CIO Greatest Hits: Sovereign Wealth Funds – Raphael Arndt (Australia Future Fund)

29:28We know their job, we know what they do, and we know what drives them. A bit of a poacher turned gamekeeper. So, we can have very sophisticated discussions with them. And rather than buying the vanilla strategy, we typically would design a strategy that suits us and then if they have one that we can buy off the shelf, that's great. And if not, we can talk to them about building a specific strategy for us. Now, I've had conversations with some of the other superannuation funds when their size got larger, but let's say larger called 40, 50 billion, which is still a fraction of where you are today.

30:05A lot of them shifted to internal management in part because of the difficulty in accessing external managers. And you talk about 120 managers, but that's on average, what, north of a billion dollars in each one. How have you navigated that landscape where the pool is so large that the investable opportunity set isn't really that large for you? Well, certainly capacity constraints are an issue that we need to think about. Obviously, in the more liquid asset markets, particularly equities and bonds, those are accessible, although not all strategies. So, we do have some levers that can scale, but we work very hard and we develop relationships with managers and we have to fight for capacity.

30:48And we recognise that those relationships are mutual, they're two -way. And we try to be very open with our managers and share our views with them and give them our feedback rather than just reading their quarterly report and never talking to them. And so, we would hope that our managers get something from us as well as part of that equation. And that helps us get access to capacity in the better managers. So it is a challenge, but we have to keep working at it. Yeah. I'd love to dive into your thought process on each of the asset classes. So why don't we just start with listed equities and I'll let you take it from there.

31:24Yeah, sure. So I guess when I came into the role, we'd been doing equities for, well, obviously since inception, that was about eight years, seven years. And the first thing we started doing was some attribution work. And I guess we're lucky enough today to be living at a time when the technological tools available to us are improving our ability to do that type of work. They weren't available a decade ago when we started the program. And what became apparent very quickly was that while the team had done a really good job of picking the best managers in a particular style, whether it was a value manager, an emerging market manager, a thematic manager.

32:02When we aggregated up all of the maybe 20 or so mandates we had across that portfolio, by and large, they cancelled each other out at the whole portfolio level. And I would have expected we would end up with something like beta less fees. Now, actually, as I said, the team did a good job. And so we ended up with slightly better than the beta, which was a good outcome, but it was not ideal. And so even if you could pick a good manager, you still had to build a total portfolio that made sense. I sort of think of it like if you want a car, you don't go out and buy the best steering wheel, the best seat, the best windscreen and hope that you get a good car.

32:39You actually have a plan for a car and buy the parts that suit the car you want. So having built the technology to measure performance and disaggregate performance, we then sat down with the board and said, let's start from first principles. What are the objectives of an equities program? One, we think that the equity risk premium exists and it's pretty reliable. And so holding equities over a long timeframe, we think should deliver a source of return for a long -term investor. Now that's not rocket science, but it's important to state it very clearly because if that's all you wanted to do, you would buy the beta and you would buy it as cheaply as possible and in as most liquid way as possible.

33:22Secondly, though, I think the research tells us today that there are certain types of factor approaches, particularly value and quality, but there are others that do seem to pay off over long time periods, albeit if you're worried about tracking an index or shorter term performance, you have to worry about that. In our case, we're not worried about that. We're only worried about whole front performance in an absolute sense over the long run. and so developing a factor strategy was high on the agenda. Now we've done those two things and we can execute those through third -party managers for literally a handful of basis points in this day and age and we do.

34:01When we looked at the portfolio originally that was where the bulk of risk and the bulk of return sat in the beta and in the factors that the managers were selecting say you picked a value manager or if not, it's just a manager who had adopted a value style. And so there was no point at all paying a manager for those sort of things. We do believe in active management. We do believe that skill exists and is sustainable. That in itself is something people could debate, but we believe in it. We don't think that skill is widely available in equity markets today. Technology means that it's being arbitraged away very quickly.

34:40And the manager business model and the way they charge essentially typically charges you for the beta return, the factor return, and the stock picking skill. But only one of those deserves compensation. And so using the technology, we can disaggregate those things and regress against different types of factor returns and things like that and isolate where this skill actually exist and we'll keep those managers. Mainly, our alpha program has now migrated to long -short market neutral hedge funds because we can pick managers with pure skill and it's very evident if they have it or not very quickly.

35:18We're only paying for the alpha. But secondly, they have very concentrated portfolios and so the likelihood that they're going to cancel each other out is very low. And we can track that in the system now and make sure that we're getting an efficient portfolio implementation. So let's dive through that a little bit. When you started using the technology to do a detailed attribution on the listed equity portfolio, what did you do with the managers that clearly outperformed? Did you hold them? Yes. You did? We have. There's not a lot of them, I would add, but yes, we have held them. Okay. So some of them survive, and that's stock selection alpha that you've determined after taking out factors.

36:04That's right. Then on top of that, you have, say, long -short equities. You just mentioned concentrated portfolios. It struck me that most of the market -neutral equity portfolios are multi -manager many, many positions. In fact, they're not concentrated at all. So I'm curious if you're really looking at stock selection skill, how are you isolating the stock selection alpha in a more concentrated book? I should clarify, we have many managers in that strategy. They're mostly actually sort of fund -to -fund separate account type mandates because we don't have the bandwidth in our team to track 30 or 40 underlying managers.

