Damian Graham … ‘we needed to invest differently and think more about downside risk’
State Super Financial Services, which has more than $13 billion in funds under management on behalf of 175 financial planners and 55,000 clients, has continued to restructure its portfolios and adopted a new set of investment beliefs and planning philosophy. Greg Bright spoke with Damian Graham, the chief investment officer, about the transition.
State Super Financial Services (SSFS) has a vision, set out in its current strategic plan. It is: to become, by 2016, “the pre-eminent provider in Australia of financial planning and implementation services to current and former public sector employees”.
The cohort of potential clients is about two million. SSFS, owned by the NSW Government’s big defined benefit fund for public sector employees, SAS Trustee Corporation (STC), otherwise known as State Super, was established to provide financial planning services to all public sector employees, retired public sector employees and their families. SSFS has its own investment management team and has been operating since 1990.
When Damian Graham, the CIO, joined SSFS from Macquarie in 2012 he was set a challenge to address the post global crisis environment and implement an investment approach appropriately aligned to the organisation’s vision. Clients who had been with the business for 10 or more years had done well, but most of those who had joined around the time of the crisis, like in all funds, had experienced significant volatility.
“In 2008 we were a simpler fund,” Graham says. “We proved to be more volatile than some other funds [during the crisis], so we have done a lot of work to further align our portfolios with our clients’ objectives. We needed to invest differently and think more about downside risk. We recovered well, but I think it would have been preferable for many clients to have less volatility.”
The average age of an SSFS client is 66,with almost all being in pension phase. The SSFS Allocated Pension, which has more than $10 billion under management, is the fifth largest in the country,. After CBA, it had the second-highest net inflow ($1.29 billion) of any of the allocated pension providers in the 12 months to September 2013.
During 2012, SSFS enhanced their investment beliefs, which have become the cornerstone of how they think about investing, along with the financial planning investment philosophy. In a nutshell, they involve delivering outcomes that support clients in meeting their retirement needs.
Concrete examples, Graham says, are:
- Security of real income in retirement is our clients’ primary objective.
- With due consideration of return objectives, we will be biased towards capital preservation, even if it means giving up potential excess performance.
- We should only invest in opportunities that we fully understand.
- Investment outcomes should be evaluated net of fees, taxes and any other investment charges or implementation impacts.
From an investment perspective, the main focus, therefore, was to diversify away from equity risk, which has been challenging in the current low interest rate environment.
SSFS has produced solid outperformance in its fixed interest portfolios over the past 12 months through a mix of long-duration and short-duration securities, an overweight position in credit and a range of fixed-term instruments.
“We got to the situation where we could generate some real yield,” Graham says. “We think that interest rate markets will continue to normalise slowly. Liquidity is also key. In 2008 we had effectively zero illiquid investments and we still have more than 90 per cent in liquid investments, so there is the potential for us to earn an illiquidity premium by sensibly diversifying into unlisted assets.”
Most recently, SSFS also introduced its first major alternatives program to increase diversification from equity risk. It is investing about $200 million across several strategies including trend following, long volatility and discretionary global macro.
“The investment committee had to make sure these strategies were clear and understandable,” Graham says. “It provides another line of defence if equities sell off. It’s not primarily a return-seeking alternatives strategy, more of a diversifier.”
Graham started his career in investment management in the difficult period of the late 1980s, around the 1987 Crash, at ANZ Funds Management.. He went back to university to do honours in economics, returning to the industry at Norwich Union, working across both equities and fixed interest. He then went travelling for a while and came back to Australia in the late 1990s, firstly in a business role at JP Morgan Investment Management, including a stint in New York, and then 10 years at Macquarie in the firm’s managed accounts business, which he eventually headed up.
He says that his earlier career had shown him the importance for a business of having a “pretty good line of sight” to distribution. He liked the fact that SSFS was advice driven but with good distribution and high customer satisfaction levels.
Since the global crisis, the specific changes which SSFS has made to its strategy would have reduced the capital loss actually incurred at that time by approximately one-third, according to the firm’s analysis.
These improvements included: adding low-volatility equities; introducing direct property; changing the approach to active currency management; diversifying into new growth assets, such as high-yield debt, global REITs and listed infrastructure; restructuring fixed income and increasing enhanced cash; introducing a tilting overlay; and the new defensive alternatives. They are not trying to solve for the last crisis, evidenced by the fact that some of these forward looking enhancements would have had a negative impact during the 2008 market downturn.
SSFS’s key investment beliefs seek to address:
- income certainty – a primary goal of retirees
- inflation protection – inflation being the number one cause of retirement ruin, with growth assets helping to protect against this
- risk capacity – ensuring clients’ financial capacity and need to take risk are focused upon when building portfolios
- path dependency – the sequence of returns in retirement is critical since clients are generally drawing income from their accumulated capital base
- delivering simple solutions, and
- addressing longevity risk.
In addition, SSFS is reviewing the opportunity to weave several themes into its strategies, including putting in place a new ESG policy late last year. Graham says the policy is being implemented at both asset allocation and portfolio construction levels.
Other potential themes include “a return of inflation” and “income inequality”. The question with income inequality, which is being asked around both the developed world, such as in the US, and developing world, such as in China, is whether the shares of economic rent will mean revert. If they do, this would impact growth rates and profit margins as well as political stability.
SSFS encompasses a blend of investment styles with its varying strategies. For equities, it maintains a passive core, exposure to low-volatility strategies and also a value satellite. The low-volatility piece includes ‘quality’, yield and minimum variance.
To achieve a sought-after outcome typically requires a number of different strategies. Graham believes that institutional investors should focus their scarce resources, particularly the governance budget of the board and investment committee, on high value areas such as asset allocation.
“Being highly focused on delivering investment outcomes for our retiree member base allows us to avoid some of the issues that can come with having multiple focuses,” he says
“Ultimately, our core focus is to provide peace of mind to retirees in retirement. To achieve that we rely on our advice processes coupled with excellent implementation. This approach means we can help our clients live the retirement lifestyle they seek.”