QSuper’s new chief investment officer, Charles Woodhouse, is sticking with a bond strategy that will help the $113 billion Brisbane-based super fund meet its return targets in an uncertain environment.
Woodhouse, who succeeded Brad Holtzberger in February, was part of the original investment team that pushed into long-dated government bonds after the global financial crisis. Eleven years on, the portfolio has a 25 per cent allocation to fixed income which is double that of industry peers including its potential merger partner, Sunsuper. They’re also betting on US commercial real estate and are weighing private credit in Asia.
“We are still allocating to those longer duration bonds and the portfolio is targeting similar levels of return and volatility to a listed-equity portfolio through time,” Woodhouse says.
The investment chief reckons bond yields should stabilise at the current low levels. And if the economy deteriorates further and the central banks adds more monetary stimulus, he says bonds will be the “only things in the portfolio that can perform strongly.”
“That’s what happened last year,” he says. “Bonds were the best performing asset class in the fund by a country mile. And we continue to see that activity – it’s a very strong performer again this year.”
Over the last 10 years, QSuper’s equity portfolio has returned 9.5 per cent per year where as its bond portfolio outperformed it by over 100 basis points.
Woodhouse says his team was focusing on diversification because with monetary policy setting the direction of yields, it was too difficult to make a significant call on the portfolio one way or the other. “It’s not that we are convinced yields will fall further but more that there are some future scenarios where having a holding of this kind will be very beneficial,” he says.
Even so, the CIO stresses that he is not building a portfolio where the outcome is based on a single big bet on bond yields. “If yields move the other way in several scenarios, there are lots of assets in our portfolio that will benefit, including listed equities and real assets.”
At 35 per cent, Q Super’s equity allocation is still the biggest contributor to the portfolio in terms of risk. About one third of its balanced portfolio is in unlisted assets, roughly double what most balanced portfolios have. “We actively work this part of the portfolio in terms of buying assets and, where it makes sense, to sell them in a very strong bidding environment.”
From time to time he has invested in endowment funds, risk parity funds and commodities. “We still have an allocation to commodities,” he adds. “That tends to be to be a bit more of a fluid part of the portfolio in term of different strategies we allocate to.”
Historically, this “fluidity” has mostly been in the unlisted asset class space where he is striving to balance those competing objectives –seeking diversification without sacrificing expected returns.
The CIO still sees plenty of opportunities in the unlisted asset classes where the fund is able to transact deals that achieve lower double-digit returns. He is avoiding the overpriced infrastructure sector and says the fund did not bid for Hobart International Airport, which was eventually bought by a QIC-led consortium.
Right now, Woodhouse is looking at US real estate market. He wants to buy more office buildings and apartment developments after purchasing Chase Tower in Texas for US$200 million in August. “The building is 98 per cent leased, got a good lease life, a nice parking asset associated with it and will generate strong returns for the fund going forward,” he adds.
A big part of his real estate strategy is to allocate with managers with vertically integrated capabilities. In other words, they target assets where something needs to happen to unlock value, such as a leasing opportunity or refurbishment or repositioning of a building in its market. “We can then either hold the asset if the market pricing is such that forward returns meet our hurdles or sell if pricing is so aggressive such that forward returns are below our hurdles,” he says.
Meeting return targets
Assuming interest rates stop falling, Woodhouse expects a balanced fund will see cash returns of 1 per cent or less, bond returns of between 1.5 to 2 per cent and share market returns of around 5 per cent.
In that environment, a balanced strategy will likely generate returns of 3 or 4 per cent which is lower than the return target. But Woodhouse expects private markets to generate high single digit or low double digits returns. And, together with the listed assets, he is convinced they have a reasonable shot at achieving QSuper’s balanced option return objective of CPI plus 3.5 per cent.
The Queensland super fund also has some exposure to emerging market debt, which Woodhouse says is more of a tactical play since yields in some countries collapsed much faster than expected. “Brazil is a good example of that where we invested in and got out because we generated very strong returns over a very short period of time.”
The CIO says the fund has been “optimistically active” in private credit and private debt over the last several years including in Europe, but got out as corporate bond spreads tightened. They are now, however, looking at private credit in Asia.
“We found the Asia private debt market behaves like private equity in terms of how the funds are resourced and the way due diligence is done,” he says. “It’s very country specific so if you look at half a dozen managers in that space, you might find they are investing in quite different countries. It’s very idiosyncratic.”
As for the global economy and financial markets, Woodhouse sas the outlook is uncertain.
“The US economy is not growing at the rate that people would expect and they’re trying to stimulate it but it is not responding the way we would expect would expect which is a concern for us,” he adds. “If you told me a decade ago half the sovereign bonds in Europe would be trading at negative interest rates, I would have just laughed at you.”