Simply put, Graeme Miller believes the primary driver of value in a superannuation fund’s investment portfolio is asset allocation decisions.

It’s no surprise, because Miller, chief investment officer of the $21 billion TelstraSuper, spent most of his nearly 30-year superannuation career in investment consulting, culminating in a role as head of investment consulting, Australia,
for Willis Towers Watson.

He is now just over two years into performing the top investment job at Australia’s largest corporate superannuation fund, and the biggest change he has made to the team and investment process is to establish a “well-resourced” asset allocation team.

“TelstraSuper has a good track record of adding value through asset allocation and dynamic asset allocation calls,” Miller says. “But the process was largely based on the views and judgements of the CIO and narrowly supported by others as an adjacency to their roles.
“Given the importance of it, I wanted to have dedicated people in that role and we thought carefully about how to structure that.”

David Schneider, who worked at UniSuper for 10 years, joined TelstraSuper in January as head of asset allocation. Including him, there are now four investment staff members dedicated to strategic and dynamic asset allocation.

Schneider’s team does the research and analysis to support asset allocation changes, which are then debated by a newly established asset allocation committee, which includes all the heads of asset classes. John Eliopoulos is chair of the panel.

“Before an asset allocation change is made, it is debated and the heads of asset classes give their deep domain input,” Miller explains. “Then the committee collectively reaches a decision. All senior members of the team are involved and encouraged to contribute and challenge. It is important those allocations are supported and tested by the team.”

Miller emphasises the importance of this not only from a cultural perspective – so the whole team makes and owns the decisions – but also from a total portfolio perspective.

“We are delivering aggregated outcomes, not individual portfolios, to members,” he says.

TelstraSuper has a well-developed governance structure and Miller and his team do not need to go to the board for asset allocation changes.

“Under the delegation structure, the investment committee has substantial delegated authority for dynamic asset allocation changes,” he says. “I don’t feel in any way constrained by the governance.”

Current positions

There are a number of asset allocation tilts in play, relative to the fund’s strategic positioning, most of which relate to making the portfolio more defensive.

“This reflects a somewhat cautious view of the level of valuations in the market,” Miller says. “We are not in the camp that is bearish for global economies, we think there are a number of powerful drivers for global economic growth. But we are in the camp that says that is already fully reflected in asset prices, so we think the risk to asset prices is skewed to the downside, which means we have taken a number of steps to make the portfolio more defensive.”

The fund is underweight equities and has also sold off some of its real assets.

“We have taken the opportunity to sell some of the real assets we own and lock in very strong returns. It’s at the margin, and very targeted and deliberate. We are making sure the portfolio is resilient but also that the assets we do sell are the least well placed for how the global economy is likely to evolve.”

The fund is also holding more cash than it ordinarily would. Some of this is from the reduction in equities and the real assets sales, but it’s also the result of an exposure to fixed income that’s lower than normal.

The tilts sit under the dynamic asset allocation choices, but the decisions to hold specific assets within portfolios remain portfolio construction decisions.

This includes tilts towards, or away from, certain industries. An example of this is within renewable energy; Miller points out the fund would much rather own a sustainable low-cost energy producer than a fossil-fuel power generator.

Big-picture themes, such as disruption, are considered by the team, and TelstraSuper recently conducted a comprehensive study on disruption, led by Miriam Patterson, head of real assets.

“This looked at a number of themes, but energy disruption is the one that rose to the top,” Miller says. “The rapid decline in the cost of producing renewable energy and the trajectory of reduction in the cost curve is really fascinating. People don’t appreciate how fast and far the technology has come in the renewable space.”

Such a deep study revealed some detail on how to invest in the space, and Miller says because the price point is moving so quickly, it would be better to invest in the distribution not the generation of energy.

“Owning distribution infrastructure is a more resilient way to play it, and just one anecdote we’ve been looking at with regard to disruption,” he says.

Another example is the disruption of traditional shopping malls and department stores, and the impact of logistics and online shopping on real estate.

Money where its mouth is

TelstraSuper believes in active management; most of the portfolio is actively managed.

About two-thirds of the active budget is spent on traditional approaches, such as stock picking. Now, dynamic asset allocation is also framed relative to the other parts of the active-management program.

