Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 220

Investment innovation beyond the status quo

Large super funds in Australia recently reported their eighth consecutive financial year of positive investment returns, with the median growth option delivering 10.7% over 2016-17 (source: Chant West). All investment options have met their long-term objectives since leaving behind the tough years of the GFC. While this is good news, our new research shows it is for investment success to breed complacency.

Larger funds have a great store of resources and experience, so it seems they are well-placed to search for, test and embed new investment ideas. But the irony is that large funds face innate headwinds in thinking innovatively and may in fact be leaving it to their smaller counterparts to develop the investment ideas of the future.

Status quo traps

These headwinds to investment innovation are identified in our research on ‘status quo thinking traps’. Larger funds have built knowledge and processes around the historical markets for their products. This includes investing a superannuation contribution stream on behalf of disengaged members to generate a lump sum payout to these members once they retire. Larger funds represent hold $1.3 trillion of superannuation capital which is no small investment pool!

So what’s the status quo?

1. Same investment processes

Current investment thinking starts with a strategic asset allocation framework, adds active or passive philosophies across the asset classes and a currency hedging belief, then selects managers across the asset classes to run slices of the investment portfolio, often with the help of an asset consultant. Funds may cite their post-GFC investment success as the reason to continue investing this way. There is an organisational impetus to continue investing this way which can make it difficult to adopt new investment ideas and genuinely innovate.

2. Familiarity of current structures

The larger the fund’s stake in the $1.3 trillion capital pool, the more its resources, processes, organisational structure and cultural values are built up around this existing way of investing. There is familiarity around these investment paradigms and it is easy to make decisions inside the paradigms that maintain the overall structure; for example, moving from active to passive, placing pressure on management fees, changing a manager or adjusting the fund’s currency hedging ratio.

3. Incremental changes only

Changes like these are no doubt valuable and funds think intelligently and then manage their governance processes well to implement these investment changes. But in our experience, what a large fund might call a ‘big’ or ‘innovative’ change is,say, changing the asset allocation, moving from pooled funds to separately managed accounts, or recognising a new asset class like private credit, US municipal bonds or emerging markets small caps. The problem is that these changes are fairly incremental, not really that big or innovative.

If the investable markets or investment problems of the future prove to be different from the past, these funds are only inching forward on the journey from ‘here’ to ‘there’.

Changing investment horizon

Our concern is that the horizon for large fund investing does suggest significant differences from the past, including:

  • Expected lower growth and yield in investment markets than historical averages
  • Flows to factor-based investing and other ‘smart beta’ trends
  • Ongoing nervousness about volatility, country shocks from political risk, climate change
  • Investment objectives focused on yield (not growth or total return)
  • Shift from mass accumulation to mass decumulation
  • Fragmenting investment risk appetite and, indeed, definitions of risk
  • New investment fees and costs transparency and accountability (RG 97)
  • The rise of Responsible Investing (ESG, values-based) approaches
  • The ageing population and governmental pressure to address longevity risk
  • Capital flows generated by ‘robo-advice’ and DIY investors
  • Insourcing of some investment management by funds
  • Capacity constraints due to the amount of capital in Australia’s superannuation system.

Investment innovation is needed to face these challenges

Meeting these (and other) investment challenges requires thinking not just within the existing paradigms, but beyond the paradigms themselves. Genuine innovation in investing could look at matters like:

  • Instead of an optimal investment risk/return blend, introduce investment efficiency and portfolio transparency as third and fourth dimensions.
  • Instead of dividing managers into active or passive, create a spectrum of manager strategies that span the continuum of possibilities between pure market-cap passive, enhanced passive, smart beta and ‘systematic alpha’ approaches, right through to active managers targeting pure ‘idiosyncratic risk’ from stock insights. There are additional levers to pull around active tax management (or not) within these possibilities.
  • Instead of choosing between investment outsourcing and insourcing, break up and re-optimise all sourcing arrangements based on their components. This includes thinking about re-positioning a fund as the ‘investment ideas generator’ and working with a specialist implementation partner.
  • Instead of slotting investment opportunities into asset class buckets, target common underlying risks or themes (for example, interest rates) that transcend asset classes.
  • Instead of investment trading done independently by each of the fund’s managers (sometimes in opposition to each other), centralise trading to eliminate redundant trading and create a whole-of-portfolio view for the fund rather than a collection of manager slices.
  • Instead of starting with a market-cap portfolio and introducing ‘tracking error risk’, start with a reference portfolio that reflects the real, asymmetric risk preferences of superannuation members (limited volatility and downside risk, full upside risk).

