As the Netherland’s overhaul of its €1.45 trillion ($1.6 trillion) pension sector, Europe’s largest, gathers pace the country’s pension funds must shift from defined benefit to defined contribution.

Asset owners are beginning to adjust their hedging policies and asset mix to prepare for a new world that replaces retirement income promises for members with a different system that bases pension payouts on contributions and investment returns, dependent on the vicissitudes of financial markets.

“Pension funds are really busy with the transition from DB to DC. Everyone is preparing for a different asset mix in the new DC system and beginning to incorporate a different approach to interest rate hedging that has always been a very prominent element of risk management in the Netherlands,” explains Xander den Uyl, somewhat of an identity in the Dutch pension landscape. He is now a trustee at €1 billion Pensioenfonds Recreatie, a pension fund for employees in the Netherland’s recreational sector that is at the forefront of a transition that is being closely watched by governments around the world, mindful of the need to reform their own pension systems as aging populations increase.

“Recreatie is really leading the pack in its approach to the reform process and sees a clear future. It’s a nice atmosphere,” reflects den Uyl, who has just taken up the role after a 12-year stint on the board at €9 billion PWRI and who was also a board member at the giant ABP until May 2023, and had been its previous deputy chair.

Rush to hedge

The reforms promise profound implications for Dutch funds’ hedging strategies; the extent to which hedging will remain active and dynamic or shift to shorter duration swaps, and the suitability of LDI strategies in the long-term.

Many Dutch funds have dynamic asset and liability management strategies where a matching and return portfolio, and an interest-rate hedging strategy, all move in line with funding ratios. An investment approach that has been encouraged by strict regulation steering funds to focus on short term stability and guarantees rather than tilt towards risk-taking and long-term returns, but which has also thrived in a low interest rate world.

den Uyl predicts that more funds will seek to hedge interest rate risk in the next few years ahead of the 2028 reform deadline. It could lead to a short-term spike in demand (in 2026 and 2027 particularly) for hedging as funds scramble to de-risk.

Most funds have a relatively high solvency rate because of the rise in interest rates, a position they want to preserve before they transition into the new system, he explains. “Funds are thinking about increasing their hedging position in the short-term because if interest rates go down, their healthy solvency ratio is threatened.”

But from 2028 and beyond, the strategy for long-term hedging will increasingly shift to demand for short-term hedging strategies. The reduction in the duration of their hedging portfolios over time will see more selling of long duration and more buying short duration, he says.

“Less demand for long-duration hedges will have some price effect on rates,” he predicts.

As a regulator, the Netherland’s Central Bank, (DNB) is hesitant to speculate how pension reform will impact asset mixes and hedging strategies, mindful that portfolio composition will only become apparent when pension funds migrate to the new system.

Still, DNB’s Chris Sondervan, a supervisor of specialist financial risk, acknowledges an important change of the new pension system will include an increased emphasis on robust risk preference surveys.

“Pension funds will have a good understanding of their participants’ risk appetite in their investment portfolios and are obliged to have an asset allocation that fits with the corresponding risk appetite,” he says.

Under this new, participant-specific risk umbrella, interest rate risk will be better allocated to reflect respective risk preferences.

“For example, young generations have a long horizon and are, therefore, more likely to hedge against long term interest rate risk, while old generations prefer to hedge short term interest rate risk. The current pension scheme does not take these differences into account, while the new pension scheme allows for tailor made interest rate hedging strategies,” he says.

Changing the asset mix

It’s may not just be hedging strategies that change. Changes to pension funds’ asset mix are also on the horizon. Many funds, particularly with younger beneficiaries, may begin to beef up their allocation to equities and reduce their exposure to fixed income.

“Of course, this will depend on the risk preference of members but there is a feeling that the asset mix amongst Dutch pension funds will become riskier,” says den Uyl, who welcomes a change that will see a shift from “overdone” hedging strategies, often at the expense of returns. Reform heralds the dawn of a healthier system that will see pension funds invest more not just in equity but real estate and alternatives, he adds.

More communication with beneficiaries

Under the reforms, pension funds will choose between two different types of DC schemes, either a “solidarity contract” where the fund decides on the investment mix or a “flexible contract” where the member can choose their own [investment mix].

It means the new regulation will see a sharp uptick in compulsory communication with beneficiaries. “This will be an important part of the work of trustees and boards,” says den Uyl.

