[REPLAY] Matt Whineray – Leading New Zealand Super Fund (Capital Allocators, EP.108)

27:06This one is a more granular approach. Doesn't require us to go and change the whole SAA construct to add an opportunity. So an opportunity can be added on the recommendation of the investment committee and the approval of the CIO. We can then allocate risk to it. The board has given us the overall umbrella of how much active risk we can have, but then the job of allocating that across the vast opportunities sits with management. And so I would say always you're going to be anchored a little bit from where you started with, but we have moved that quite a way. So what I guess we wanted to get away from with the SAA was the SAA says you're going to have 5 % infrastructure, whether you think it's attractive or not.

27:51you can have 5 % of timber whether you think it's attractive at the time or not we wanted that to be a little bit more dynamic and a little bit more responsive and not just put it in just because we've made an SAA call to do that and then also you're able to much better attribute accountability for decisions because in an SAA world you can never actually be at 5 % infrastructure so why are you not there? Are you not there because management has chosen not to be there because they don't really like the asset that much or because they just can't get there? And this one, it's really clear. You've got a reference portfolio.

28:28When we add a new asset to the portfolio, we sell a chunk of that reference portfolio to fund it. And we can measure the difference between those two things, the returns we would have made versus the returns we actually made. And it's really clear who owns that. Management owns that. In a fair amount of the implementation, you've touched on things like strategic tilting. There's a blend of what you're choosing to do internally and what you're choosing to outsource to external managers. What questions are you asking to determine whether you're going to try to bring the resources in-house or hire externally?

29:00We start with a few questions like, can we get satisfactory alignment? And that probably is one of the biggest drivers. Not so much a cost one, because while you can get some cost improvements, I think the bigger driver of our decisions, especially where we are down in the bottom of the Pacific, it's going to be very hard for us to build teams in the US or in Europe or whatever and replicate what we might get from managers. So the cost one is less of a thing. A lot of it is alignment or we can't get some sort of critical risk control that we might want or the ability to move it. So strategic tilting is a good example.

29:37Strategic tilting is entirely managed through derivatives. It benefits from the liquidity management that our portfolio completion team runs and the counterparty risk that we represent as a fund as a whole. But also, the thing about strategic tilting is that you can be, for a long time, underwater. And because you're waiting for these markets to mean revert and they might be slow or they might move further away from whatever you think the mean is. And so that one we thought is really hard to get alignment with external managers. And also what we've seen is where managers are running those types of programs, sometimes they have a pooled program and other clients in that program start to lose their nerve and want them to take the risk off and that's exactly the wrong time to do it.

30:23And so this allows us to control that and we're responsible for it. We manage it and that feels like a happier place to be. When it comes to other things like, for example, merger arbitrage or cat bonds or life settlements or that stuff, there's expertise externally that we don't want to build internally. It gives you more flexibility if you're using those externals and sure, you're going to pay for that. But in a construct like ours where through time we might be in those, we might not be in those, it's very hard if you've built the team internally to say, actually, we just don't want to invest anything in this opportunity.

30:59because then you've got a team who's sitting there going, twiddling their thumbs and going, well, what am I doing? It's really around alignment, ability to manage risk in a way that is critical to us, a bit of cost, and also just being clear-eyed about who's got the expertise. Can we actually get the expertise here in New Zealand versus what we need? And that strategic tilting effort, what different asset classes are in that mean reverting strategy? It's got global equities, global bonds, currency. It's got some credit, so it's sovereign and credit. We've just recently introduced a small bit of risk in commodities, so we're starting to tilt those as well.

31:36So the big global equity markets, big global bond markets, large currency markets. So these are all liquid things that we can use either futures or TRSs on and can trade, and that team will trade pretty much every day. And are you going down to the security level? So you could do mean reversion across markets. You could do it tilt to value and growth. You could get into sectors. You could get into securities within sectors. How far down are you going? The genesis of it was it started with basically two levers. It was either a view on global equities versus global bonds, and it was a view on the Kiwi versus the basket of currencies.

32:12So those are two things. And then over time, we've significantly increased the breadth of it. So now we've got global equity markets like Japan, Canada, US, Europe, UK, emerging markets. We've got the same bond markets. We've got about four different credit markets, Australia, Japan, US, Europe. We've got all the major currencies. So we haven't gone down below to sector or individual securities because we're more confident at the whole of market level of being able to say, what do we think the long run equilibrium prices or value is? And then compare that to the current price. When you get to individual sectors and individual securities, we're just much, much less confident in that.

32:58So you can increase breadth, but I think you reduce confidence. And so we probably don't improve the performance of that by doing that. I think that's the key is to have breadth of non, hopefully uncorrelated positions, but without destroying the confidence by just getting to a point where we just can't have a view. And what metrics are you using to determine equilibrium and markets that move away from equilibrium? Yeah, so the team builds DCF models for all of these markets. We have long run views on the big drivers, so growth, inflation, real interest rates. And then that's which come from our internal economics teams, as well as gathering data externally.