36:43But what we're doing is they're accounts that designed in such a way as they're very unlikely to overlap with each other. So each of those underlying managers might hold 20 longs and 20 shorts, for example. Our system can aggregate all of their positions and report back to us on an aggregated basis, either in isolation or overlying the long only portfolio. And we can see where if we've got position concentration, we can see if there's a rotation going on and we can take that information into our broader thinking in our own portfolio construction and we can see where the alpha is being generated.

37:20Have you thought about marrying off a pass -through separate account through a fund of funds or a large multi -manager hedge fund? Well, we have some of those. So, our manager list is on our website. It's quite public and we have, for example, Citadel as one of those managers. So, I think it's the same thing. It's just when we aggregate those things up, what are we getting? What are we paying for? Those large hedge fund, sort of multi -strategy hedge funds, many of them have delivered significant beta, whether it's equity beta or credit beta, and that is not something we want to pay for. So I think it's just a matter of, again, in the same way, analyzing the track record of these managers, regressing it against a whole variety of factors.

38:09In this case, things like carry and commodities as well as bulk asset leaders and understanding where is the skill, where is the return coming from and only paying for the part that's valuable. Have you thought about the construction of a core portfolio? So you can access, as you said, low cost market exposures, factors, some alternative betas, and then alpha on top. How important is it to own the core or to just access what you found is special in the alpha piece? Well, if you go back to the objectives and also your comments about scale. So today, the equity book is maybe $45 billion, and we're just not going to find enough skill out there in the world to invest $45 billion.

38:59But also, a pure alpha book does not give us the beta. We've actually structurally taken the beta out of it. So this desire to get exposure to the equity risk premium only comes from those other things. But we can do it very, very cheaply. Yeah. All right. Let's move on a little bit to private equity. How you approach that investment area? We approach everything the same way. The question is, what can this asset class do for the portfolio as a whole? Under what scenarios will it pay off? Under what scenarios will it be penalized? How does that compare to some combination of equities and cash or equities and bonds?

39:39and so why are we doing it? So again, we don't set out to buy a diversified portfolio of private equity. I guess the typical portfolio construction would be 60 or 70 % buyout, for example, and then a bit of growth and maybe a small amount of venture. Our portfolio has no large buyout at all because we think that large buyout is really just levered equities typically. And if there's skill added on top, and there might be, then most of that goes away in fees. So we don't think it adds a lot for the portfolio. So our private equity portfolio is about half venture and growth equity, and the rest is small buyout.

40:23And what we're really looking for in private equity is two things. One is a clear, sustainable outperformance over equivalent equity indices after adjusting for market timing ability by the managers. So we're not interested in people who can just time markets, putting capital in and out, because if we're doing that, we're probably putting the money in equities when it's not sitting with the private equity manager. And so we started by identifying managers with real skill who can improve a business, not just slice and dice it or list it or delist it and move the money around. because as someone approaching a universal owner, we're going to own it, whether it's listed or unlisted, and there's no point just paying fees for those transactions.

41:10And how do you do the due diligence to figure that out? Well, it's quite analytical. So in most cases, we would like a manager with some track record, and we would like to understand the underlying performance data at the asset -by -asset level. So we would deliver the returns, would take the use of debt out because usually just using more debt gives their LPs more risk and more upside for the manager, but with a lot of downside risk. And we take the market timing out by doing something called a public market equivalent analysis, which is really just saying, if we take the cash flows that go in and out of this private equity account and put them in the equivalent equity market index with the same timing, what would the return have been?

41:52And then compare those two things. we're going to take a quick break in the action to tell you about srs aquium want to make sure your m &a processes aren't stuck in the past partner with a company that's been defining the future of deal making for nearly two decades instead when it comes to m &a innovation srs aquium has reshaped the way that deals get done streamlining processes for maximum efficiency and minimum headaches. Professional shareholder representation, online M &A payments, digital stockholder solicitation, SRS Aquium pioneered each and continues to set the bar for game -changing innovation.

42:36So leave the days of disjointed deal management behind and define your future with SRS Aquium, the smartest way to run a deal. Learn more at srsaquium .com. That's S -R -S -A -C -Q -U -I -O -M .com. And now, back to the show. And what do you find as you look at a group of managers compared to your sense of how the industry looks at the same group of managers? Well, there's a lot of brand names we don't have, and it varies why, but one of the most significant reasons is because they just use leverage we found to juice up their returns, and we don't think that's attractive. And we're really focused on the smaller managers that have a tremendous amount of skill in how they can improve a business.

43:26It's not just where they listed or delisted or selling off bits or buying other companies to merge in. It's actually helping the management team access a new market, grow to a new industry that they've got some experience in, providing capital to help them grow where they can't get that capital from the market for some reason. and it's those types of managers and those types of skills. What does small mean at your size? So how big are the range of the funds that you'll invest in? We do use funder funds for very specific strategies. So we're very agnostic as to how we implement. For the larger managers, we could write a $300 million or $400 million check to a fund.

44:07And ideally, that's what we would do because we've got only seven or eight people in our profit equity team and we've got a lot of managers to get across. but for the smaller ones where say we can write a 50 or 70 million dollar check but they're in a strategy we really like so small US buyout for example then we would do that through a fund to fund. And how big do those funds tend to the direct funds tend to be? Probably about a billion dollars. Okay so you'll be a substantial investor in those funds yeah? Yeah we typically are. Okay have you thought about co -investment opportunities? We think that's an important tool in our toolkit We do do quite a bit of co -investing in all the private market asset classes and also a little bit in alongside the hedge funds and credit managers.

