Flavour of the month - Chasing the international equities alpha

The fine-tuning never stops. Over the past 12 months a number of major superannuation funds have announced changes to their asset manager line-ups, with the most common element being a change to their international investment managers.

In just the past two months changes have been announced by funds such as Tasplan, HESTA and Asset Super, with the common underlying thread being the pursuit of alpha in what is perceived to be a deteriorating return environment.

More recently, Hostplus has been reviewing its manager line-up with chief executive David Elia making clear that in circumstances where funds are being warned of lower returns they are looking for additional alpha.

According to Elia, the current environment requires that funds remain strongly aware of their asset allocation and manager performance, with larger industry funds such as Hostplus having an advantage borne of their strong inflows.

“Inflows in the region of $40 million a month give us the capacity to make tactical decisions because, clearly, we are not being hampered by liquidity constraints,” he said.

“That means that we are actively over-viewing our managers and have a capacity to act when we need,” Elia said.

While Hostplus is currently reviewing its manager line-up, one of Australia’s biggest funds in terms of members REST, used its annual report to announce thetermination of mandates such as Australian Alpine Enterprises (BCR Asset Management), Bank of Ireland (concentrated overseas equities portfolio) and Portfolio Partners (Australian small caps portfolio).

At the same time, REST said it had appointed new managers during the year including AMP Floating Rate Income Fund (cash), Brandes Global Mid Caps (overseas equities), Orion (Australian equities), Renaissance (Australian equities small caps), MFS (overseas equities) and Marathon (overseas equities).

In other words, investment managers remain under almost continuous scrutiny and are on notice that ultimately, performance is everything.

The pursuit of alpha from international equities investments by Australia’s major superannuation funds is hardly surprising in circumstances where the latest Australian Prudential Regulation Authority data shows that international equities account for $59 billion of Australian superannuation fund investments.

This compares to the $93 billion directed towards domestic equities.

The changes are not resulting in an overall diminution in exposure to international equities but rather a pursuit of international investment managers who can be relied upon to generate better than average returns in a relatively volatile market.

However, the refinement of international asset management arrangements is not a new phenomenon. One of Australia’s richest funds, Unisuper was an early mover, announcing a restructure of its international share portfolio in late 2003 with the underlying reason being the pursuit of more efficient returns.

Not unlike a number of the smaller funds which followed it, Unisuper was effectively moving to adopt a more aggressive strategy to its international allocation.

The process has been on-going, with Unisuper’s chief investment officer David St John confirming that the fund had only recently completed another major review of its asset allocation.

St John said that asset allocations and the selection of investment managers represented a work in progress for most superannuation funds.

However, he stressed that keeping or disposing of an investment manager was not a decision solely based on investment performance, with a number of other factors coming into play.

“It is not just investment performance, but the judgement you make about whether a manager will be able to add value moving forward,” St John said. “Firing a manager who is out-performing is not a decision you make easily or lightly but it is not as unusual as you would think.”

One of the funds to most recently change its arrangements was the Tasmanian-based Tasplan in the wake of a review of both its domestic and international share allocations triggered by its merger with two other funds. That review saw the fund terminate investments managed by State Street Global Advisors, Credit Suisse and Putnam, while keeping Barclays Global Investors, GMO and MLC Implemented Consulting and adding MFS Investment Management.

For its part, Asset Superin late April not only announced a strategic rearrangement of its custodian holdings but a change to its investment strategy with the adoption of a more ‘active’ management approach, while HESTA appointed Western Asset Management to manage a global fixed interest mandate.

The bottom line, according to InTech Investment Consulting chief investment officer Ron Liling, is that funds have been expecting lower returns and are searching for additional alpha.

Liling said this had resulted in both a search for diversity and a preference for boutiques pursuing a highly concentrated approach.

In a wrap-up of what had occurred in 2004, InTech’s senior consultant Andrew Korbel said that the strength of Australian returns had led some people to question the merits of funds diversifying their investment strategies offshore.

“It cannot be denied that, had the typical growth fund been invested solely in Australian shares rather than the approximate average allocation of 20 per cent to international shares, its returns would be around 3 per cent per annum better over the past five years,” he said.

“However, it needs to be remembered that there are sound reasons for putting diversification strategies in place,” Korbel said. “International diversification is about providing stable returns over the long-term and safeguarding against the risks specific to Australian stocks and the Australian market generally, rather than picking the best performer in any given year.”

“Discussing the reasons behind the changes, Tasplan’s general manager, Neil Cassidy said the reviews had been prompted following the fund’s merger with two NSW funds in 2003.

“We undertook a review of our equities sectors with a view to realigning investments with the fund’s investment strategy and consolidating the number of investment managers,” he said.

Unisuper’s St John summed up the situation facing Australian superannuation funds in looking at their asset allocations and the relative performance of investment managers when he suggested that it would be wrong to suggest that the fine-tuning became more critical when investment returns were expected to be lower.

“That is a common belief, but the reality is that it is tough no matter what the level of returns you’re expecting,” he said.

“It is always easier in hindsight.”