The $37 billion State Super has been building up its exposure to Asian credit as chief investment officer Charles Wu says the sector is being slightly overlooked.
The fund’s defined benefit assets are mandated to be managed by TCorp and Wu was primarily addressing strategies for the $7 billion defined contribution assets.
“It [Asian credit] allows you to tap into the growth in the region by taking the more senior parts of the capital structure; it has a relatively lower duration and also a higher yield to maturity, and running yield,” he tells Investment Magazine.
“There used to be about 40 per cent in China allocation, particularly Chinese property, and it’s now dropped down to 28 per cent,” Wu says.
“You do need active management to mitigate some of the country risk, the regulatory risk, and higher ESG risk – like modern slavery and poor governance in certain selected countries.”
The fund is working with two active managers in the broader emerging markets credit portfolio, “one active manager and one opportunistic manager”, Wu says.
“They both are incumbent global credit managers that we had to start with,” he says.
“We feel very comfortable with their credit selections, their country risk assessment and ESG credential, and so that’s why we can broaden out that partnership with our partners.”
State Super has been closed to new members for around 40 years, and has a 7 per cent net annual outflow, which means that on a pooled fund level, and considering things like spousal membership transfers, the last member will depart the fund sometime in the 2080s.
“[That prospect] is somewhere well into the future – hopefully I won’t be working,” Wu quips.
But as a fund with negative cashflow, Wu says it does invest differently and has a “natural bias” towards yield instruments, which makes the primarily listed Asian credit attractive.
It also means when it comes to managing investment risks, liquidity is “more important than anything else in our portfolio”, he says. On top of the outflow, State Super has around 11 to 13 per cent of the defined contribution assets pegged to older members.
State Super is “peer-aware”, Wu says, but is not as bounded by relative returns as other super funds are. Its annual surveys of members suggest they prioritise stability of the outcome over peer performance.
COVID lore
Wu says the biggest liquidity crunch he has had to deal with during his time at State Super came during the COVID, when the fund grappled with a triple threat.
“There is the market event, and it coincides with the quarter end, which normally some of the FX settlement happens, and then potential market movement – so it’s the combination of the three that got us really worried,” he says.
But Wu says the fund has two tricks up its sleeve, and the first one is its long-term risk overlay.
“I’ve been with State Super for nine years, almost coming up to 10 years. All these times, we have downside risk overlay,” Wu says.
“The risk overlay is designed to address certain attachment points, and if you recall, the market dropped quite sharply [during COVID].
“So the increase of the volatility and also the market drawdown effectively take our risk overlay to potentially the max payoff that we are expecting – or close to – and it was a fast market.”
The State Super team was told to work from home on 7 March 2020, and it took a couple of days to establish communications across the investment team. Then, one of the first decisions fund CEO John Livanas made was to hold a daily investment committee meeting, which continued for a good two months.
The committee saw the need to unwind the risk overlay and delegated responsibility to Wu.
“I have my external risk overlay manager on speed dial for those days, so literally every morning I’ll call him and then ask about what’s going on, and we talk about market depth – like to what extent can we unwind this overlay,” he says.
“We unwound everything and the timing was fortunate, and we had the governance framework to facilitate that process. The proceeds effectively helped to mitigate most of the liquidity needs.
“I remember we ended up that financial year positive, so now that was a good outcome in a somewhat unfortunate event.”
State Super’s second trick is that it has the same portion of illiquid assets across DC premix investment options, Wu says, so that when a member switch from growth to a conservative option, for example, the fund can manage that transition with ease.
“But that does mean you need to be able to use other asset classes to manage the risk profile of the premix options…we try to ensure we don’t put ourselves into a forced selling position,” he says.
While circumstances were challenging during COVID, it was a great test case of State Super’s risk management system to figure out which risk mitigation lever pulled its weight and which didn’t, Wu says.
“I can tell you 2022 was a much harder case for us, because on the back of Russia invading Ukraine and higher inflation, a lot of the relationship between asset classes changed,” he says.
“Our original forecast – there is a level of reliance on the on the asset class relationships – that probably did not do as well as what we like it to be.”
Wu says the shifting asset class dynamics need to be explored beyond the often-discussed stock/bond correlation.
“To me, it’s a little bit more than just that,” he says. “Wind the clock back to 2008, a carry trade will be short Japanese yen and long Australian dollar. Now when you have a carry trade that’s primarily short in Japanese yen and long US dollar.”
“Is the Australian dollar still [a] defensive lever for us, or is it still going to be as effective?
“Those are the big questions that I think will take us a bit of time and research to really think about it, because the data is not readily available. But that probably will be the key topic that’s keeping us busy for the next little while.”
Charles Wu will speak at the upcoming Investment Magazine Fiduciary Investors Symposium in Healesville, Victoria. Register here.