44:53But particularly in private equity, the issue with co -investing is, well, firstly, you want the manager focused on their strategy first and foremost in their fund. You don't want them worrying about are they keeping their LPs happy? You know, have they sized it right or do they have to undersize it in the fund to allow some co -investment? So we don't demand it. We want first and foremost, the manager to be good at investing the fund. But where they would have a situation where they might otherwise bring a competitor in alongside them, for example, we'd prefer them to bring us in and other people who are like -minded.

45:27We don't try to re -underwrite the deal. We've already underwritten this manager. We've already backed them and we trust them. So our due diligence process will be focused on, is it in their skill set, firstly. Secondly, is there alignment with the manager? Are they putting enough capital in? Are they underwriting and selling down in a secondary, which we typically would avoid? Or are we coming in the primary deal? And then are we tied to them so that we go in when they go in, we go out when they go out? And then lastly, more of a portfolio risk point of view, what is the exposure and does it make sense for us?

46:06And so we've developed a process internally where we can do that reasonably efficiently and typically would be able to be there when the transactions close. I guess the other part of it is you do get quite a good insight into the manager and their process. So it does help us re -underwrite the manager if that's what we're intending to do. And have you done enough of it to be able to measure whether it's been value added relative to just giving that same manager more money? Sure. We've done probably 20 or 30 co -investments in private equity over the years. So it's not an enormous number, but it's enough to have a view.

46:42We also co -invest in the venture portfolio and we've done about 40 there as well. And so I would say that broadly speaking, the performance is in line. It's a little bit of a younger portfolio. And so we don't really have the same data yet that we do in the fund book, but certainly we don't think there's an adverse selection happening. Yeah. I'm fascinated to turn to venture capital with a fund your size, how you've thought about it and how you've tackled it. Sure. Yeah. So the first question is why bother? It's a capacity constrained strategy and will it move the needle? For us, I think there were a couple of things.

47:19Firstly, research showed that unlike almost any other asset class, the strongly performing managers tend to be persistent. And I think that's probably due to the fact that the entrepreneurs are attracted to the people who back the last successful deals and go to them first. And that does change. The so -called winner's circle does change over time, but only very slowly. And so the first decision we made was if we're going to do it, there's no point doing it at all unless we can get into the high -performing managers. I think the data we saw at the time was something like 80 % of venture managers don't return capital and only 6 % or 7 % return enough capital to justify their existence.

48:01So that's pretty daunting statistics. The second thing was there seems to be a correlation of high -performing venture vintages with recessions. And a hypothesis that we can't really test is that when people lose their jobs, they go and start up that business and do that thing that they've always wanted to do, but never got around to before. And so we thought that was something that was attractive for the fund from a diversification point of view. And then lastly, a good idea doesn't need economic growth to be successful and it doesn't need leverage. So it seems to be a strategy that can perform even in adverse market conditions, albeit that you have to be conscious of the flow of funds in and out of the space.

48:43And so those things together led us to a focus on early stage venture rather than the late stage. We've tended to avoid the late stage. And we've primarily done that through funder funds because, as I said, small team, small check sizes, hard to get access to the best performing managers. And we were lucky enough in 2009 that there were other people going the other way and we were able to get some access. And so we've worked very hard to slowly build the portfolio to the point where today it's about a bit over $2 billion of exposure, which is meaningful to some extent at the fund level. But more importantly, it's also very diversifying from the rest of the fund, and that's quite valuable.

49:29And we have also in the last three years or so started to co -invest with the venture managers. So we do fund of funds, we do directs, and recently we've done some co -investments which really follow -ons similar to the private equity approach where we would only do that if the manager was following on themselves. And if they were saying to us, this is an attractive idea, we think you should look at it. And we've done about 30 or so of them, as I said, and that portfolio has delivered really strong over 20 % net returns over 10 years now, which is very satisfying considering what's been happening in the world.

50:07Yeah. The Futures Fund started investing the capital in 2007. What was it like in those first two or three years. So I think we were very, very lucky with timing. I actually joined right at the beginning of 2008. I signed on at the end of 2007. And in the second half of 2007, the board was under immense pressure to get started with the investment program. They literally had tens of billions of dollars of cash being rolled overnight. And as you know, markets were running very hot. And so They made a decision to start to put an exposure on just through index positions and to just steadily step into the market over a period of time.

50:48And David Neal, when he was hired as CIO and the person who was in the head of strategy role at the time, Tony Day, came on board before I joined. And the very first thing they did was look at markets and say, we're not sure what's going on, but we think the equity risk premium is negative. Something's wrong and we should just stop investing. And they did, which was a very brave call. And I would say really set up the DNA of the fund ever since, which is if you have a very high conviction in something, then you should act on it. And so when I joined, it was really just prior to the crisis. And I was really confronted with this problem in the infrastructure where everyone said, how will you ever get set?

51:25It's a crazy job. Assets are really expensive already. Nothing's available. And I started writing a strategy. And as I spent more time here, I ripped up that strategy at least twice because it took me a little while to understand what a one portfolio approach was that eventually emerged with a strategy that said, let's be flexible. Let's not lock into a particular asset allocation and let's sort of approach this from first principles. And suddenly the financial crisis happened. And so, fortuitously and through some good decisions made by the people who were here before me, we were sitting with about 80 % in cash when layman's went broke.

