Boosting fund liquidity amid heavy outflows

State Super chief executive John Livanas is at the forefront of the challenge for super funds when their members retire.

Unlike most superannuation funds with massive positive net contributions, State Super - as a closed benefit fund - sees annual cash outflows of around $5 billion.

Incidentally, all but about $8 billion of State Super's assets are managed for defined benefit members who, upon retirement, receive lifetime pensions,

So, while his peers focus on regulation, member engagement, and growth, Livanas is coming to grips with the opposite issue: how to manage a closed fund, in negative cash flow, with a membership nearing retirement and a long tail of defined benefit pension liabilities.

In essence, the fund is in managed wind-down working towards paying the last member around 2080.

Livanas is locked into a cycle of rising cash outflows leading to more pressure on investment returns to meet future retirement payments.

He points out that meeting the twin challenges of paying out big licks of cash while also achieving high returns adds complexity.

How do you manage the portfolio for a member who may have only two, three, four, or five years left in the fund?

Here, he faces a dilemma. He can't invest for the long term. And, he has to generate high returns but in a manner that outgoing members are unaffected by a sustained fall in markets.

Such limitations force him to take a specific approach. The much shorter time horizon means liquidity is a constant worry. Accordingly, the fund has iron-clad hedges against extreme market events.

"While these strategies limit the fund's growth strategies, paradoxically, a strong protection program that helps smooth returns allowed us to take more upside risk," he says.

In many ways, State Super looks much like a post-retirement style fund.

Accordingly, Livanas can claim to have more expertise than most industry funds running post-retirement type schemes.

Importantly, he understands longevity risk, which he thinks the other super funds will find challenging. "Dealing with longevity risk is tough.. It's difficult to create a lifetime product that can take on longevity risk without some insurance or pooling.

SAS Trustee Corporation is the trustee for four funds that collectively go under the brand name State Super: State Authorities Superannuation Scheme, State Superannuation Scheme, Police Superannuation Scheme, and the State Authorities Non-contributory Superannuation Scheme.

The assets of all four schemes are pooled into one of Australia's largest super schemes.

"Only governments and organisations with large balance sheets can take on that risk, and unfortunately, the super funds don't have big balance sheets."

"I don't know how this problem will be solved," he says. "We can take the risk because the NSW government acts as our backstop."

Sticking with equities

The defined benefit fund has a returns target of CPI plus three percent annually over rolling seven-year periods.

Around half of the portfolio is allocated to equities to help generate returns above inflation.

The big question for Livanas is whether he plans to maintain the high exposure to equities since the rest of the capital structure won't get him there.

Importantly, he doesn't see anything disrupting that allocation. Certainly not inflation.

"Most of the inflation we experience right now is cost-push inflation rather than demand-pull," he says.

"I'm a guy who remembered the last part of the 1970s. It's not fun to have inflation which pushes the economy into recession because interest rates have to go up.

"If interest rates rise too quickly and too much, we could go into recession."

In his view, the jobs market might be steadily tightening but there isn't the same level of wage pressure in Australia as in other countries.

Structurally, from a wage perspective, Australia is quite different from the US, which saw sizeable wage increases because salaries fell so much during the lockdowns, he goes on to say.

"Ours did not generally fall. We have maintained salaries to a certain extent. Accordingly, they won't go up as much."

Also, he thinks migration will help with skill shortages.

Consequently, Livanas doesn't think inflation will "pop" to the same extent as the US.

"As a result, we won't need much of an increase in interest rates to guard against demand-pull inflation getting out of control."

Livanas suspects Australia will stay in a relatively low-rate environment. "In real terms, interest rates are still negative - less than inflation, and that's likely to be the case for some time."

A contrary view

The State Super chief explains how his investment style differs from many of his peers.

The current trend - whereby super funds are bringing more of the investment function in-house - does not work for a closed fund.

Much of the investment function is outsourced to external partners. For State Super outsources the management of the $35 billion defined benefits fund to TCorp.

Livanas says outsourcing investment allows him more time to focus on risk management and strategy.

Further, he does not see a massive difference between the two styles.

For instance, he vehemently disagrees with the argument that you can't fire someone for underperformance when managing funds in-house, whereas you can when outsourcing to an external manager.

"That's a theoretical construction because you have to understand what's happening with the partner as though they are an integral part of your fund. You establish a long-term relationship with them and you share intellectual property," he adds.

Partners like Mercer and TCorp might manage the administration and investment operations, but the obligation to members still rests with State Super.

That means understanding an outsource partners' business as though it were part of the fund.

"You have to understand the outsource partner's people, culture, and dynamics to anticipate any risks coming around the corner," he says.

Livanas' team takes a broader, strategic role focused on the future.

"We are strategic and operate on different time horizons," he says.

"Short-term events don't taint our vision to the extent they might if we ran things on an operational basis. That means our team is well-placed to anticipate issues that might occur in a few years."

Neither does he agree that outsourcing is purely about cost savings.

"If you look at it outsourcing that way (costs only), you may end up with a particular outcome in a narrow sense, but it might not be the best outcome for members overall."

As for net-zero carbon - State Super has a plan to reduce carbon by 45 percent by 2030 and a "path" to 2050.

"We rewrote all our mandates and talked to managers to make sure they could meet their obligations, he said.

"Our target of a reduction 45 percent reduction by 2030 is tough, but it's aligned with the Paris agreement, so we are pulling in the same direction as everyone else,"

From where he sits, the path to 2050 will demand big changes to Australia's economic structures and sweeping government legislation. Good intentions on climate issues are not in short supply. But to Livanas, it's not yet clear exactly how we are going to get there.