The responses to the 2018 Investment Magazine CIO Sentiment Survey reflect changes funds have made during the late-cycle economy to prepare for the expected downturn. Key decision-makers have leveraged their longterm horizons, negotiated on fees and lowered expectations, allowing them to stay calm in the face of the coming storm.
Australia’s largest asset owners’ ongoing appetite for infrastructure investments, keenness for passive products and optimism in the face of market uncertainty are key findings of the 2018 Investment Magazine CIO Sentiment
For respondents to the seventh-annual survey, infrastructure and other real assets were the most popular asset classes for allocation of more capital, with 43.5 per cent of respondents saying they intended to up investment in those areas in 2019.
Whereas, in 2017, 47 per cent of respondents said they planned to allocate a greater proportion of their fund’s assets to hedge funds or other liquid alternatives, in 2018 only 34.8 per cent of respondents said they planned to do so, dropping the asset class to second most popular for allocation of more capital.
On the flipside, domestic equities was the asset class where most respondents said they would allocate less capital, with 39.1 per cent saying they planned to reduce investment in that area.
This year’s CIO Sentiment Survey was conducted online over three weeks in October. It was open to investment chiefs and other senior investment professionals from the 100 largest institutional asset owners in Australia and New Zealand.
The investment bosses who completed the survey were overwhelmingly from local, not-for-profit funds. The 25 funds represented in the results control a collective funds under management of $556.15 billion.
Australia’s largest super funds are long-term infrastructure lovers. Industry Super Australia states that, in 2018, industry funds held direct equity investments in major airport, seaport, utility and community infrastructure valued at about $17 billion.
That figure is set to rise. Super funds are well positioned to provide debt for infrastructure projects, given their long-term investment horizons and appetite for what some may see as non-traditional asset classes. The 2018 Investment Magazine CIO Sentiment Survey confirms the trend.
“We continue to see strong demand by investors for infrastructure assets globally. This partly reflects low starting allocations for global investors, relative to many Australian superannuation funds,” Frontier Advisors director of consulting Kim Bowater says. “While infrastructure is less attractive as an asset class relative to history – prices are higher and we expect headwinds against returns as interest rates rise – there are positive fundamentals in many sectors and the supply/demand environment remains strong.”
Cbus Super CIO Kristian Fok told the Master Builders Australia National Leaders Summit at Parliament House in June 2018 that as much as $260 billion would flow from the super industry into the infrastructure sector by 2025.
“When superannuation fund balances were smaller, investment in greenfield projects was not realistic from a capability and cost perspective,” Fok explained. “[But] with the growth of funds under management, many super funds are now building internal teams and expertise. That means greenfield projects are a real consideration.”
Just this year, AustralianSuper, as part of a consortium led by toll road giant Transurban, has been successful in its bid for 51 per cent ownership of WestConnex, the largest road infrastructure project under way in Australia. Also, First State Super CIO Damian Graham told Investment Magazine in October that the fund was moving from a “more vanilla-type portfolio” to one heavier in unlisted securities.
Chant West head of research, Ian Fryer, says the infrastructure love affair reflected in this year’s survey is the continuation of a pattern that has stretched for more than 10 years.
“Not-for-profit funds have moved about 10 per cent of their assets from equities and fixed interest to these unlisted assets over time,” Fryer says. “Funds have built out their portfolios to take advantage of more diverse sources of returns to make them more resilient to market shocks.”
In line with last year’s survey, respondents remained confident they could meet their investment return objectives. This is despite October being the worst month for global equities since 2012 and the word ‘correction’ being on the tip of many tongues.
In fact, survey respondents identified a pullback in equity markets as the biggest portfolio risk for the year to come, just ahead of rising interest rates. We “hope to be wrong about lower, more volatile returns for longer”, one respondent commented. “Equity markets are generally highly priced. Rising bond yields are likely to trigger a devaluation in all assets, especially equities,” another said.
Among geopolitical risks, respondents were most concerned about China tensions and US politics. One respondent commented that if China sneezes, Australia gets a cold. An additional respondent was more specific, citing as matters of concern “the populist politics leading to a sustained trade war between the US and China” and “a frozen US congress stymieing further stimulus or a co-ordinated response to the next crisis”.
Another respondent was less concerned, however, and said, “Geopolitical risks rarely matter much to markets and are currently relatively benign, despite the focus in the short-term news cycle.”
Despite the acknowledged concerns, seven in eight (87.5 per cent) respondents said they were confident of meeting their balanced return targets in 2018; few (8.3 per cent) believed they needed to take on more risk to do so. This reflects more confidence in meeting targets than in recent years. In 2017, about 60 per cent of the respondents were confident of meeting their balanced fund return target. One year earlier, that figure was a mere 30 per cent.
Over the last few years, many funds have dropped their targets to reflect more realistic expectations in a difficult market. About 1 in 5, 20.8 per cent, of 2018 respondents said they had lowered their stated return targets on their balanced portfolios in the last year. For the 2017 survey, this figure was almost 40 per cent. (The survey shows that the average balanced fund return target was CPI + 3.6 per cent.)
