledge and expertise resident within the organisation. The less pleasant realisation was just “how thinly resourced the organisation is” compared with the private sector.
“It really runs off the smell of an oily rag,” he says. “Compared with a fund manager or an investment bank, where if you want something, you just dial up and it’s delivered to you pretty quickly. Here … we really have to prioritise the resource allocation.”
State Super chief executive John Livanas says the outsourcing of investment places a premium on hiring staff who have the experience to work with limited resources – an approach he says has been characterised as “small team, big brains”.
“Over the last 12 months, we’ve reviewed our strategy and our forward-looking projections of who we are and who we’d like to be,” he says. “We’ve moved to an increased outsourcing model.
Focus on allocations
The most important function for Hedley and his team is getting the fund’s strategic asset allocation (SAA) right.
Hedley says the internal team interprets the information external suppliers provide,
and has the capacity to make changes.
State Super general manager, asset allocation, Charles Wu, was recently recognised by the Australian Institute of Superannuation Trustees with its 2017 Investment Rising Star award, in part for his innovation in how the fund conducts its SAA reviews.
The reviews take place annually, setting views on asset class returns, appropriate investment targets, expected returns and risk, also assessing the potential to include new asset classes in the mix.
Hedley says it’s “a huge body of work” that informs the fund’s target returns and sets a basis for its portfolios. “Quarterly, we undertake a formal dynamic asset allocation review where we take a shorter duration view on markets, and form a view on where we want to overweight or underweight our SAA position.”
As at July 1, 2017, the SAA for State Super’s balanced option was 36 per cent in liquid growth assets, 27.5 per cent in alternatives, 36.5 per cent in liquid defensive assets and 26.5 per cent in cash. This represented a reduction in exposure to growth assets and an increase in exposure to alternatives.
Return targets for the fund’s investment options were also reduced from July 1. The target on the balanced fund was dropped from CPI + 3 per cent a year to CPI plus 2.25 per cent a year, over rolling seven-year periods. Likewise, the yearly target for the fund’s growth option was revised from CPI plus 4.0 per cent to CPI plus 3.5 per cent.
“Over that time horizon, we’ve taken the view, on advice from our asset consultant but also consistent with a lot of funds in the market, that return expectations are likely to be lower than they’ve been historically,” Hedley says. “We wanted to be very clear with members what return they should reasonably expect.”
State Super members typically do not have the luxury of 20 years to recover if there’s a significant downturn in markets, Hedley says. The fund employs illiquid assets and an equity options overlay to help smooth returns, and insulate members from potential downturns.
The equity options overlay strategy is designed to protect the DC portfolio from equity market falls ranging from about 5 per cent to 20 per cent.
The fund also works closely with the managers of its illiquid assets to assess opportunities to monetise their value to bring forward returns, and to redeploy capital.
“We can’t just sell them all, convert those assets to cash or put them in our liquid portfolio, because the overall portfolio would suffer,” Hedley says. “We’ve sold almost $500 million of infrastructure assets out of that defined contribution portfolio in the last 12 months, and we’ve deployed a substantial amount of those divestment proceeds into new unlisted assets.”
The options overlay allows the fund to maintain an overweight position in growth assets, such as Australian equities.