“Done well, our dynamic asset allocation will [use] one-third of our active risk budget in the fund,” Miller says.

TelstraSuper is prepared to put its money where its mouth is in terms of its return expectations from dynamic asset allocation, and has articulated the expected value add from the program.

“Over a full cycle, 5-10 years, dynamic asset allocation should add 50-70 basis points above the benchmark,” Miller says.

With the current size of its positions, however, the fund is not taking enough risk to make that a reality.

“I’ve encouraged the team to look carefully at how to spend the active risk budget,” Miller says. “The case for investment has to include active risk, fees and returns. Sometimes, the case for investing isn’t as strong and our members are better off if we spend those dollars in a different way or not at all.”

Active currency management is an example of how the fund is willing to make changes. In the past, TelstraSuper had a big currency overlay but that has been reduced and the fund has changed its thinking in this area. Traditionally, it was managed at an asset class level. But about a year ago, the fund started managing currency at the whole portfolio or investment option level.

“At the overall option level, we now look at what the desirable level of currency exposure would be,” Miller says. “We look at the likely risk/return outcomes of that and ask the same questions as for any exposure to any asset class. We target currency exposures independent of physical assets we hold in that option. It’s a commonsense way of looking at things.

“Previously, the actual foreign exchange exposure was an outcome of the hedge exposures in asset classes, our currency exposure just fell out of that. Now we are more targeted in allocating forex exposures, and the asset allocation team looks at that.”

The fund uses internal resources to make decisions around currency and an external manager to implement them. It also adopts this hybrid in real assets.

“We have a couple of portfolios that we manage totally in-house but in real assets we have a very successful hybrid model. This means we retain the ability to influence the way the portfolio evolves and the transactions in it, but we have a manager implement it,” he says.

TelstraSuper has about 90 manager relationships. Miller says about one-third of those are legacy relationships in closed-end private market and real-estate funds and are going through a natural winding down. That leaves about 50 to 60 active, ongoing relationships with managers.

Miller observes that the trend in the industry towards fewer managers and larger relationships will probably resonate at TelstraSuper but the fund does not have a set target.

“We recently terminated an Australian equities manager but rather than replace them, we decided we would be just as well off distributing the assets across existing managers and getting economies of scale,” he explains. “An undeniable trend, and one we’re very supportive of, is for funds to leverage their relationships with fund managers. There is so much intellectual capital embedded in our fund manager partnerships and having a smaller number of larger relationships allows us to more effectively exploit that intellectual capital.”

Perhaps due to his time as a consultant and exposure to hundreds of managers, Miller has quite a profound view of how managers will need to add value, and model themselves, to thrive.

“The traditional fund manager model is challenged,” he says. “If you’re a well-resourced partner engaged for a specific role but can add value across the portfolio, that gives increased relevance for the manager. If the only source of value it can bring is narrow domain expertise, that’s a big risk to the manager itself. As pressure mounts on fees, managers are in a better position to negotiate if they can offer more.”

Fees and costs are an important focus for Miller and his investment team of 20.

“Far and away the most important thing we are focused on is returns net of fees for our members,” he says. “We are always looking at how much value we are deriving from what we’re spending.”

This is also the lens the fund looks through when it is deciding whether to manage an asset internally or externally.

“There is much more value for money spent internally. We spend about 20 times more on external management,” he says. “We will always be heavy users of external managers but they have to present a compelling value proposition and not all do at the moment.”
Miller is challenging his team to see itself as an investment management organisation, rather than an investment department of a super fund.

“I challenge the team to operate in the way a world-class fund manager would in everything we do,” he explains. “For too long, super funds and consultants haven’t thought of themselves in the same frame of reference as investment managers, and they have sold themselves short. They have thought that a dollar spent on external resources and agents is different to internal systems, processes and people. When you look through a value lens, it is almost always the case that an internally spent dollar will generate a multiple of external dollars.

“We aim to challenge our thinking and culture and ask if this is the way a world-class investment management institution would do it. If not, why? Sometimes we can’t, because of resources, but other times it’s because of a frame of reference. We apply the same principles to ourselves we expect from external providers.”

This article is the cover story in the August issue of Investment Magazine.

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