Mercer's Sue Wang warns of difficult year ahead

First and foremost, I'm stepping into massive shoes. Ronan is not only a colleague, but a friend, and a mentor, and we are sad to see him go.

I've been at Mercer for over a decade, and after leading the Pacific manager research function and more recently being responsible for the fixed income funds within the Mercer investments business, I'm ready for a new challenge. 

The new role offers a great opportunity for me to further my career and turn my attention to a whole of portfolio perspective. Given my tenure at Mercer, having worked within our consulting and investments businesses, I see this as a great opportunity to channel Mercer's leading global investment research capabilities into our Funds for the benefit of clients. I'm particularly excited about the challenge and opportunity to do this.

When our CIO Kylie Willment first asked me to take on the role, I thought there would be a lot of areas that I would need to brush up on. I'm not saying there aren't, but I have stepped into the role more naturally than I thought I would. It is early days though and I'm sure there'll be challenges and new learnings ahead.

We have a deep and well-resourced team so while I'm responsible for all the liquid asset classes, we have experienced investors focused on managing each of these asset classes.  This gives me a lot of comfort knowing that I'm working with such capable colleagues. Also, our CIO, Kylie Willment, is a seasoned investor and has been great to bounce ideas off.

Having a fixed income background is particularly helpful, given a whole of portfolio perspective requires a sound macro understanding. 

We might characterise other asset classes as having a more bottom-up approach. Of course, equity managers take account of the macro-outlook, but fixed interest is first and foremost, about getting the top-down macro decisions right. 

Things such as the inflation outlook and how central banks might respond, and how that might affect the growth outlook etc. These are standard considerations for fixed income investing. Understanding how such top-down factors influence all asset classes is critical for a whole of portfolio approach.

In a changing world, it's imperative to understand the various risks on the horizon, and respond to these threats from a holistic perspective, and not in a siloed fashion. In this regards, I'll be working with my colleagues to ensure that the asset allocation and manager selection processes are working together.

The role of risk management in portfolio management has never been more important. Scenario and stress testing your portfolio for various risks, no matter how unlikely, will be key to staying on top of potential outcomes. 

Leading up to March, many managed their portfolio with a clear base case. But this year saw some stark changes. Many didn't think the Ukraine war was a real risk - even in the weeks leading up to the conflict.

But the market got it wrong which forced the entire industry to become more thoughtful. The confluence of crises that we have experienced recently - covid followed immediately by a post-covid inflation shock and now a war - is new to us. 

The current environment represents a clear regime shift from loose to tight monetary policy, disinflationary to inflationary, and directional to more choppy markets. 

With a number of near-term event risks, geopolitical and economic, it's particularly important to ensure that our funds are well diversified. This includes diversification in our asset allocation decisions and across investment managers. Having defensive exposures such as maintaining some fixed income and quality-based investment styles are clearly helpful. So is having sources of active asset allocation, to remain nimble to such risks.

Finally, keeping the Funds liquid and up in the capital structure is also prudent.

Portfolio returns will be more varied as beta returns will display more volatility. This volatility will present challenges but also opportunities for fund managers to generate alpha, and we've seen a refocus on alpha generation across the industry.  

In terms of what we are doing in the Mercer portfolios, we are focusing on liquidity, changing asset class correlations and seeking out opportunistic exposures which may have been beaten down unfairly due to current market dynamics.  

There is a lot of industry concern around YFYS regulations, however, a lot of the YFYS reforms are things that many of us were already doing, such as focusing on total return outcomes and measuring the contribution of our active investment processes. 

The YFYS reforms do provide some additional perspectives on how to measure active returns, and we've be taking those perspectives into consideration when we construct portfolios.

A complication of the YFYS reforms is how to best integrate ESG-related issues, as implicitly the reforms do not seem to be conducive to such considerations. Mercer has committed to net zero emissions by 2050, and the reforms at first glance do seem to make this commitment more difficult. We view climate change as a material long-term risk that should be considered in investing. Further, we view that investors increasingly expect their investment managers to consider climate change not just from an investment risk perspective, but also from an ethical perspective. As such, we're actively looking at ways to further integrate ESG considerations in our portfolios and will engage with the regulator where we view the YFYS reforms could be more conducive.  

Super funds should start with an understanding of the desired member outcomes from a return, risk and fee perspective. Once these objectives are clearly understood, it's our job to select the right combination of managers to best meet these objectives. In some instances, it may mean blending a high alpha strategy with a lower alpha or passive strategy, but this is not necessarily the right framework for all funds and all asset classes.

The key is to make sure we invest in the best managers at all times, that are complimentary and within our active risk and cost constraints. An important point about passive management is that it tends to only dilute active risk, and not diversify it, and as such doesn't improve the risk-adjusted outcome which is the main aim when blending managers.

We continue to like real assets, particularly private debt and have reflected this in our SAA. Asia, and China in particular, remains an area of interest, although we acknowledge the geopolitical risks at play. With more volatile and less directional markets expected, we view active management will be more important. Seeking out new managers and ensuring we're always invested in the best managers globally and in a complimentary fashion, will become even more critical for long-term success.