There is a possibility heightened communication could have consequences for ESG integration. Although many Dutch funds have integrated sustainability off the back of pressure from their beneficiaries, the success of far-right leader Geert Wilders in recent Dutch elections and who has a hostile stance on attempts to cut carbon emissions, could signpost a population beginning to cool on sustainable investment.

den Uyl believes by focusing on the sustainability message, beneficiaries are unlikely to request changes in sustainable investment, even if the Netherlands political landscape shifts to the right.

“There will be even more communication with members around responsible investment in the new system, but members are pushing for sustainable investment, and I don’t see that changing very much and I don’t see the transition to a new system stopping the focus on sustainable investment.

Although not every political party is committed to reducing the impact of climate change, members understand that a sustainable return requires a sustainable world.”

Still, he does warn that if pension returns start to fall, priorities may shift. “If returns drop, the conversation could change,” he concludes.

 

At $26.4 billion and 28 per cent of Oregon Public Employees Retirement Fund’s total assets under the management, the pension fund’s private equity allocation is at the very top end of its target range.

Not only is the exposure stubbornly high, lacklustre M&A deals and “anaemic” exit activity; a slowdown in fundraising and deployment and market volatility creating benchmarking havoc have also conspired to cause consternation for the Oregon Investment Council (OIC).

“We are still in a phase of markets digesting what has been a wild ride since COVID,” said Michael Langdon, director of private markets at OIC, who charted how unprecedented stimulus in 2020 led to record deal activity; inflation and tightening ensued, and now a disconnect between private equity and volatile public markets continues to thwart performance.

Bias to larger funds but smaller funds do best

In its Annual Review of the asset class, the private markets team told the investment council that OPERF’s large program is skewed to allocating to larger funds – yet smaller funds have significantly outperformed. The team have now begun a “manager by manager” analysis to dig down into “why this has happened” although they noted “actual, crystalized IRR” confirming smaller fund outperformance, remains unproven.

The size of the program means OPERF can only access a narrow selection of the manager universe because small managers can’t take large commitments. Of the 5000-odd funds in the asset class composite from 2013-2022, only 352 raised $3 billion plus of committed capital – during the same time period 50 per cent of OPERF fund investments by count and 71 per cent by commitment went to funds with $3 billion or more of total commitments.

Positively, large commitments enable OIC to negotiate more favourable fees.

Cash flow negative

In another challenge, the slowdown in distributions means the private equity allocation has turned cash flow negative for the first time in a decade. In 2023, the portfolio processed capital calls of $2.9 billion and distributions of $2.4 billion leaving net contributions of $518 million.

“2023 was the portfolio’s first negative cash flow year since the GFC,” state board documents.

Moreover, it’s difficult for LPs to model how fast distributions will show up to ease the crunch of negative cash flows. “We control what we commit, but we can’t control how fast managers invest,” the board heard.

The team has also been unable to use the secondary market to pull forward distributions because of challenges around execution. Still, looking ahead, improved pricing in the public market will feed into the secondary market, helping OPERF generate more strategic liquidity.

Pacing and fewer GP relationships

OPEF has a strict private equity pacing commitment of $2.5 billion total annually. But this has also caused challenges to appear in the portfolio because it has led to an underweight in vintages that have performed well. It has created a drag on OPERF’s relative performance due to the strong, early performance from recent vintage years where OPERF is underweight, say board documents.

Around 60 per cent of OPERF’s fund investments in mature vintages are ranked below median as compared to other funds pursuing a similar strategy in the same vintage.  “Fund size continues to have an outsized impact on quartile rankings, particularly with respect to OPERF’s core allocation to North America buyout funds,” say board statements.

The pension fund will keep its pacing range of between $2-3.5 billion while there is a slowdown in distributions.

OPERF is currently “lighter” than it wants with some 30 GPs on its roster rather than a preferred 40. In a catch-22, the team will only add managers as the pacing allows, and given the team will stick with the existing roster unless “the manager gives reason not to reup” it means scant opportunity for new GPs. Since 2015 the program has sharpened manager selection, reducing the number of managers from 70.

The OPERF portfolio has buyout, venture and growth equity. An overweight to buyout and North America has served the fund well. In contrast, the struggle to retain the target weight to venture has been a detractor. In another trend, the investment team expect to tilt more to developed markets in America and Europe because of the challenging geopolitical landscape.