33:39And then with those, we form views on what the long run equilibrium values are. we use particularly in the rates and the impacts on the currency as well we use the sort of the near-term market pricing because what we're not trying to do is is forecast where things are going over the next couple of years what we're trying to say is is there some sort of reasonable difference from the long-run equilibrium value and then if we think it's a little bit lower then we'll buy it you know if it goes down at that point we'll buy some more and we'll do that incrementally and then if it starts to go up then we'll start to sell it so long-run economic drivers is try to have economic identities so that you don't have these sort of divergent models, but they are all ultimately consistent with each other.

34:23How do you think about sizing the strategic tilting effort as a percentage of the whole? We have a view on what we think the overall information ratio is, what we can make in terms of active return versus the risk that we take. Then we have individual views on the different markets, how confident we are. So there's a sizing thing going on within tilting about how much we allocate to equities versus bonds or currencies versus each other's or whatever. For strategic tilting itself, strategic tilting is the biggest chunk of our active risk budget. And that comes from being really consistent with our beliefs and our endowments and us having a lot of confidence in our ability to execute that, which has sort of developed over time.

35:04So we look at what we expect to make on that. So our risk-adjusted return expectations, we adjust that by our confidence versus every other thing that we'd allocate active risk to, and that gets the biggest chunk of active risk. And where do you end up? The budget for tilting at the moment is about 2.5 % active risk at the fund level, within a total active risk budget of 4%. But of course, things don't add up because they're not necessarily correlated with each other. So it is definitely the biggest chunk of active risk that we've got. The other internal effort you mentioned was the completion strategy.

35:40How does that fit into the puzzle? The portfolio completion team is what a lot of other organizations might call their treasury function. And so they're the team that do all of the market trading. So all of our derivative trading, all of our FX hedging, all of our transitions or rebalancing. So their job is to basically take the actual portfolio, compare it with where we want to be from a risk perspective and then rebalance to get back to that by using those liquid ones, as well as execute the strategic tilting trades, as well as do the FX hedging, as well as trade the New Zealand equities that we might trade internally.

36:19So that's a really important team. We created that after the GFC. So going into the GFC, all of our stuff was outsourced and we didn't have great views of almost anything, liquidity or risk or any of that. So it's a big program to create some critical functions, which allows us to have visibility and control over our liquidity management. And then also, you know, a window into where markets are. So that team is a team that is doing all the market facing activity. Can we talk a little bit about the external manager relationships? You did mention you'd like to have fewer of them and deeper relationships and aligned.

36:58how do you go about and how does the team go about picking those managers that fewer deeper came from go right back to when you're an saa and you're saying okay we've got five percent of pe so then we want to have a whole bunch of different managers to give us some sort of broad exposure to a world where we said okay under the reference portfolio we're going to allocate to something if we think that there's really something about that market or that that manager that gives us great confidence that we're going to beat the reference portfolio. In doing that, we'd necessarily become a bit more concentrated.

37:31We want to allocate more, but also what we want to do, because I talked about the confidence. We've got more confidence if we can change that risk allocation. So that fewer, deeper one said, okay, we want to try and make these flexible mandates. And so what that means is you go to a manager like Bain and you say, I'd like a European distressed mandate and they say oh we've got a fund and say okay well yeah that's great but actually we'd like it to be a bit more flexible so we can allocate capital to it according to our view of the attractiveness of that opportunity over time and so you can't do that if you're turning up with a 50 million dollar check what we found is actually around about 200 you start to have the ability to create a flexible mandate you can say okay we will we'll set this up so that you can draw it down but periodically we will reassess the attractiveness of the market and if we say if we really like it we can allocate more if we don't like it we can just rule it off at wherever it is it's more intensive to manage so you need fewer of them and you want to be closer to those managers so that you're getting a feedback loop as to attractiveness that's something that we worked on but also what we want to get out of those managed relationships is a bit more IP, a bit more input into our teams that we can use for just getting our people smarter and our processes better.

38:52And as you filter through those manager relationships, do you tend to find that larger managers are more conducive to being able to help you the way you're looking to? Yeah, it tends to be like that. If you think about it from a manager's perspective, to be able to manage the allocation process that you've got to go through, if you've got a bunch of different mandates and you've got a fund, for example, and you find an asset, you've then got to say, okay, well, I'm going to give three bits to the fund and one bit to this mandate. That sort of allocation infrastructure, I think, means that they have to be bigger and more sophisticated, generally speaking.

39:28That probably pushes you more up this size. You mentioned that you want these managers to be able to help you with the flexibility and shifts in asset allocation and strategies. How much do you come to those judgments on your own? And how much are those inevitably informed by the very managers you're giving the money to? Often they are, at least partially informed, but also you get quite a bit of information by their activity because generally speaking, if a manager is slow from allocation perspective in terms of, well, slow versus what, but not seeing lots of opportunities, that's pretty useful information for us because that says, well, actually, maybe this isn't that attractive.