The potential payoffs from genuinely innovative ideas are lucrative because they will deliver over and over again. The long-term investment horizon of super funds and many other investors would powerfully leverage the value of any such rewards. The investment success of large super funds to date could help them think boldly and confidently about what is needed for the future … or it could trap them in the investment paradigms of the status quo.

 

Raewyn Williams is Managing Director of Research at Parametric Australia, a US-based investment advisor. This information is intended for wholesale use only. Parametric is not a licensed tax agent or advisor in Australia and this does not represent tax advice. Additional information is available at parametricportfolio.com.au.

banner

Most viewed in recent weeks

How to enjoy your retirement

Amid thousands of comments, tips include developing interests to keep occupied, planning in advance to have enough money, staying connected with friends and communities ... should you defer retirement or just do it?

Results from our retirement experiences survey

Retirement is a good experience if you plan for it and manage your time, but freedom from money worries is key. Many retirees enjoy managing their money but SMSFs are not for everyone. Each retirement is different.

A tonic for turbulent times: my nine tips for investing

Investing is often portrayed as unapproachably complex. Can it be distilled into nine tips? An economist with 35 years of experience through numerous market cycles and events has given it a shot.

Rival standard for savings and incomes in retirement

A new standard argues the majority of Australians will never achieve the ASFA 'comfortable' level of retirement savings and it amounts to 'fearmongering' by vested interests. If comfortable is aspirational, so be it.

Dalio v Marks is common sense v uncommon sense

Billionaire fund manager standoff: Ray Dalio thinks investing is common sense and markets are simple, while Howard Marks says complex and convoluted 'second-level' thinking is needed for superior returns.

Fear is good if you are not part of the herd

If you feel fear when the market loses its head, you become part of the herd. Develop habits to embrace the fear. Identify the cause, decide if you need to take action and own the result without looking back. 

Latest Updates

Economy

The paradox of investment cycles

Now we're captivated by inflation and higher rates but only a year ago, investors were certain of the supremacy of US companies, the benign nature of inflation and the remoteness of tighter monetary policy.

Shares

Reporting Season will show cost control and pricing power

Companies have been slow to update guidance and we have yet to see the impact of inflation expectations in earnings and outlooks. Companies need to insulate costs from inflation while enjoying an uptick in revenue.

Shares

The early signals for August company earnings

Weaker share prices may have already discounted some bad news, but cost inflation is creating wide divergences inside and across sectors. Early results show some companies are strong enough to resist sector falls.

Property

The compelling 20-year flight of SYD into private hands

In 2002, the share price of the company that became Sydney Airport (SYD) hit 80 cents from the $2 IPO price. After 20 years of astute investment driving revenue increases, it sold to private hands for $8.75 in 2022.

Investment strategies

Ethical investing responding to some short-term challenges

There are significant differences in the sector weightings of an ethical fund versus an index, and while this has caused some short-term headwinds recently, the tailwinds are expected to blow over the long term.

Investment strategies

If you are new to investing, avoid these 10 common mistakes

Many new investors make common mistakes while learning about markets. Losses are inevitable. Newbies should read more and develop a long-term focus while avoiding big mistakes and not aiming to be brilliant.

Investment strategies

RMBS today: rising rate-linked income with capital preservation

Lenders use Residential Mortgage-Backed Securities to finance mortgages and RMBS are available to retail investors through fund structures. They come with many layers of protection beyond movements in house prices. 

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.