52:07And so, we didn't have a problem with liquidity, but we, of course, were a bit nervous about the world and it took a little while for us to decide that it was time to start investing. But more importantly, we only had probably about a dozen people in the investment team and we were still writing strategies and we didn't know each other and the board didn't know us. So actually, the first time I went to the board with an infrastructure investment, I had to say, what would you like the board paper to look like? Should it be five pages, 15 or 50? And they actually said, we're not sure, write one of each.

52:41So I did. But we made the decision early in 2008 that the world wasn't going to end, that something was going to happen to save it. And if you had that view, that assets look very cheap. And being somewhat timid, what we decided to do was move a lot of money into credit. And so we appointed three broad credit managers. I said, we use external managers. And in this sort of situation, there was really no other option, but we just wrote multi -billion dollar mandates to three managers and just said, get set, get in the market, do whatever you want, make money. How much were you able to deploy as a percentage of the portfolio at the time?

53:18It was probably about 15 % to 20 % of the portfolio into credit over about three months. So it was quite a big decision and clearly that decision paid off very well. Those initial investments returned above 20%. Yeah. So you were pretty senior in the capital structure then? Yeah. This was all senior and investment grade credit at that time. There wasn't much point in buying high yield if you could get those returns in investment grade. As the crisis unfolded, that portfolio started to rotate out of investment grade into higher risks, high yields and other things. And at some point, we decided that it was appropriate to start the investment process into equities again and kick that off.

54:03And also, by then, we had started to build teams in the private markets. And so, we started to get set in the private markets. And And in fact, back then in about 2009, end of 2008, 2009, we were buying core infrastructure and core property because they looked very attractive given where prices had gone to. So in the decade or so since then, we've rolled those assets out of the portfolio and replaced them with higher risk assets where we think we're getting better rewarded. And so today you had mentioned what sounded like a, let's say, a cautious macro view. how are you thinking about the flexible positioning of the portfolio?

54:44Well, we've built a lot more process in the 10 years since then, which is both good, but also we need to be careful not to let that lock us into a position that isn't the best position. So we run a couple of tests. We suffer like many Australians from a very volatile currency. and so it also tends to be correlated with risk or more particularly risk off scenarios so that as someone with a large global portfolio we have to worry about liquidity in those type of scenarios quite a lot. So the first thing we do is run a sort of a crash test liquidity test every night through the portfolio where we expect a currency fall and an equity market fall to be correlated and make sure we can survive that.

55:29And that test is somewhat worse than the financial crisis overnight. So we've been somewhat cautious appropriately around that test. The second thing though is if we have not quite so severe an event, but something close to it, we actually want to be able to buy cheap assets. And the option value of flexibility is not something that traditional portfolio theory really takes into account. And so that's why you see us sitting with sort of a bit over 15 % in cash and why we manage our illiquid asset pool carefully. Because while you would hope you get an illiquidity premium from those assets, it also means your portfolio isn't as flexible as it might be in those sort of scenarios and there is an opportunity cost that arises.

56:13So we try to build the portfolio to those liquidity metrics or flexibility constraints and then look at, okay, if that's our capital budget, our risk budget, our liquidity budget, how should we best spend it? What are the things that are returning the best risk -adjusted returns given those whole portfolio budgets? And what does that look like today? Well, today we look at the world asset prices are expensive. They're probably slightly less expensive than they looked a year or two ago because we've had, at least in the US and in other places a strong earnings print or series of prints. So the economy is quite healthy.

56:51And so risk has become more attractive. And towards the end of last year, we increased the risk in the portfolio as a result. But on the horizon, we've got a couple of really significant issues. One is just the business cycle returning in the US. We've got the Fed raising rates and shrinking its balance sheet, liquidity coming out of the system. And usually that ends in a recession. In fact, while we've got some unusual experience here in Australia, you would expect a recession in the US in the next two, three, four years, something like that. We've also got a very strong fiscal impulse at the moment going through, but the current view is that that will roll off around the same time.

57:30So, we think the chance of a recession in the US is quite high over, say, a three -year time horizon, and it doesn't appear that markets are currently pricing that in. Secondly, we've got really, as a consequence, I would say, of the financial crisis and the monetary policy response, which inflated asset values but kept wages down, we've got a growing populist politics trend across the world. And that's true in almost every developed market. It's more reported against in the US, obviously, at the moment, but it's true in most markets. and populist politics, which is not unusual in history, usually ends in lower growth because tariffs and trade restrictions usually lead to that or other types of protectionism and higher inflation.

58:17And so we've got some skirmishes going on between the US and China currently, and there is the potential for that to become far more significant. And so I think if we look at the world today, I would say there's a lot more downside risk than upside that we can see. And the only upside scenario is we can really come up with a sort of productivity boosts based on things that aren't in the data yet and we don't know what they are. And so it's not really likely that central banks can respond again in the same way they did after the last financial crisis because they've used up that ammunition. So we're not expecting a financial crisis.

58:57We think banks are more robust now and markets are better regulated, but we certainly think the risk of a recession and some repricing of risk assets to below average is likely in that scenario, and markets aren't pricing for that. So, we have been reducing risk in the portfolio gradually, and as we sit today, we're just slightly below neutral because we think the cost of foregoing some return in good market scenarios over the next year or two is far, far outweighed by the opportunity cost of getting caught up in a downturn in markets and not having ability to invest into that at the time when asset prices are cheap.