Shifting dynamics

The board heard how the dynamics behind private equity are changing. Since 1981 – when Oregon was one of the first US pension funds to invest in private equity – interest rates have steadily fallen. It means rates have been falling for the entire time the fund has invested in private equity, bolstering the allocation as well as bidding up all risk assets.

The new interest rate environment means that fundamentals and earnings growth will now be the most important contributors to returns in excess of the market. Moreover, if returns are muted on a real basis by inflation, every single basis point is important.

Other market trends include inflated valuations in the tech sector. GPs hunting for capital for their next fund are under pressure from LPs to sell assets but because valuations remain inflated, buyers are cautious. Still, technology is unaffected by cyclical ups and downs. In contrast, PE opportunities in healthcare and services are buffeted more by macro trends, while investors in consumer brands do best focused on the luxury segment and from digitization trends.

The current market is also characterised by an uptick in demand for and availability of leverage from direct lenders.

The board heard concerns about the rising cost of leverage, with the team counselling on the importance of paying close attention to OPERF’s ability to serve the cost of leverage so as not to impact cash flows. Many GPs didn’t hedge interest rate exposure heading into rising rates and worryingly, a fair amount of debt has come due, requiring refinancing across the capital structure.

The $35.9 billion Employees Retirement System of Texas (ERS) has altered its allocation boundaries to permit a 10 per cent maximum allocation to cash.

The pension fund for state employees currently holds just under 8 per cent of its assets in cash in a boosted portfolio that taps the benefits of higher interest rates. It  is also a creative response to diversification challenges given the ongoing elevated levels of correlation between stocks and bonds in the current economic landscape.

“It’s not like the old days when it [cash] was dead money,” said Daid Veal, speaking at a recent board meeting, adding that alongside allocating more to cash, ERS is profiting from its bias to long-dated fixed income in a barbell approach.

However, despite “good returns” the cash allocation won’t edge higher because a larger allocation would move away from risk-seeking assets and potentially hinder the fund’s ability to hit its 7 per cent return handle. ERS’s exposure to the correlation in stocks and bonds is also capped because of its return-seeking focus with the portfolio split 80:20 to return-seeking/fixed income respectively.

Latest results have ERS beating passive indexes; peer averages, and the policy benchmark with three-year returns of 9.3 per cent. Veal attributed much of that success to the investment team’s implementation and prudent selection of securities and managers, a key focus at the fund that has helped reverse its fortunes since 2014 when ERS was rated in the third quartile compared to peers. Veal joined as CIO in 2021, but worked at ERS between 2009 and 2012.

“Security selection is the beating heart of what we do,” he said. “Asset allocation is on the margin – although we are investing more in our asset allocation teams, security selection will always be our bread and butter.”

Still, despite this commitment to implementation, internal management at the fund is at its lowest level since June 2020, responsible for around 42 per cent of the assets. Veal said he was doing his “darndest” to hang onto staff in a competitive market.  Texas ERS has a 78-person investment team, recently set up in refurbished offices that make collaboration easier.

Next year the fund will RFP/RFQ seven investment consulting roles, spanning all private market consultants, its general consultant and governance consultant. In November 2024 it will bring those recommendations to the board.

New look public equity

ERS’ commitment to implementation and stock selection is particularly visible in public equity where the fund has just completed a reorganization of the program – an actively managed allocation of which about 70 per cent is managed internally. The portfolio’s recovery is a direct consequence of the team travelling to meet managers; understanding how they conduct their business and add value, and finding the best strategies and securities they can.

The new look allocation is structured around a ‘Lone Star’ core fund which has an overweight to AI and other Magic Seven themes, drug manufacturers and aerospace. A key development in the public equity portfolio includes “materially” reducing the number of stocks by half to 1200 in an effort to increase the quality of companies and prepare for possible sub-par returns ahead.

Around 35 per cent of the portfolio is in public equity and when public equity underperforms, it drags down the entire trust. “In my book, investment is not like a base ball home-run, it’s more like tennis and avoiding making mistakes,” said Veal.

Since the restructuring, public equity has gained 9.7 per cent versus MSCI ACWI IMI Index returns of 8.2 per cent, which represents outperformance of 1.4 per cent (annualized net of fees to the end of September 2023).

