Super prospects from Australia’s most powerful CIO
Suspicions are growing over superannuation fund valuations of their unlisted assets, but AustralianSuper says it's in their best interest to ensure valuations are up to date.
AustralianSuper is the largest superannuation fund in Australia, rapidly growing driven by member contributions and mergers, with about $270 billion in assets under management.
Despite its size, it has retained an impressive long-term performance track record, and Mark Delaney has been the Chief Investment Officer (CIO) since 2006. The enormous size of savings in his funds makes him the most powerful investor in the country, in both public and private markets.
AustralianSuper CIO Mark Delaney speaking at the 2023 Morningstar Investment Conference in Sydney. Picture: Morningstar
At the Morningstar Investor Conference last week, Director of Manager Research Ratings at Morningstar, Annika Bradley, asked Delaney about his current portfolio, especially since earlier in the conference, BlackRock had called for an increased allocation to alternatives, while Vanguard made the case for staying the course on a basic 60/40 stock/bond portfolio. Delaney replied:
“The argument is that higher inflation is going to make it harder for bonds to work and more difficult for stocks, and there's a degree of truth in that. More than likely higher inflation, if it manifests itself over the medium term, will result in lower returns in all the investment classes. The absolute total return comes down but the relative ranking of asset class returns probably won't change that much, i.e. on a 10-year view, stocks will beat bonds, bonds will do better than cash, et cetera. Instead of getting, like AustralianSuper's Balanced plans have done, 8.25% over the last 20 years, you'll be getting 6.5%.”
Managing illiquid assets
Delaney made the case for the role of private assets, such as infrastructure and private equity, in portfolios. While no longer sold at a discount to public market valuations, there is greater operational leverage and growth potential.
With private assets, it's not so much what the revenue is today but what the revenue can be in the future with good active management. He cited the boost in profits at airports when managed by private investors.
Bradley highlighted the suspicion about valuation practices and the amount that is allocated to illiquid, private assets.
Delaney explained that if a fund holds a material percentage of its portfolio in private assets, it must be appropriately valued because smart members can take advantage of a lagging private market valuation. They can transfer value from the existing pool of members and that’s not the right thing for a fund to allow.
But he emphasised that private assets are not market-valued but appraisal-valued. It’s like saying there is no stock price for a house. There is no stock market price for a private equity investment.
AustralianSuper has added resources to its independent valuations team which sits outside the investment team and performs stress testing of valuations to make sure they are not transferring value between members.
Morningstar's analysis across five large industry super funds showed net inflows and member demographics play a part in determining an appropriate allocation to private markets. AustralianSuper has strong net inflows and a relatively young member demographic, but how did Delaney feel his fund’s characteristics permitted illiquid assets in this portfolios?
He explained he thinks about sources and uses of liquid assets. The sourcing might be covered by large inflows, but the future uses of liquid assets, particularly in stress markets, might include taking advantage of buying cheap stocks.
For example, if equity markets halve as they did in 2008, the illiquid allocation will rise by 40% to 50% because private values will not fall much in the first phase of the equity market selling off. He said:
“You need enough liquidity to be able to rebalance your portfolio, when the chance to buy stocks is the best ... So we've got a figure of around 30% for our balanced plans is about the maximum (in private assets). And that's a function of the sources and uses and the ability to rebalance the portfolio if equity markets were to halve.”
Bradley turned to AustralianSuper's unlisted property book, which has not performed as well as some of its other unlisted, illiquid parts of the portfolio. Delaney gave an honest appraisal:
“It has been really disappointing. It was the long and the short the wrong strategy. We had a strategy of overweighting retail and having more international property than Australian property. Both of them were the wrong decisions. And with property, when you've got one, which is underperforming, it's very hard to get out of because you never want to accept how bad it is until it gets really bad. Retail got disintermediated by online shopping, and we had a short exposure to industrial. So that was the worst of all worlds, and that's performed really poorly. Our response basically has been to freeze the allocation to reduce the amount of capital going in there and then have to work our way out of that problem. So with private market investments once you've got a problem, they take five years or 10 years to work your way out.”
Positioned for a recession
Delaney said he is short stocks and long bonds because he expects recessionary conditions.
First he expects a bear market in US stocks due to a derating as the money bubble is popped, but the second leg will be when earnings go down. He expects central banks to continue to push against inflation until it is tamed. He sees a paradox where the market finally expects inflation to remain stubbornly high for the medium term, but the short term might look better. So the market will think inflation is under control but in two or three years, structural factors such as tight labour markets, deglobalisation and the energy transition will push inflation up a bit higher again.
So he likes floating rate bonds but does not see this as the right time to go overweight equities:
“When do you want to own stocks? You want to own them when they're cheap, and when you're at the bottom of the cycle, so you've got a long runway to come back up again, and you've also got to think of buying. And so you want to buy stocks in 2009 when the U.S. on a P/E of 14 times, U.S. unemployment was 9%, and really hold them for the next 13 years and just go on holidays. And when do you want to sell stocks? Well, you want to sell them when they're expensive. And when the economy has run out of runway.
"So if you start with those two anchors in your thinking, it just provides a very good discipline as to how you should do it. And what happens is people get confused too much about the short-term noise of what's going on and the short term just provides opportunities to get in or get out. It doesn't really change the underlying trend. Investing is always about a view of the future ... (you need) that degree of detachment from where your current circumstances are and typically the worse you feel, the better it is to invest.”
Delaney said when his funds have more members in the retirement phase, perhaps in the 2030s, when there's a lot of money going out, it will be a different world for managing liquidity. In preparation, and recognising the aging of members, the next big frontier for industry funds is a focus on retirement rather than accumulation.
“There's another million Australians in the next 10 years going into retirement. AustralianSuper's already got $36 billion of assets in retirement pool that's going to double or triple. And those people will want their pension managed and need affordable advice, and they want super tailored to deliver the total outcome. And the challenge for the industry is to put all those three legs together rather than having separate legs.”
In managing a downturn in both economic activity and equity markets, Delaney is trying not to be too precise, but to be decisive at the same time. Precision is not possible, as he summarised:
“I think that you're better to be broadly right than precisely wrong. People spend too much time generating precision in all their numbers rather than getting the broad framework right. So broadly right, rather than precisely wrong.”