59:41When you say neutral, is that neutral beta across the entire portfolio? Yeah. So the way we think about that is we map every asset onto a factor lens. And at its very simplest, we'll just think of two factors, a cash and equity portfolio. And so we tend to think about risking the portfolio on that basis. We don't know whether any of those scenarios will play out. And the most likely outcome is some other one will play out completely that we haven't even thought of. So it's important to be humble about this. We do know that risk isn't being particularly well rewarded right now. And we do know that all the risks I discussed are out there.

1:00:21And so it doesn't seem sensible to be taking a lot more risk than normal in this market. I can't envisage a view other than a very short term view why you could support taking more than average risk at the moment, for example, for a long -term investor. So going back to the beginning, you have to have a clear set of objectives and risk parameters as a language that you can talk about with, in our case, our board and our investment committee. And we have this very open conversation with the board. And so the sort of scenario we're talking about is, well, if equity markets are doing 10, say, which is pretty healthy considering where they're priced today and we have a diversified portfolio and in that scenario, we're only doing seven or eight, which beats our mandate.

1:01:10But in a big drawdown, we might only lose 10 % rather than 30 and then we can invest into that and deliver 15 or 20 % returns beyond that. Is that a risk worth taking? And we think it is because we're an absolute return investor over the long run. We don't have to worry about peer risk. We don't have our performance published in league tables annually, let alone quarterly, like some funds. And so we can just focus on that long -term goal. The other thing to think about, and as I said before, the industry doesn't do enough of this, is thinking about the risk part, not just the return part. And so we sort of think about volatility, but also Sharpe ratio.

1:01:54And it's a hard thing to measure, and there's all sorts of debates you could have about it. But in terms of our 10 -year Sharpe ratio, it's about 1 .3, which we think for a fund like ours is pretty good. Yeah. Yeah. How do you make decisions as a team? Well, it depends how big the decision is. And I would say that we're evolving this at the moment. But the big picture portfolio decisions, how much risk should we have in what scenarios are we're worried about, we make those decisions at the board level. But obviously, those views are filtered up from the team to the internal investment committee and then recommended to the board that way.

1:02:32And how many people sit on the board? Seven. And they're appointed by the government. They're appointed for fixed terms. They're not allowed to be current politicians and they've all got financial services skills. So we're very lucky that the governance structure that was designed for us by the creators of the fund is very robust and really I would say is the whole reason why we've been able to deliver what we have. What's the structure of your team? So the investment team, I said about 60 people. It's split into three teams. One is public markets and there's a group doing equities, which includes the longshore.

1:03:12There's a group doing debt and that includes both public and private debt. There's a group doing all the overlays, so all the derivative positions that shape the portfolio and put on interest rate, currency, and some option tail shaping strategies. And then there's the hedge fund team. We call it alternatives. They also do alternative risk premium, things like reinsurance. And so there's a deputy CIO, David George, who leads that team. And we'd like to think that those skills are fungible and that we can share the insights across those sub -teams. and benefit from each other's skills and opportunity sets.

1:03:49And then we've got a private market team led by Wendy Norris, and that's infrastructure, property and private equity teams. And they obviously focus on their areas, but increasingly they're sharing their skills and resources across those areas as well. And then we have a portfolio strategy team, which is a top -down portfolio design team, and they're also tasked with looking at the economic situation, how markets are priced and looking at portfolio risk settings and investment process that I've been talking about. My job actually is much more about team structure and process and strategy and most importantly, culture than about making investment decisions.

1:04:31What's the nature of that culture? Well, I would hope it's very collaborative. I think we aren't into star investors or single people taking the glory. We're into a real team effort. We trust each other. We empower people to make decisions and we have to support them with the right framework so they know what decisions they should be making and when they need to escalate something and how much risk they can take. We do vigorously debate ideas with each other in a very open way and we encourage that. And so, we certainly think that diversity of thinking is really important, having different people around the table with different backgrounds, different experience, and that clearly in investing, there's no right or wrong answer.

1:05:17And no one really knows what will happen. And so the more views you've got, the more able you are to make a good decision. And then importantly, it's a no blame culture. So we know we won't get all the decisions right. In fact, we'll get a lot of them wrong. And so as long as we've made those decisions in the right way, we just move forward and learn from it. And we might ask the questions, what do we learn from this? Can we improve our process? But then we just get on with life. How have you tried to address human biases and improve them on your team? Yeah. The first thing is to acknowledge them.

1:05:50And so, you know, we're all very logical, analytical people here working in investment markets. And so actually, we've got a really good chief culture officer and she's led our thinking in this space. She's a psychologist. So she's been great at educating firstly me and then the rest of the team using data. So it's very clear from the data that diverse teams make better decisions when presented with cognitive problems and they have time to debate them as opposed to teams that have to make very quick decisions like a sports team or armed forces group or something like that. And so using that, getting buy -in across the team for that observation, we've then looked at our own processes.

1:06:31And the classic one is an investment committee where you have some wise and old person, usually a male, chairing the meeting, debating things, but then dominating the conversation or letting some people with loud voices dominate the conversation over others and go around the table and vote one at a time, raising your issues. Well, it takes a strong -willed and courageous person then to vote against the chair or it might be your boss or the views of the other people who might have been in the organisation longer than you. Or in some cultures, actually, they just never would do that. You know, in certain Asian cultures, they never would argue against the views of their boss.

