Women in Super, NSW lunch
13 February 2017
Check against delivery.
It is a pleasure and honour to be here with you today.
I have been asked to talk about how long-term investors might evolve their business models in the context of a changing world.
I certainly don’t want to presume to tell others how to evolve their business models. What I can do is tell you what the Future Fund is doing and why, and I hope that some of you might find some bits interesting. For the rest of you, I hope lunch is good.
I’m delighted to be joined by two of the Future Fund Board of Guardians, Carolyn Kay and Steven Harker.
The Future Fund now manages just under A$150bn on behalf of the Australian tax payer, across five public asset funds. The largest fund is the Future Fund itself which is valued at $128bn. This is the fund I will primarily focus on today.
Our organisation often gets confused with being a superannuation fund. I can understand that – the money is there to back the Australian Government’s unfunded liabilities for public service superannuation. However, the only people who own a stake in our assets are Australian tax payers. The superannuants themselves do not have any claim on our assets.
Our job is relatively simple, perhaps more simple than running a superannuation fund. We just get to focus on managing our investments as well as we can on behalf of the Australian Government.
Principles for how we operate
There are six key principles that set out how we operate:
- Everything we do is focussed on the specific objectives of the Fund.
- Maximise returns, subjective to acceptable but not excessive risk.
- Investment Mandate benchmarks the Fund against at least CPI + 4.5 to 5.5%pa.
- Assessed over the long term, which we define as 10 years.
- We construct a diversified portfolio that is, as far as possible, robust to an uncertain future.
- We believe prospective returns and risks change through time, and therefore manage the portfolio dynamically.
- We act as a single team, running an integrated process, managing a single total portfolio.
- We seek a relatively small number of relatively large relationships.
- We manage for a net of costs return.
Everything we do is focussed on the specific objectives of the Fund
The most important of these principles is this first one, and it is incredibly simple.
So why make this obvious statement? Because I think much of the superannuation and long-term investment industry gets distracted from their long-term objective.
It is extremely challenging to manage a long-term portfolio against something like a real return target. The noise that comes from markets whenever you try and take a measurement of how you are doing is so significant that any kind of signal as to whether you’re doing a good job or not gets completely drowned out. It’s all about whether the market went up or down over that particular quarter or year or three years. Perhaps over 10 years you can draw some conclusions but it’s very difficult to get meaningful measures over the short term.
Structures such as fixed strategic asset allocations or a reference portfolio are in common use by long-term investors and they are used for good reason – they help strip some of the noise out. However, we do not use these.
The problem, as we see it, is that in the act of stripping out the noise, you end up listening to the wrong tune. You are hearing some music that you are responding to but it isn’t that long-term objective that you wanted to pursue.
All of a sudden you have a board who is trying to achieve CPI + 4.5-5.5% but you have a management team that is trying to beat a benchmark and CPI + 4.5-5.5% no longer features in their thinking. That immediate distraction, we think, causes a whole series of misalignments through the investment decision making chain. At the Future Fund, we have tried very hard right from the very start to avoid that.
Prospective returns and risks change through time, so we manage the portfolio dynamically
One of the things we do is to change our portfolio depending on the market conditions. Again, conventional wisdom is that you should have a fixed portfolio and ride out the peaks and troughs and that will get you to your objective. I think that is a perfectly reasonable and, in most cases, sensible way of managing a portfolio.
However, at the Future Fund we have built the resource and capability to be able to respond to conditions changing through time.
It is clear when you look back over history that the risk adjusted returns on offer from markets change quite markedly through time. You can observe quite strong correlations between the ‘expensiveness’ of markets and the 10 year return that might follow. So why not use that information? The hard thing is not observing that it exists, the hard thing is having the structures in place to respond and adapt.
We’ve been talking for some time now about bringing our risk profile down. It’s now just below what we consider normal levels and we are sitting there quite contently for now.
Long-term results and performance
I’m not up here to tell you how good we are. What is important is evidence that shows that perhaps we are worth listening to and can offer useful learnings.
Plotted on the graphic I’m showing you are the 10 best performing super funds over the last 10 years. The light dot blue is the median. The red dot is the Future Fund – as you can see we have generated good, strong returns with relatively lower risk. When you adjust our tax rate to what the superfunds pay you can see that we have still achieved good returns with less risk in our portfolio.
The slide I’m showing you gives an illustration of some of the metrics we use to assess whether our investment model and process is working. As I said earlier, it is hard to measure how well you are doing when you’re focused on a real return objective.
We measure our performance against our primary objective. We then we try and break it down into a range of different metrics to get to a greater level of detail and dig into whether we think we are doing a good job or not.