Frontier Advisors’ Bowater acknowledged there had been a trend towards lowering return targets for default options in recent years.
“While lower returns have not yet eventuated, it has made sense for investors to consider if their return expectations are realistic over a five- to 10-year timeframe in the context of the prevailing interest rate environment,” she says. “The survey results suggest this has continued over the past year. They also show a relatively high conviction that these objectives will be reached over the coming year. This will depend on global growth remaining strong over this period.”
Last year, Investment Magazine predicted that the multi-year trend of skinnier risk targets would draw to a close, with only 10 per cent of CIOs expecting to lower targets in 2017. In 2018, this trend does appear to have peaked and begun to subside.
A PASSIVE PUSH
Last financial year, Australian fund managers’ fees took a hit of more than $80 million after the country’s sovereign wealth fund, the Future Fund, moved more of its portfolio into passive investments.
This move by the Future Fund reflects a global trend. Boston Consulting Group’s (BCG’s) Global Asset Management 2018 report found that passive products were the fastest-growing category “by far” in 2017, with a record 25 per cent increase in assets under management. The value of passive assets sat at $16 trillion in 2017.
In last year’s survey, CIOs appeared to have somewhat of a muted attitude towards the potential of passive investing but in 2018, 25 per cent of respondents said they planned to move more of their portfolio to passive or smart-beta strategies – which passively track the index but include an active, rules-based component – over the next three years.
More than a quarter of respondents said they were using passive or smart beta as a way to reduce costs. It is this growing appetite for smart-beta products that BCG warned should be of major concern to asset managers.
“That is because smart beta seeks to replicate active management results at lower cost to investors. Fee levels for smart beta equity funds average about 35 basis points, well below the 50 basis points for active equity products,” BCG’s report stated.
A desire to reduce fees has been a consistent theme across the seven-year history of the CIO Sentiment Survey. This year, almost half (47.8 per cent) of respondents said their investment costs had decreased in the last three years. New, lower-fee products were the most frequently cited driver of decreased costs.
Is it possible this reflects too great a focus on fees in super? Chant West’s Fryer believes so. “CIOs must focus on how to deliver a strong long-term return to members but they also don’t want to look too expensive,” Fryer says. “There have been some retail funds that have put more in passive and enhanced passive for their MySuper products, and a few industry funds have as well.
“But overall, there is still a strong preference for active management and industry funds, in particular, have generated good alpha in asset classes like Australian shares.”
Fryer says private equity is probably the most expensive asset class “but good private equity managers have delivered strong returns even after fees are taken out. But funds are hesitant to put much in this asset class, as it blows their fee budget.”
The 2018 CIO Sentiment Survey found that private equity was the fourth most popular asset class, along with nondomestic fixed income, to allocate to in the coming year.
Respondents also felt they had the balance right on fee structures. Flat fee structures and performance-based fees with smaller management fees were the preferred pricing structures, with the largest share of respondents’ balance of assets.
The 2018 Investment Magazine CIO Sentiment Survey revealed that relationships with fund managers remain integral, with 3 in 5 respondents (59.1 per cent) saying they considered an asset manager a “strategic partner” and 72.2 per cent saying they had not reduced the number of managers with whom they have relationships.
Respondents nearly universally (95.7 per cent) mentioned negotiation as the main step to reducing investment costs, with access to key professionals and content delivery mentioned as the most important factors from these partners.
Fryer says strategic partnerships with select global managers were also playing a more important role – the survey showed 60 per cent of funds have these relationships.
“One reason for these partnerships is access to proprietary research from these managers to supplement inputs from the investment consultant and internal team – why not include some of the world-best managers to help inform the internal team on how they approach a particular asset class?” he asks. “In the unlisted space, these relationships can be used to access transactions that are not available to others, especially in infrastructure and private equity.”
Despite this, three in 10 (30.4 per cent) respondents recently insourced, or are planning to insource, more of their investment capabilities, and almost a third used asset consultants for manager research. In 2017, 19.4 per cent of CIOs said they would increase their internal capabilities.
Chant West’s Fryer says funds’ relationships with asset consultants are changing.
“It is now really only some smaller funds that use asset consultants in the traditional way, where they advise on all areas of strategy and manager research,” he explains.
Frontier Advisors’ Bowater comments: “The way we work with clients is tailored to each fund’s circumstances and has evolved as internal team delegations and insourcing have occurred.”
Fryer adds that while the CIO is the “key employee” for investment matters, the investment committee and board have overall responsibility for how the fund invests, meaning outcomes to members are not due only to investment team skill.
“It is the ability of the investment committee to test and challenge recommendations, when appropriate – to provide the extra level of oversight,” he says. “We are seeing more funds appoint board members and investment committee members with significant investment experience. We believe this is very important, given the large amounts of money managed by super funds.”