Super funds call on industry to get creative

Superannuation funds expect to increase their support for private capital but want the PE and VC industry to present them with more creative investment opportunities, according to some of Australia's largest funds at the AIC 2019 Conference.

Hostplus CIO, Sam Sicilia, said funds will increasingly invest in private markets because the bulk of the world's assets are unlisted, however, he called on the industry to change.

"If you persist with the old model – that we raise capital, invest, harvest, get my fees, raise the next fund – that might be a short-sighted approach," he said.

Sicilia suggested the industry could create entirely new investment structures. For example, the PE industry could create vehicles that keep companies private forever as some funds don't want to divest.

"Do we create a private exchange, for want of a better term, that has a group of sovereign wealth funds and large Australian pension funds and others that contribute capital for the sole purpose of keeping those companies private?"

Another possibility he raised was industry helping develop stronger ecosystems around universities to commercialise their work.

"Rather than waiting for investee companies to be created by other people and for you to assess them in order to invest, why don't you help them build them?"

AustralianSuper Senior Portfolio Manager, Shaun Manuell, also backed the call for more creative investment opportunities.

"We've created an environment where there's incredible amount of capital. What we want are people knocking down our doors and giving us really good options to allocate that capital to."

First State Super CEO, Deanne Stewart, said private capital will need to become more aligned with super funds as they grow bigger and focus on the long-term.

"It's thinking about how is value created: Is it created with imagination and creativity? Is it created for the long term… it isn't just about burning and churning so whether that's stripping out costs, getting rid of people, making short-term profits, that will not be the focus of these long-term players."

AustralianSuper was the top performing super fund over the decade ended June 30, 2019 (9.8% p.a.), followed by Hostplus (9.7% p.a.), according to SuperRatings . First State Super has also performed well, earning a place in the top 10 for 2018-19.

Investors embrace the new normal

Sicilia said central banks were fighting a futile battle to return inflation and interest rates to pre-GFC 'normal' levels.

"We're likely to be in the environment that we're in now, forever – there is no storm. You have to keep investing in the environment that you have at any point in time. The reality is that those other days, they're gone."

Sicilia joked that the simplest solution for central banks to revive inflation was to "switch off technology."

"Technology is massively deflationary – we know that – and it is the root cause as to why we don't get inflation anywhere in the world," Sicilia said.

Hostplus and other super funds such as First State Super have become strong institutional supporters of the VC industry in recent years. Hostplus' total VC investments stood at $1.3 billion in June.

Manuell pointed to two secular trends changing the world: the role of technology and the ease of capital formation.

"We know that with technology, it is genuinely different this time," he said.

Partnerships and DIY being embraced by super funds

The call for greater industry innovation across private markets comes as super funds are reshaping themselves. AustralianSuper has brought a large proportion of its asset management in-house over the past six years in an effort to lower costs.

"Listed Australian equities was an obvious one for us. You think back 15 years ago when people were still paying 70-80 basis points – we were able, on a fixed cost platform, to bring that down substantially."

Those costs savings are then re-deployed in other strategies or partnerships that the fund believes can boost overall returns.

While Hostplus has not gone down the same internalisation path, Sicilia said he agreed with the aim of lowering fees but preferred to ask managers for the equivalent fee discount.

"Either way, you lose out… you either get terminated – Shaun's way – or you survive, and you give me a fee discount – my way."

Australian super funds are also embracing alternative structures to lower fees and exert more control over unlisted assets. A recent report by Preqin showed that 47% of local super funds are making co-investments compared to 26% of global pension funds.

AustralianSuper raised some controversy when it teamed up with BGH Capital to bid for ASX-listed private hospital operator Healthscope and education services provider Navitas last year.

"We actually started our co-investment program back in 2014-2015 and Healthscope was our 41st co-investment deal," Manuell said. "It's just that the first 40 were overseas so no one paid much attention to it."

Manuell said short-term market behaviour was leading to sub-optimal outcomes which created investment opportunities for AustralianSuper.

"If we think there's a value arbitrage by taking a longer-term view versus where the market's pricing something in the short-term, we're going to take advantage of that. That's the beauty of the platform that we've created, that we can actually do that in our drive to create better longer term returns for our members."

Super fund industry addresses growing pains

Despite approaching $3 trillion in assets, the Australian super fund industry is undergoing a significant period of evaluation in the wake of the Royal Commission into financial services misconduct and a Productivity Commission report into the sector.

First State Super CEO, Deanne Stewart, said the market was set for another round of consolidation with the Protecting Your Super legislation set to sweep out inactive low-balance accounts in October.

"There literally will be funds that will halve overnight and be left with a much smaller base and not enough to sustain themselves."

While scale usually delivers greater net benefits to members, large funds also face challenges investing as they attempt to manage significant cashflows.

Manuell said AustralianSuper recognises it has an obligation to the domestic economy, where its more than two million-plus members live. "We will always be putting a marginal dollar in Australia more so than we would in other markets," but finding more creative investment opportunities was crucial.

Stewart said scale raised investment challenges as well as cultural challenges. First State Super is currently working through a binding heads of agreement to merge with VicSuper, which will make it the second largest fund behind AustralianSuper.

"The people and the culture, and all the what I call 'soft wiring', is actually as critical as the investment side, so we're working through both of those."

Many industry funds have benefited from significant inflows following the Royal Commission's findings. Sicilia said various forms of the union-employer representative trustee model had delivered outstanding results.

"What's important here is that when vested interests around the table all have their money in the same pot, those vested interests disappear."