In private markets the investment team also attributed performance to implementation and tweaking allocations to ensure the best exposures. For example, the fund’s private real estate allocation is different to its public market exposure, underweight office and with a careful approach to leverage.

Uncertain outlook ahead

The investment team predicts a period of uncertainty ahead, unsure whether the favourable economic environment of late will continue or more extreme conditions lie ahead.  A middle path of economic cooling where the economy also “chugs along” in the context of “elevated volatility” is the most likely outcome.

Much of what lies ahead will be determined by US consumer behaviour and consumption patterns. And despite low US unemployment and high nominal wage growth, the investment team said these trends don’t support more purchasing power.

“Folks’ real purchasing power has not improved,” said John MacCaffrey, senior portfolio manager. “They are making more money, but they are still feeling the cost of living.”

Moreover, because many people depleted their savings coming out of the pandemic, consumer spending is also being funded by debt leading to a spike in delinquencies. “Consumer spending is expected to cool at least in the near-term. This will detract from economic growth but it may also bring down prices and decrease inflation,” said MacCaffrey.

The indebtedness of the US government was another conversation point. Veal voiced his concerns on the level of government spending, adding that government finance is crowding out the private sector and skewing supply and demand with consequences for investors.

Moreover, the Federal Reserve and the market seem to be at odds regarding the future direction of interest rates. The market is expecting five cuts next year (helping fuel recent highs in the S&P)  but Fed guidance points to sustained higher interest rates for longer, indicative of sustained inflation. “Markets are fighting the Fed,” said Veal. “It’s a big disconnect. Are markets right, or is the Fed?”

The board also discussed the drag of missing productivity in the labour market. Although AI might supercharge productivity, it is still unclear how the gains in tech-related productivity might manifest. They noted that the last time the workforce got a significant boost in productivity was when women entered the workforce en-masse decades ago.

Elsewhere, the team flagged that the government’s anti-trust agenda could also pose a threat to the ability of companies to earn profits.

The World Economic Forum’s annual meeting in Davos served as a pivotal forum for leaders to deliberate on the challenges confronting today’s business community. Artificial intelligence was the talk of the town – you would be hard-pressed to walk down Davos’s promenade without seeing “AI” emblazoned on a half dozen storefronts or events.

Beyond main street, the impact of geopolitics was a focal point for corporate and investors alike. In a world grappling with war in Ukraine and the Middle East, US-China tensions, and polarised domestic politics in many countries, business leaders find themselves at the crossroads of global complexities and investment decision-making.

Which begs the question: how are investors assessing and addressing geopolitical uncertainty in their strategies?

The cross-border risk premium has gone up

In discussions with institutional investors from around the world throughout the week, including in FCLTGlobal’s own CEO roundtable event, the overarching trend is one of viewing geopolitics through the lens of risks, commercial, reputational, and organizational. In that sense, the risk premium associated with cross-border investments has witnessed a significant uptick, forcing leading investors and corporates to acknowledge and incorporate geopolitical factors into their decision-making processes. Geopolitical effects are now an inescapable consideration for any new capital allocation decision, with risk management taking precedence over risk avoidance.

Insights from an EY survey of 100 global CEOs highlighted the pervasive influence of geopolitics on decision-making. A staggering 99 per cent of respondents acknowledged this influence, with 40 per cent reporting delayed investments and 37 per cent having to halt planned investments due to geopolitical concerns. This survey underscores the widespread impact and urgency of addressing geopolitical challenges in the investment landscape.

Engaging with governments emerged as a key strategy to assuage geopolitical concerns. While this has been a longstanding practice for corporates, it is a relatively novel pursuit for the investor community. The importance of bridging the gap between geopolitics and global investment through active dialogue was emphasized by participants, recognizing it as a critical component of risk management.

Not all crises are created equal

Each crisis must be assessed based on its strategic importance to the organization or portfolio, demanding the ability to distinguish short-term noise from long-term trends. With conflict in Ukraine, Gaza, and now flare ups on the border of Iran and Pakistan just this past week, sifting through which events require action and which don’t will be a critical skill for investors.

For the last several decades, investment behavior vis a vis geopolitical events has been far more reactionary than anticipatory. This approach was appropriate as geopolitical shocks were mostly temporary fluctuations. Now, there will be structural change to the industry as alliances and alignments are constantly changing shape.