1:07:13But actually, that could be the most important thing they should do. So we've transitioned to a model now for some of our committees and it's in trial where we canvas views the day before the meeting, whether people are inclined to vote for or against something and why. And then the chair of the meeting gets that information. They can feed it back to the team so that the team can firstly focus their presentation on the issues rather than wasting time just repeating what's in the paper. And secondly, use the time in the meeting where it's most needed. But then we can call out those views so that even if it's only one person who says, I don't like this because, the chair can actually say, well, you raised a concern about this.

1:07:56Why don't you share that concern with everyone? And we can see if we can either relay that or agree with it. And that could take us in a different direction. So it comes to how we chair the meeting as well. and it's very important in the dynamic that the chair or me if I'm not the chair are supporting those views and encouraging people to do that and have a dynamic where we're all working together for the good of the whole portfolio there's no us and them there's no let's just get through this committee so we can do what we want it's you're still responsible if you're presenting the paper but it's do they know something I don't have I got an expertise that I don't how can I use that So we all get to a better position.

1:08:34And so we're trying to change the culture to that. We've got a way to go, but we're getting there. And how is everyone incentivized in their compensation? So obviously we get base salaries, but we also have a bonus arrangement, which is linked to some extent to personal goals, which might be about the team or the individual responsibilities. And they're assessed by the managers. But the quantitative performance measure, and the more senior you are, the more important that is, is solely based on the rolling three -year whole -of -fund performance in an absolute sense. So it's to create alignment, sort of whole portfolio thinking that I've been talking about.

1:09:19Yeah. What do you think are the core differences between a US -based, kind of US -focused investor and an Aussie -based investor? So it's very luxurious to be a US investor these days because you don't have to worry about currency. And that's probably the most important thing, the most important difference, I think, that there's so many opportunities in the US market in US dollars and you don't even have to think about it. And if you decide to go offshore, then suddenly that's a big decision. Whereas if you sit here in Australia, we don't have that luxury. and as I said before, the Aussie dollar is very volatile compared to the US dollar, so that is a big impact on portfolio construction.

1:10:04But there are other differences too. I would say, and it's easy for me sitting on the other side of the world, but I would say that the US investors largely are quite introspective. I think we have a very different view of the rise of China and the impact China's having on the global economy than most people I speak to in the US who rarely talk about it. And we've probably got a much more open mindset to the benefit of exposure to emerging markets than a lot of the US investors I speak to. So what is that view on China? Well, it's probably one of the oldest civilizations in the world. So we've got a lot to learn from them just in that respect.

1:10:44It's an enormous country with an enormous population and it rightly deserves to be the biggest economy in the world. And it no doubt will be before too long. And the Chinese government, whatever you think of the political structure and regime in China, has done a really amazing job in improving the life of the average Chinese person in the last two generations. So that we've had this huge and one -off tailwind to investment markets and global economies, but from the creation of a middle class in China. and they're very aspirational. The policymakers are very clever and they have a plan. And so, one of the things I'm most excited about actually in the world at the moment is the opportunities that the creation of that middle class consumption generation and an investing population.

1:11:39There's a huge internal domestic investment markets and they haven't really been opened up to the world yet, but they will be. The currency has become tradable and will become more tradable over time. And so someone who's interested in the long term really needs to be aware of that and learning about it and thinking about what is their strategy. How have you thought about allocating when your domestic economy can be tied to what's happening in China, then you have a whole sort of Chinese market opportunities? Yeah, so you're right. So the first thing is, you know, if you're Australian, you have an exposure to China, just in the Aussie dollar and the local economy.

1:12:16So we're not setting out, for example, to play commodities because we feel like we've got enough of that exposure already. And if we look at, we sort of loosely call it old China and new China. So old China is the investment driven wealth creation through building roads and buildings, particularly property investment. There's all sorts of debates about whether that was overcapitalized and whether capital allocation was efficient. We don't get into that. All we would say is we don't see that as a particularly attractive investment opportunity right now. But the new China, the creation of significant demand for healthcare, for education, for entertainment opportunities, as people become middle class, the trading up in terms of the types of goods and services that people buy, those opportunities are absolutely tremendous.

1:13:08And so we've been playing them a little bit in the equity market. We're working on some further strategies there, but significantly in our private equity program, where we have quite a bit of onshore Chinese exposure, really playing those themes. And then the tech space in China is really interesting at the moment too. And they're really market leaders in a lot of cases. And so we have a venture program focused on China as well. So now that the fund's been up for 12 years, things have sort of settled in. You said there's processes now. As you look out for the next, let's say, three to five years, what are the key initiatives you're looking at to improve what you're doing?

1:13:49I think the first one is actually about our people and the way we interact with each other. So I sort of look at the traditional organisation, which has a top -down hierarchy, where you have one person sitting at the top and then a few people below them and so on and so on, and the authority cascades down. And I think that structure is just too inflexible and too slow to make decisions to meet the challenge of the world that sits in front of us. And frankly, our portfolio is too complex as well. and so I think that we need to move much more towards a sort of a network organisation where everyone knows what their role is where they're in touch with a set of opportunities and a set of information and where we have to use our structure to empower those people to make the decisions that's appropriate for them and to take the information they generate and bring it back to the rest of the portfolio and the rest of the investors.

