Investment internalisation is still creeping up across the superannuation industry, with funds such as AustralianSuper and UniSuper sitting above 50 per cent and 75 per cent respectively, and other funds sitting in the range of 12 to 35 per cent.
But there should still be a high bar for internalisation, says Chant West senior investment research manager Mano Mohankumar, and when Chant West rates a fund it spends a lot of time making sure that fund knows what it’s good at – and what it’s not.
“We want to see evidence over time that a fund does have the preparedness to axe an internal mandate, and we have seen that; just about every fund that has internal management has terminated a mandate or multiple mandates,” Mohankumar told media on Tuesday.
“Not every internal strategy is going to work. Some can work well in a particular market environment and then may not work well in a different market environment.”
And while there’s long been suspicion that super funds would naturally be more forgiving of internal teams and give them more leeway on poor performance, Mohankumar’s experience is that they can be terminated even faster than the relatively brief three-year period most external managers get to prove their worth (though that’s rare).
“In some cases it can happen even quicker,” Mohankumar said. “I’ve seen a mandate terminated in less than [three years]. Some funds will tell you that the bar for internal mandates is higher and there is some truth to that. In this case it was a fixed interest strategy – it was probably two and a half years.
“They felt it wasn’t working, but it was also about the way they structured the portfolio – they wanted it into different sub-sectors, so it wasn’t entirely because of failure of that particular strategy but because of the way they wanted to manage that portfolio in aggregate. This strategy just didn’t fit.”
Funds tend to keep a closer eye on the performance of internal strategies because their remuneration is typically linked to the performance of the default option, Mohankumar says, incentivising the CIO to think in terms of the entire fund and move fast when an internal mandate isn’t working.
“Any sort of growth of internal management, if you want to go down that path, you’ve got to do it opportunistically. That’s how funds think – they’re not thinking we need to have 80 per cent of our portfolio managed internally by 2035. You have to be really careful about which sectors and subsectors you internalise.”
Funds returning to active management
Meanwhile, Chant West is also “observing some changed behaviour from the super funds” around the Your Future Your Super performance test, with funds that had previously piled into passive to build up a performance buffer now moving back into active management.
“We’ve seen some funds that struggled early on are now doing much better. They’ve built up a meaningful buffer and can reintroduce some of their best ideas, and we’ve been really happy to see that,” Mohankumar said.
“Some funds (with smaller buffers) also moved away from active asset allocation positions – so we saw smaller tilts or a pause on dynamic asset allocation (DAA) programs. Some funds that have built up their buffer have now rebuilt their DAA programs and have the preparedness to make active asset allocation decisions.”
But while Chant West and other commentators have in the past questioned funds’ high passive allocations to equity markets, Mohankumar reckons that members have probably benefitted from their big passive exposures to the US over the past four years. Now that the S&P500 and NASDAQ are looking shakier, it’s a good time to get active again. But funds are in no rush to add uncorrelated strategies like hedge funds back into their portfolios.
“We haven’t seen a [swing back to hedge funds] yet,” Mohankumar said. “The unfortunate thing about the timing of the performance test was that the first year was 2021, and a lot of hedge fund strategies were removed from portfolios, and that was the worst possible time to do it. They were incredibly valuable in 2022. Personally, I think hedge funds play an important role in multi-asset portfolios, but in terms of the trends that we’ve seen, super funds have gone down and their allocations are quite small now.”