It almost goes without saying that the evolving US-China relationship, which I heard described as a “fall thaw,” is firmly a trend rather than noise; this dynamic has universal implications for the investment community. Fundamental disagreements persist, and while tensions may ease of in the year ahead, the consensus is that cross-border investments will decrease over time. This transition to a multipolar world, coupled with rising protectionism, supply chain realignment, national security investment laws, and increased regulatory scrutiny, adds layers of complexity that necessitate strategic adjustments.

All geopolitics is local

More than 60 countries will hold elections in 2024, and the significance of domestic politics in shaping future policies cannot be overstated. Investors are increasingly recognizing that their home government policies can either exacerbate or mitigate the complexity of operating internationally.

The trends of nationalism and a desire for more autonomy underscore the evolving landscape. In response to these shifts, corporates are strategically reinforcing regional supply chains and adopting a “building local for local” approach, cultivating local supply to cater to local customer bases. The challenges extend beyond politics, with disparate sanctions regimes and climate policies presenting obstacles to scaling decisions across multiple jurisdictions. The inconsistency in governmental approaches to climate, specifically, has emerged as a major variable, with some nations prioritizing ambitious green initiatives, creating investment opportunities in renewables and sustainability. This policy divergence forces investors to navigate varied regulatory frameworks, incentives, and penalties.

As the world witnesses increasing tensions in key regions, the traditional notion of geopolitical events as strictly buying opportunities no longer holds. Such considerations are now inseparable from capital allocation decisions, prioritizing risk management and rendering risk avoidance nearly impossible. As new developments unfold, the ability to distinguish signal from noise will be more critical now than ever before.

Sarah Keohane Williamson is chief executive of FCLTGlobal.

Sweden’s Fund Selection Agency, the government agency charged with procuring and monitoring the funds on offer on the country’s €100 billion premium pension platform has embarked on a re-tendering process that promises a bonanza for global fund managers.

At the start of 2024, the agency will award the first mandates from its inaugural search launched last summer and plans a further six searches totalling €20 billion through the year. It will kick off with €5 billion worth of global and European index funds, likely divided between four to six managers in each category.

Over the next three years the Agency plans 25-30 RFPs that will amount to around $100 billion worth of mandates (the whole portfolio is being re-tendered)  in a concerted effort to raise the quality of the funds, reduce fees and benefit Sweden’s pension savers.

“We will be one of the largest fund investors in the world over the next three years,” Erik Fransson, executive director at the Swedish Fund Agency tells Top1000Funds.com. “We have spent the first year setting up processes, recruiting and making our name known outside Sweden. Our goal is to create the best fund offering possible for our savers by procuring the best products from all over the world.”

Working Swedes have paid into the mandatory DC state pension fund ever since it was established in 2000 and assets on the platform are forecast to double by 2040. Today the entire “premium pension system” accounts for around $190 billion split between the Agency and ($90 billion) default fund AP7 for savers who eschew an active choice.

The overhaul is rooted in a handful of fraudulent and other poorly performing funds on the platform in the past, a consequence of lax requirements on the funds offering their wares – daily liquidity and UCTIS certification aside. In recent years, the number of funds on the platform has dropped from 900 to around 450 in a drive for quality that resulted in many falling away.

Funds that have remained are all being re-tendered, with managers competing for the mandates.  The value of assets under management in the categories won’t change under new management so managers have a clear idea of the amount of assets they will be able to manage from day one if successful, helping the Agency secure the best price.

“We ask a lot of questions, and at the end of the process we conduct a site visit with shortlisted managers to make sure what they have written in their answers is aligned with reality,” says Fransson, describing the new due diligence. “If a fund manager doesn’t have professional Tier 1 clients, the tender process will be time consuming and onerous but if they have done it before, they will find a lot of similarities.”

New mandates

The 25-30 RFPs scheduled over the next three years will include tenders for most flavours of equity, fixed income, target date funds; balanced funds and liquid alternatives. “A lot of our savers are young so there is a lot of equity risk in our savings products,” says Fransson. All funds have a daily NAV, and most will be UCITS compliant.

Fransson believes the drive for fewer, higher quality funds on the platform and a more competitive process will deter managers without a good chance of success from going through the lengthy RFP process. All managers applying pay a tender fee and if they are successful a platform fee, based on assets under management.

“All our costs are being financed by an annual fee of 0.5-1.5 bps of assets under management on the platform.,” he says.