1:14:48Now, we're not there. It's a hard thing to do. But I do think that having a venture program also exposes us to sort of the technology that's out there available to help people collaborate. And we've started to implement some of that. So we're using Confluence and SharePoint, for example, for internal teams to be able to communicate with each other and work on things together. and we're investing into our own technology quite heavily to uphold that. And I think for the next couple of years, a lot of my focus is going to be on that internal structure and team to get to that space. So it's not really about we have to take the investment program here or there.

1:15:29Actually, I have no idea what will happen in investment markets. I know we just have to have an internal structure and process that can adapt as that evolves. I guess I want to ask one last question about how you've thought about fees, because you're in this interesting inflection point where you have a lot of external managers, but you also have a lot of capital and bargaining power. So how have you tackled that with your external managers? Yeah, we do think a lot about fees. It's very important, of course. The first point is we were focused on net returns. And some of our local peers here in superannuation who have to compete for members have decided to go down a road of setting a fee budget for the whole fund and then reporting those fees as a competitive advantage in their marketing.

1:16:16And we think that risks cutting out whole swathes of the opportunity set, the higher fee areas of hedge funds and private equity and venture in particular. And that would be fine if they didn't do much for your portfolio, but I think they're really important for a properly diversified portfolio going forward. So we're agnostic as to the level of fees, if I can put it that way, in an absolute sense. Of course, we don't like paying them, but we mainly think about net returns. And so that's the first thing. However, the second thing is, as I was alluding to when I was talking about equities, there's no point paying fees for things you can buy more cheaply.

1:16:57And so each team thinks very hard about what are their arrangements and are we getting bang for our buck. So I'll give you an example in infrastructure. Some years ago, well, the typical fee model in infrastructure is coming to our fund, we'll charge you, if we're not too avaricious, we'll charge you 1 % base fee and 10 % over 8 or something like that. If we are, we'll charge you 2 and 20 like a private equity fund. And if you're buying core infrastructure assets where most of the return is coming from continued economic growth or flat to declining bond rates. That's not manager skill. That's an economic view that I can buy in my fund using liquid market proxies.

1:17:41So there's no point paying high fees for that. If the strategy is highly value added, if they're turning around poor performing businesses, if they're growing businesses through add -ons and creating something and then exiting, much more like a private equity manager would, then maybe it is worth paying. So that's the insight we bring. And in the case of infrastructure, a few years ago, we actually, so I said we only invest through external managers. That is true. But there was an opportunity in Australia to buy some domestic airports from a listed company. And we wanted to use a manager. But when we started talking to the market, we found that they weren't aligned sufficiently.

1:18:24They all wanted to put it into funds and structures where we couldn't get enough capacity or where they locked themselves in as a manager forever or where they charged fees that were not really sensible for those type of assets. So we actually went out, surprised the market by doing the transaction ourselves in -house and then acquiring some assets which left us with essentially two large airport exposures here in Australia, Melbourne and Perth Airport, which were approximately a billion dollars each of value. Now, in this case, we'd bought the asset and we understood them and we are going to make the decision about when we should sell them and if and why.

1:18:59And so we don't want to hire a manager that can take the value away from those decisions. So the board said to me, why don't you manage the assets? You bought them. You know how to do this. You used to be an infrastructure fund manager. And I could, and I actually built a business case or a plan to say, how would I do that? But I felt like hiring eight or so people that I thought we would need to do that well risked our culture because how do you incentivize them? Do you incentivize them on the whole of fun when they're just managing one asset? And what if I want to sell those assets? What do I do with those people?

1:19:37So we preferred to hire an external manager. So we went to the market and we said, we want you to bid to manage these assets. And we want airports really there, you know, They earn aeronautical revenue, but they're also shopping centres. And they're sometimes property development plays as well if they've got a land bank. So we want you to bring your property people or a partner who's got that expertise alongside. And it was really interesting in Australia where there's a number of fund managers who have both infrastructure and property strategies. Those teams had never worked together, even though they already own some of these assets.

1:20:11So we sort of said, don't turn up if you can't do that. and then secondly we want to know the people who will be working on these assets how much time they'll be spending on it and we'll pay you a cost plus and so we're happy to pay you a profit but we want to know what that is you can bid on that basis so that was unusual in space secondly we said we believe in alignment we believe in incentivizing you to add value but we've bought the assets if the economy does well and the value of the asset increases that's not your doing it might even be that this particular business has lost market share but still grown in value and so we decided collaboratively to set one and three year operating goals how much revenue per car park whether the capex program was delivered on time and on budget what's the spend rate per passenger in the retail business and we would agree fixed dollar bonuses based on the share of the value created by achieving those metrics back to the manager.

1:21:11And we sit down every year and renegotiate those bonuses. And if we can't agree, then there are none, is the approach. And so we also said, we've bought these assets. We want to be able to terminate at any time we want. Although we recognized there was an initial cost in setting up the mandate. So we decided to pay them a sort of a demobilization fee on a schedule for the first three years. And so as a result of the wonders of competition. We actually achieved what we wanted with both of those assets. We think we've got a more engaged manager who's working harder on creating value than a traditional infrastructure manager would for a core asset.

