Ian Patrick expects a surge in activism

The investment chief of the $230 billion Australian Retirement Trust says balancing the desire for returns with the court of public opinion is growing increasingly contentious.

Following Russia's invasion of Ukraine, investors and governments piled pressure on pension funds to divest Russian assets even at zero value.

Moreover, investors continue to urge funds to dump 'planet-wrecking' stocks. QSuper and Sunsuper members recently slammed the funds for lagging behind peers on climate change and are agitating for the funds to phase-out ownership of fossil fuels.

Patrick concedes that reputational risks associated with holding unpopular assets have come under the spotlight.

Further, he expects member activism to surge.

But from where he sits, it's not just about the ethical case for dumping Russian stocks or gas stocks.

As a fiduciary, the guiding principle for the investment chief must be to deliver the best financial outcome for members.

That means planning for the world that capitalism is creating.

"Part of that relates to the volatility of returns if there are unintended outcomes, if, for instance, regulatory responses are particularly harsh, or if we don't address climate change and suffer a catastrophic natural disaster," he says.

"Where the desire for returns and the reputational risk intersect is that in 30 years, members will be living in a world shaped by how capital allocation decisions are made today."

Patrick means that poor capital allocation decisions would have repercussions for members.

"That means being clear about we see the world, how we plan to deliver the right financial outcomes for members and put our case accordingly."

Divesting Russian assets was the right decision from both a governance and members' best interest perspective.

Also, for Patrick, it was a pretty straightforward investment decision following Russia's removal from the major equity indices.

"Would you buy those assets today given the risk to the downside? You probably wouldn't. "Then why would you hold them?

" Is the probability of an upside surprise sufficient to offset that risk? I don't think it was."

The problem was selling assets when Russian markets were closed.

Patrick seized a small window.

In many cases, emerging equity portfolios were not holding assets directly but American depositary receipts that allow US investors to trade in foreign stocks. Or, global depositary receipts.

"Clearly, once everything closed up, you could not trade."

However, Russian accounted for less than 0.15 percent of Australian Retirement Trust superannuation accounts.

Despite the growing pressure to exit fossil fuel companies, the investment risk is not the same as for Russia.

Patrick doesn't believe that divestment is an effective way for members to achieve their social goals since they lose their voice as a stakeholder.

Neither does he see selling fossil fuel assets as necessarily helping members achieve a better financial future.

"The right thing to do is engage with companies that use or produce gas and exert influence over them to transition to a lower-carbon world in an orderly fashion. That should improve the value of the investment and improve the net outcome for society."

Calls to sell their fossil assets and invest in renewables might not make sense.

The competition for private assets hasn't changed, and he is not about to risk overpaying for assets.

"We're not finding a lot of renewable energy assets attractive. They are so highly sought after that we think those prices are quite rich at the moment."

Different strokes

Although historically Sunsuper and QSuper each adopted distinct investment strategies, the funds shared similarities. Both funds outsourced a substantial part of their portfolios to external managers.

Yet, in one important area, they are diametrically opposed.

While legacy Sunsuper is benchmark aware, QSuper refuses to peer review.

QSuper famously decided that anchoring its investment and strategy to peers would be contrary to achieving the best outcomes for members.

After the global financial crisis, QSuper responded by slashing equities and loading up on high-duration bonds.

This strategy made the top-performing fund an outlier in the local superannuation industry.

Whereas the legacy Sunsuper portfolio was to deliver competitive returns relative to the other industry funds and is heavily skewed to equities, QSuper took a risk parity or outcomes approach, basically CPI plus a return.

Patrick stresses that asset allocation depends on the fundamental objective of the strategy, noting that the two legacy funds had opposite goals.

"QSuper's goal was to deliver a return over the long term in a way that didn't exhibit the drawdowns of a balanced fund when equity markets weakened.

"They did that through having a higher allocation to bonds but in a leveraged bond portfolio whereby QSuper extended the duration to generate a similar return to equities.

"To my mind, both strategies are valid in terms of meeting their respective objectives, but whether those two distinct approaches remain products that Australian Retirement Trust wants to offer in the future is the question. Once you know the objectives of the portfolio, the allocation will follow."

In terms of benchmarking, Patrick acknowledges that the introduction of the APRA performance test may lead to Australian Retirement Trust being less agnostic because the performance test will highlight areas of difference between the strategy employed by the fund and that reflected in the benchmark.

For example, commodities as an allocation are not specifically catered for in the performance test benchmarks, and therefore including exposure to commodities introduces the risk of differing performance.

"Being such a large fund, you can't take the existential risk of going against the performance test so I think we will gravitate to a more aligned asset allocation approach.".

Managing in-house

Unlike AustralianSuper and HESTA, Patrick has shied away from managing assets in-house.

The Australian Retirement Trust investment chief remains unconvinced that the active management of public markets or origination should be in-house, explaining that it's hard from a skillset, depth of coverage, and access point of view.

"Active international equities were probably the best potential bucket in terms of reduced fees if you could be sure that the net return outcome was equivalent," he says.

"Yet, this is probably the most complex to implement since you need to be offshore to attract the right talent. Also, you're not just creating an investment capability, but operations, middle and back-office, and licensing capabilities simultaneously."

That is causing pension funds to rethink internalisation of global equities. While it initally looked attractive, the operational complexity was quite a bit higher than expected.

"I'm not saying it's impossible and that others shouldn't do it, but we remain unconvinced of sustainable advantage. Hence, we have no near-term plans to internalise global equities."

Patrick can see evidence of a swing back to external fund managers with the middle eastern sovereign funds and entities like Korea Investment Corporation.

He says the swing recognises that despite a geographic footprint of offices and well-credentialed investment professionals in those offices, they still do not have the coverage.

He notes, however, that the Canadians have stabilised somewhere in the middle while North American funds are pursuing internalisation of some functions.

"It's a mixed bag."