Managers are free to charge whatever fee they want but Fransson hopes competition will drive down charges. Moreover, weeding out weaker managers from the application process means the ticket size of mandates is likely to go up. “Our job is to get the right combination of quality, price and funds offering sustainability on the platform.”

Ensuring choice

Another balancing act involves ensuring enough sophistication in the fund choice alongside selecting strategies based on genuine demand. New strategies include liquid alternatives, but savers choice is also crimped. The platform doesn’t offer access to private markets and some liquid public market allocations are deemed too risky, niche or not suitable for the long-term. “We can’t spend money tendering and monitoring a strategy if clients aren’t interested because it is too expensive or too complex.”

Fransson hopes to reduce the average fee charged across the platform under the new model. But he says the main benefit will come from increasing quality rather than cutting fees. “You can lose a lot more by picking a poorly managed, underperforming fund. Poor performance can end up being more expensive than the difference in fees you might achieve.”

Still, he believes the combination of better performing funds and lower fees could add another 50 basis points onto beneficiaries’ annual return.

“That is a significant number. If we can increase returns by 50 basis points based on $100 billion, we can add a lot of value going directly to the savers.”

The selection process is governed by Swedish law and follows European principles around procurement including equal treatment and transparency, and Fransson has spent the last year and a half honing the process, finding the people and building teams to select funds and monitoring quality and performance.

Still, although it is important to terminate poor quality managers in time, he says the monitoring team are also mindful that even the best managers suffer bouts of poor performance. “It is more than just numbers,” he concludes.

The $171 billion (A$260 billion) Australian Retirement Trust, which sets itself apart from its Australian peers with the identifying investment features of lower infrastructure allocations and less internal management, is looking to opportunities in digital infrastructure and the energy transition.

Head of investment strategy, Andrew Fisher says his biggest concern for this year is whether central banks, particularly the US Federal Reserve Board, can deliver the transition to lower inflation with a soft economic landing.

But he sees digital infrastructure and the transition to a low carbon economy as potential new areas of investment for the fund.

“Digital infrastructure wasn’t a thing five to 10 years ago, but it is possibly the biggest opportunity set we see at the moment,” he says.

He sees the transition to a low carbon economy is another area which will be a “huge opportunity in the infrastructure space and, in an economic sense more generally, over the coming decades.”

Fisher says ART historically had a lower exposure to infrastructure as it was not structurally tied to the $216 billion industry super investment vehicle, IFM Investors.

ART’s Queensland origins have seen it partner in some investments with the state’s sovereign wealth fund QIC, and ART has more money invested in private equity and private debt compared with many other Australian funds.

“There’s a tendency in most of our peer universe to be a little bit more heavily weighted in the unlisted asset space,” he says.  “We have tried to be a bit more diversified. We certainly have large allocations to real assets, but we try to offset that with reasonably sized allocations in private equity and private debt,” he says.  “We’ve probably not moved as quickly and as aggressively into infrastructure as some other funds.”

In a wide-ranging interview with Top1000funds.com sister publication, Investment Magazine, Fisher, who has been with ART and its predecessor fund Sunsuper for more than 13 years, says returns of 8-9 per cent were still possible over the longer term – a much more optimistic scenario than expected given many funds have warned members to be prepared for larger falls in investment returns.

“We have a more constructive forward-looking view looking out than we have had for some time, in terms of expected returns,” he says. “10 per cent is probably high relative to our long term expectations, but 8-9 per cent is not.”

Fisher’s role includes responsibility for managing strategy, asset allocation and investment risk at ART, working closely with the fund’s chief investment officer, Ian Patrick.

He says ART, which has its origins in the merger of major Queensland-based funds QSuper and Sunsuper in 2022 was delivering its returns through a different approach to investing than other funds – including relatively less investment in infrastructure and more in both listed equities and private equity.

Keeping it external 

Unlike some other big industry funds, such as the $310 billion AustralianSuper, ART has no great plans to bring its investment management in-house beyond the current level of around 36 per cent, despite the fact that it is now the country’s second-largest fund.

“It is always something we will always question [whether to take more investment in-house], but we are not necessarily thinking of doing more today,” he says.

“At a certain size and scale there is arguably less benefit to internalisation in some areas because you are so big, you can’t be active.”

