“Poster child for honesty in naming options": Q&A with Australian Catholic Super’s John Phokos August 2019
Australian Catholic Super has taken a new approach to how it manages its fixed income investment options. Portfolio manager John Phokos speaks to Industry Moves about what was involved and why the end result is truly true to label. He also outlines the benefits of being a first mover when it comes to investment managers and how lack of scale is sometimes a benefit.
- Why was the bonds option under-performing?
Like many other funds, Australian Catholic Super had a diversified fixed interest investment option, which was a mix of absolute return strategies and bond strategies.
This posed three problems requiring resolution. They were:
The investment option was advertised as a bonds option with the objective of outperforming the BloombergAusbond Composite Bond Index and, whilst being a good strategy and in the members’ best interest, was mislabelled;
The strategy would underperform bonds when rates fell; and
Members were unable to select a pure bond or pure credit exposure.
- What did you do to restructure the portfolio?
With the support of the CIO, Michael Block, we suggested the creation of a new investment building block for use in our diversified portfolios. The CEO, Greg Cantor, further supported and encouraged offering this to members as a stand-alone investment option called ‘Credit Income’.
That meant that the Diversified Fixed Income portfolio could be renamed ‘Bonds’ and restructured to have duration closer to the index. For those members wanting credit without duration, ‘Credit Income’ was suitable. And for those members wanting a very safe option without credit or duration, our ‘Cash and Term Deposits’ option was suitable.
- Is your option true-to-label?
It is now. ‘Bonds’ means Bonds and similarly ‘Credit Income’ means credit income and ‘Cash and Term Deposits’ is cash and term deposits.
ACSRF can now be seen as the poster child for honesty in naming options.
- Why is your option different from some of your peers?
The ‘Bonds’ option is effectively only three asset managers using a differentiated approach to the benchmark-relative risk-managed style traditionally used. None of our managers believe that rates or duration calls can sustainably add value, which aligns with our view.
In fact, our ‘Cash & Term Deposits’ option is exclusively cash at bank including term deposits, which represents a zero chance of a negative return over any time period through mark to market movements. This is because unlike securities such as credit instruments and bonds that carry a traded price, bank accounts including deposits are valued on a capital plus accrued interest basis. So our ‘Cash & Term Deposits’ option is unlike many other cash options as it will not lose capital as some enhanced cash strategies did through the 2007/8 financial crisis.
- Who are the key managers in your bonds option?
Ardea, Coolabah and Kapstream.
- How did you choose them?
Totally on merit based on the manager’s ability to add value and the fee for value added over the benchmark.
- Why did you choose managers that had not previously managed to a composite bond index?
Primarily two reasons. Firstly, because it is very hard to add value through duration over the long term. Secondly, because it is more efficient to allow managers degrees of freedom away from the benchmark universe to add value through their particular edge than to utilise a traditional benchmark approach constraining managers to the securities in a benchmark index.
There has been an added benefit to our members invested in our diversified options. As we invest via the same managers across our ‘Bonds’ and ‘Credit Income’ allocations, this has allowed us to add, or remove, duration as needed with less frictional transaction costs given the underlying manager’s assets are fundamentally the same across their Bond and Credit Income portfolios.
- How did you convince the CEO and investment committee to support you in this endeavour?
They applauded this initiative because they could see the benefit to members in restructuring our defensives offering, and reducing fees. They backed the investment team’s manager selection as they understood the unorthodox approach made sense, and could see that we were utilising our relatively smaller size against larger super funds to our members' advantage.
- How did it work out?
We are now on top of the heap as we have an option with duration, which has helped given falls in bond rates and our managers have all performed well. Whilst each manager has worked well in isolation, they have combined exceptionally as their value adding drivers are diverse, making the whole greater than the sum of the parts on a risk-adjusted basis. The Composite Bond Index has returned 9.6% for the year to June 2019 and 4.2% per annum for the past three years. Our program has added 2.2% over the benchmark for the year to 2019 and 1.6% per annum for the past three years before tax.
- Do you think your approach will be followed by others in the industry?
Potentially not. Some strategies are more capacity constrained than others. Consolidation in the super fund industry means funds are becoming larger, and it is more difficult to identify new managers and strategies that have sufficient capacity to “move the dial”. Even when capacity is not an issue, portfolio managers and asset consultants are generally not incentivised to take the risk of recommending talented managers at an early stage, or in a different capacity to their existing strategy, and “it is better to fail conventionally than to succeed unconventionally”.
- Is this the future for fixed income investment options?
Bonds have been rallying for a very long time and whilst this may continue for a while longer all good things must come to an end. Financial markets are ever changing. Today’s market is unique and to some degree a function of a decade of unprecedented synchronised central bank intervention. Successfully adapting fixed income strategies to the vicissitudes of future central bank innovation is possibly the future for fixed income options. Such a future provides ample means for skilled managers to add value, and for skilled manager selectors to find the right managers and portfolio construction to succeed.