Doug Talbot. Photo: Simon Hoyle

Australian superannuation funds shouldn’t rush to develop internal investment capability for the sake alone of reducing costs, the Fiduciary Investors Symposium has heard.

1886 Consulting founder and director Doug Talbot said it was beholden upon investment leaders in the industry to consider very carefully the gamut of issues associated with developing internal teams.

In the context of an ongoing trend towards internalisation and increased allocations by super funds to private markets, in particular, Talbot said “there’s a huge number of challenges as well as factors that are needing to be brought together by the investment leaders of our funds”. 

It’s important that these leaders recognise that they don’t know what they don’t know, he said. 

“They’re rapidly growing and maturing and becoming and looking at operating as much like an asset manager as they are an asset allocator,” Talbot said. 

“When all of a sudden in the private market space you are both an LP and a GP, then I think it’s just that there’s an openness to recognising that there are continued improved ways of setting up your systems, your processes and your people.” 

Investment issues are far from the only ones that come up when investment capability is internalised, Talbot said. There are people and culture issues as well, for example.

“The common pathway around public [markets] is pretty well known: that [you start as an] analyst and become a portfolio manager and you go from there; but often, the pathway and heritage of careers for people in private markets is quite varied,” he said. 

“They come from the specialist sector – that may be that they’re an engineer, it may be that they’re an investment banker. And so all of a sudden, you now have this interesting career motivation and cultural dynamic that’s occurring inside an asset owner business.” 

This means that internalising investment capability – particularly in private markets – solely for the purpose of driving down or eliminating external asset manager fees might address one issue but, if not managed carefully, could raise a host of others. 

In the same session, AustralianSuper global head of real assets Nik Kemp said that even though reducing fees is often touted as a key benefit of internalising investment teams, cost savings are actually a third or even fourth-order benefit of internalisation. Kemp said control over the timing of investments and the flow of information from directly held assets – and how that information often can be used across a portfolio – are much greater contributors to net returns for members.

Talbot said there’s a continued internalisation, there’s all these extra external factors.

“Of course, there are challenges around governance around risk and compliance; people; careers;…the motivators and purpose of the investors; fees, investment horizon; ESG; data systems,” Talbot said.

“When we think about it, the challenge on [investment] leaders is different to if you’re a DJ, and you’re trying to get the sound mix right, and you’ve got all your levers there. [For investment leaders] constraints exist continually, so how do you actually pull those levers right to get the right tuned sounds, the right balance?”

Talbot said it’s clear that when internalising investment capability, “foundations are fundamental, particularly from a private market perspective, as all of a sudden internalisation means that there there’s some pretty sophisticated capabilities that are needed”. There may also actually be an increase in costs, because “asset owners are competing for talent in a market that pays very, very well in the private market space”.

And funds must never overlook the issue of reputational risk, Talbot said, “and understanding how big that is”.

“Do you really, really understand the risks of what you have inside a portfolio from a private markets perspective, whether it be through… operational due diligence analysis, and [are] you really lifting the hood and understanding what actually are the risks that are sitting inside,” Talbot said.

“And I’m not just talking about the investment risk, I’m talking about the operational risks.”

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