The key is that none of these measurements are very powerful over short term periods. I think you would be very surprised by how little our Board talks about returns. The Board is focussed on process, how are we doing what we are doing, why we are doing it that way, and talking about the investment environment and the investments in our portfolio.
I can’t emphasise enough the importance of implementing a measurement framework all the way through the investment chain, and getting the incentive structure behind every measure right. If you’re using a measure, make sure it’s encouraging you to move your business in the right direction. The right direction is your long-term primary objective. If it’s not moving you in that direction, you shouldn’t have it. Measures that move you in the wrong direction are dangerous and create false incentives and misalignments throughout the investment chain.
Economic and market context
When you are looking at setting an investment strategy going forward, you need to know the environment you are operating in.
As you are all aware, we are operating in unusual times. We are witnessing an extraordinary policy response to an extraordinarily powerful set of influences on the macro-economic environment and markets. As a result of that it feels like we are in a fragile environment with lower prospective returns.
We are setting our organisation up so that it is understanding the environment as it evolves, and so that it is robust to whatever the environment throws at us. We need to be able to move the organisation rapidly and nimbly to wherever it needs to be in order to respond.
Our business strategy
This brings me to the business strategy we pursue at the Future Fund. We have three pillars to our strategy which we think put us in good stead to face the uncertain future.
One team, one portfolio
Originally this was an investment concept – the idea that we don’t want to optimise any individual asset class portfolio in its own environment, we want each asset class to contribute to an optimal total portfolio.
The philosophy now extends to all aspects of our business, from the investment team to our technology team. We want our people to look for the optimal solution for the whole organisation, even if it is the sub-optimal solution for their specific area.
Building this mutual understanding requires constant effort and a consistent and persistent reinforcement of expectations for behaviour. But it gets you the very best decisions by getting the perspectives and skill sets of the entire organisation feeding into decision making.
Flexible, nimble and opportunity-driven
If you’re in an environment where significant change can occur, it’s helpful to be flexible.
The superannuation industry, and the long-term investment industry more broadly, is plagued with conservative decision making. When you’re dealing with other peoples’ money it is very easy and reasonable to be prudent, cautious and conservative with how you invest that money.
But when you build processes that support such an approach, your decision-making can easily become too conservative. Decision-making can become slow and ponderous, and you can easily slip into not making the best decisions to create value. You have to try and find a way to maintain strong governance and conservatism while finding a way for the organisation to move and respond to its environment.
Leveraging the best in the world
We think that if you want to have a team that can be collectively, flexible and nimble, it probably needs to be small. Our organisation has been on a journey of incremental growth over the years and we are now a workforce of just over 140.
One way we can maintain a small and joined up mindset is by leveraging the best in the world.
We are in an extraordinary position of having access to the best thinkers in the world through our peers and partners, but we can do better at extracting their thoughts and leveraging off them. Applying all of the insights and the data that our fund managers have into our portfolio would be very powerful. We are at the start of our journey to be better at that.
People & Culture Strategy
We have a range of strategies in place that support everything I’ve discussed so far, but one thing I will focus on is culture.
Culture underpins our ‘one team, one portfolio’ philosophy. We have to be consistently and persistently explaining to our people what behaviours we expect from them – to move people to a place where it’s safe for them to make that sub-optimal decision in their context that is the optimal decision for the organisation.
In order to encourage people to look for those opportunities and decisions you have to create a culture where people belong to the whole, and want to belong to the whole.
We can do better on diversity and I think the industry more broadly can do better too. It stands to reason that if you have complex decisions to make that you need to have diverse perspectives colliding to analyse the problem and make decisions. We are trying to improve the gender diversity in our organisation and we have a number of strategies in place to address this.
We are focussed on building an inclusive culture that will allow flexibility to thrive. We have always offered flexibility in the work place but we are looking for ways to formalise our arrangements so that people take up the options available to them. We are increasingly seeing work as an activity, not a place. We expect that people will return commitment to us if we give a commitment to them.
We are pursuing a series of technologies strategies to support our organisation.
One key area of focus is data and analytics. We have so much information at our disposal and we want to be better at gathering and analysing this information so we can understand our portfolio in greater detail. Technology gives us the ability to do that and it is something we can do much better at.
And it’s not just us that can do better, I think the long-term investment industry has been underfunded and undercapitalised to take advantage of the data at its disposal. The race to the bottom with fees doesn’t help. I think that investment returns can be meaningfully improved if we can tap into the powerful information out there available to us.
So in summary, as an industry I think we should be focussed on finding ways to bring together all of the information and resources available to us.
Being efficient means removing barriers and constraints to working as a single team towards a clear, single goal.
Being effective means doing that in a flexible, nimble way that will adapt to a rapidly changing environment.