“I think our reticence, or lack of enthusiasm for internalisation, relative to some other funds probably gives us a bit of an advantage in terms of being quite tactical around where we think internal management will work best for us and our members.”

“We’re much more focussed on building the best external partnerships we can, and using them in the best ways we can, as opposed to the prioritisation of internal management just for the sake of being internal.”

Some industry fund chief investment officers have argued that one of the benefits of internalisation means funds are approached at an earlier stage about coming into big deals, potentially on more attractive terms.

But Fisher points out that the two funds which formed ART were invited to be part of two major deals – QSuper in the $25 billion bid for Sydney airport and Sunsuper in the $10 billion takeover of AusNet – in 2021, before the merger went ahead in February 2022.

He says the two deals were so large that they were not ones which ART would consider doing on its own these days despite its larger size.

“If you think about our participation in the [Sydney airport] consortium- even if we doubled our participation, we would not be doing it on our own.”

Fisher says the increasing size of the fund has meant that ART is being approached with “a different style of inbound inquiry” on potential investment deals.

He says ART was willing to work with external managers including paying the higher fees needed to invest in private equity.

“We certainly don’t like paying fees, but we think we can be adequately rewarded for the fees we are paying. We think that diversification is worth it.”

ART has about 51 per cent of its assets in equities, a factor which was behind the 10 per cent returns it was able to deliver in 2023 for its balanced option.

This helped counter the writedowns in commercial office blocks last year which occurred at ART and most of the rest of the super fund sector.

Fisher says the returns of 2023 had come in higher than expected because of the stronger than expected performance of equities.

“Equities have outperformed a lot of people’s expectations,” he says. “We have underestimated the capacity for equities to be a reasonably good inflation hedge. We have underestimated the capacity of earnings to capture inflation and offset [inflation].”

Origin story

ART’s different approach to investing to some other industry funds was highlighted in its decision to vote in favour of the bid for Origin Energy by Canadian investment giant Brookfield Asset Management and its US partner, last year.

But its support was not enough to see the deal go through following strong opposition by AustralianSuper, which boosted its stake in Origin to 17 per cent, with its vote supported by several other industry fund investors.

This meant the bidders were unable to garner the 75 per cent of shareholders to succeed despite the support of the Origin board. (Origin’s shares have continued to trade below the offer price since the bid was rejected.)

ART did not make its view on the bid known before the vote, in contrast to AustralianSuper which actively opposed it, staying out of the public arena during the bid where its voice could have been influential had it chosen to speak out.

“It’s a matter of public record that we did vote in support of the bid,” Fisher says.

“It was our view that it was in the best interests of our members to accept the offer. We thought it was a good price,” he says. “But these things happen all the time- some takeovers get up and some don’t.”

Fisher says ART is “relatively neutrally positioned in equities” at the moment.

“There’s always reasons not to want to invest in equities,” he says. “But (at the moment) we are not underweight, we are not overweight [in equities]. What we are increasingly focussed on is trying to be as diversified as possible. If you take bond yields for example, they seem relatively evenly poised. They’re probably a little bit lower than we think is fair but not low enough to take a position on it.”

He says ART’s appointment of former Australian Reserve Bank deputy governor Guy Debelle as an external adviser to its investment committee in March 2023 was an example of a high-quality personnel investment the fund could make given its larger size.

Debelle has had a long interest in the economics of climate change and green energy, leaving the Reserve Bank in early 2022  to join Andrew Forrest’s green energy arm, Fortescue Future Industries.  He left the full-time role at FFI a few months later and the FFI board last year, and is now a company director and adviser specialising in green energy.

Fisher says the global economic outlook is “delicately poised in terms of whether inflation is well and truly finished or not.”

“There is certainly a growing body of evidence that the inflationary challenge is under control, particularly in the US,” he says. “The concern we have is that there is still a sizeable elevated geopolitical uncertainty around the world.  It doesn’t take much for something to happen to create some sort of supply side impact on inflation. We are seeing it now with regards to shipping costs.”

His biggest concern for this year is whether central banks, particularly the US Federal Reserve Board, can deliver the transition to lower inflation with a soft economic landing.

“Soft landings are really hard [to engineer],” he says.  “The Fed has done a really good job to this point, but the US is still facing a difficult election year, an insane fiscal situation. I don’t think it will be as easy as the market thinks for the Fed to deliver a soft landing in the next 12 months.”