1:21:49And as it happens, the fee we're paying is substantially lower than what it might have been under the old arrangement. And I would encourage any of your listeners who happen to be in a role where they could do that to think about whether their managers are actually adding value and to speak up and to make a difference. And yet you're not planning to do more of that? Was that a one -off? Where there are those types of opportunities, we're very happy to do that. But again, we're not arrogant about it. In a situation where a manager is finding an opportunity and bringing it to us, we think they deserve to be compensated for that.

1:22:22We just want to make sure that we're paying for actual value add. We're not paying for beta. We're not paying for luck. We're not paying for useful effort. Across your portfolio, Roughly, how much would you say you've achieved that objective where what you're paying today is really a good, fair assessment of value add? I think we're there in every part of the portfolio to a point, but there's always room for improvement. And I think as technology improves, I would aspire to look at those infrastructure or property assets and regress them against the broad factors, just like we do with the equity managers and the hedge fund managers in the more liquid space and say, how much of this return is due to discount rate compression or changes in economic growth assumptions or inflation?

1:23:09How much is due to your actual skill? And the industry has a way to go to evolve to that model. But what's happening in infrastructure and properties, the big funds, rather than doing that, they're internalising, as you pointed out. And that is creating pressure on the industry and that will force change. And I think the same is true in equities and hedge funds, but in a slightly different way. Yeah, great. Well, Raph, I want to leave a little time to turn some closing questions. But I think before we dive in, as you know, from the first time we spoke a number of months ago, my historical first closing question was this question about what's your favorite sports moment.

1:23:46And you told me you didn't like that question. Why don't you explain why? I don't think it's an appropriate question. We've done a lot of work internally on how to get diversity of thought into decision making. And we've done a lot of work educating ourselves onto unconscious bias. And I think the problem with the sports question is I would hazard to guess that more males than females are probably interested in sports, although I'm not saying females aren't. and that your listeners are probably thinking about, at least a chunk of them are thinking about, how can I get to be a CIO or a portfolio manager or some type of lead consultant?

1:24:23And the point I'd like to make is you don't have to be a sports fan to get there. All people are different. Some are sports fans, some aren't. Yeah, which is great. So I've been working on the wording. And so here's my new wording for this first question. What was your favorite extracurricular achievement? Okay, that's probably even a harder one to answer, but that's okay. So leaving aside work and family, which obviously take up much of my time, I would say in the last few years, I've really decided to try to put something back into the local community. And I've gone on a couple of not -for -profit boards.

1:24:57One is the school where my kids go. And somehow I've ended up as the treasurer there. And we're doing some work around the sustainability of the capital budget and how we can get the school fees down. And I think putting effort into educating kids and making sure that's sustainable in the long term is really important. I've also gone on the board of a community foundation called the Lord Mayor's Charitable Foundation here in Melbourne that's a 90 -year -old institution that looks at the problems in and around Melbourne, which are currently things like homelessness, kids' education, integrating aged people and migrants into society.

1:25:35raises an investor corpus and gives away about $10 million a year. And I'm sharing the investment committee there. So I feel like we're making a difference and that's really important. That's great. What's your biggest investment pet peeve? I think it's probably a couple of things. One is just people who assume the future will be like the past. And I don't think that's a valid assumption. There's a whole lot of things over the last 50 to 80 years, a huge leveraging cycle, a huge demographic boom post -war that have meant that certain things behaved the way they did that I just don't think are likely to continue.

1:26:12So I think we have to go back to first principles now. And someone who says, well, I've done it before and it worked, so therefore it will work again, I'd just get irritated by that approach. And linked to that, people who just don't understand why something works. Like if something's a great investment idea, there's got to be a reason. And if you don't know the reason. Don't do it. Right. It's good. All right. Here's a new one. If you could look one person, dead or alive, one person in the eye, shake her or his hand and just say thank you, who would it be and why? It's an easy question for me to answer, but it has nothing to do with investing.

1:26:48I'm a real animation fan and I love theme parks. And so for me, it would be Walt Disney. He's a person who was an innovator, who was prepared to take a lot of risk, who went broke more than once. He really bet everything on his vision, but also he used technology to communicate with the masses. So he was the first person in an existing movie studio to use television, and he was roundly criticized for that. He built the first theme park, and he really saw people who worked for him for their talents and didn't really care what the rapper was, despite some of the rumors about him in my readings. He backed all sorts of people from all types of backgrounds.

1:27:25And so it would be fascinating to talk to him about that. What teaching from your parents has most stayed with you? Pretty simple. I think they're sort of pretty straightforward people. Just work hard and be patient. Don't expect everything to come to you straight away and be prepared to take a risk if it comes along. What information do you read more than any other? I get a lot of things to read. and some of the writings from our hedge funds and things like that are interesting but really I read the work of our internal team because they synthesise all of that together into what's important and I find that the most valuable and if I have any spare time what I try to do now is read about historic economic conditions and I'm particularly interested actually in a period called the Gilded Age followed by the Progressive Era in the US, 1880 to 1920, when following the railway bubble and bust and financial crisis, there was a huge rise in populism that led to Theodore Roosevelt getting elected.

1:28:28And there's a lot to learn, I think, from understanding that period. Last one, what life lesson have you learned that you wish you knew a lot earlier in your life? That I don't know all the answers and that other people quite often know better than me, or certainly they've got different views to me. So really had to listen to other people. That's great. Raph, thanks so much for taking the time. Really enjoyed it. Thanks, Ted.

1:29:15You