40:12So you often probably, if you really looked at it, you'd say there's a reasonable correlation between the pace at which managers are allocating risk and our view on attractiveness, as you'd expect, because they're close to it. And if they're not seeing opportunities, then our other indicators will probably tell us that we don't think it's that attractive either. Do you run the risk that the managers as a group sort of form a consensus? And as a result, you're tilting towards a market consensus instead of, as you want, a mean reverting kind of contrarian approach? Possibly, but that's where having a bunch of them, and particularly a bunch of them who think in sort of different ways is quite useful because then you're not totally driven by a single information source or data source.

40:55You can talk to them and what's really useful from some managers is notwithstanding that they might not be in a particular asset class, they've got sort of frameworks and structures for thinking about how they would view the retractiveness. So that can be really helpful outside of their immediate area for us for thinking about that. And the other way we try to deal with that is those risk basket teams have got a bunch of different people in them so that it's not just the person who is dealing with the manager at the access point level who is doing the target allocation. It's that team that's doing it.

41:27So you get a bit of protection against capture, if you like, through that process. What does the structure of your team look like across the investment side of the organization? Yeah, so we've got two GMs involved. So Stephen Gilmore is the chief investment officer, and he looks after the investment group. And within the investment group, there are four teams. There's a responsible investment team. There is a team called external investments and partnerships, and that's our external manager team in large part. There is a direct investment team, and there's an asset allocation team. So we've got what we tend to call them as access point teams.

42:04Our access point teams are the external investments and partnerships team and the direct team. And then so outside of Stephen's group, there's a group called the Portfolio Completion Group. So that's headed up by Mark Fennell, who is the GM of Portfolio Completion. And that has within the Portfolio Completion team that does all the market trading and another team called Portfolio Investments, which is generally running our internal credit mandates and a strategy we call the direct arbitrage strategy, which just looks to take advantage of dislocations in markets. So yeah, four teams under Stephen, two teams under Mark, and the whole lot represents our investment function.

42:41How many people are in each of those teams? So there's about 50 in the investment group. There's about 10, I think, in the portfolio, the overall portfolio completion. So maybe we're in the sort of the 55, 60, somewhere around there. So I'm going to circle back to two of the beliefs you talked about and really bring them into the present market. So one is the notion of markets that are conducive to active management and the ability to generate alpha. Where are you seeing those markets today? We don't see that many, to be honest. So we do think that in New Zealand. So the New Zealand active equity market is an interesting one in the sense that the median manager has been able to generate alpha or excess returns over time.

43:27Why is that? Is that because there's a bunch of real special managers or is that because there's something about the benchmark or is there something about the structure of that market? So we think that the New Zealand market is one of those that's conducive to it. So as a result of that, we have actually relatively few listed market active managers. So I could count them on pretty much one hand. We've got two managers in New Zealand that run active equities. We've got one global emerging markets active manager. And that's it. So we don't have any developed markets active managers. We don't have any fixed income market active managers in those listed spaces.

44:07And that's really because we look at those and we say, in those really large developed markets, there are lots of really smart people trading with each other. And we don't think that there's a persistent production of excess return. Contrast that with the New Zealand market where we think there is, although that might also be declining over time. And we think what's happening in the New Zealand market is that the New Zealand market is made up of retail investors, international institutional investors, some international strategic stakes and the New Zealand active month. And the relative proportions of those mean that generally speaking, we think the New Zealand active equity managers managed to trade off those other groups and get their alpha off them.

44:47Whereas you go to the US market, there's a lot of active managers in there. And on average, the whole market is paying fees, but not generating alpha. Yeah. And this may be tied to a bit, this belief about understanding that there's a life cycle of asset classes. As you look at the markets today, where do you think we are in a variety of different asset classes in their life cycle? I think about sort of forestry Forestry I think is you go back from an institutional investor perspective maybe 10, 15 years started, the TMOs started and institutional investors started to allocate timber and then you had all this big trade where all of the timber assets went from the integrated forest product companies to investors who had lower cost of capital and then now there's just a lot fewer of those big things So I would look at forestry and say, I think that has moved through the life cycle.

45:42I think of other ones, I think life settlements is probably a little bit like that. So life settlements is a shorter timeframe, but a lot of capital allocated to it. And the big trade was large insurance companies selling these books to mostly these private managers. And those big tertiary books are kind of done, right? So now there's just sort of less there. where are the ones where it's sort of a little bit newer? I think farming and agriculture is still earlier in the life cycle one. I think that because it's just hard to get scale in that, right? So whereas you might be able to buy a billion-dollar forest, you can't buy a billion-dollar farm.

46:23You come to New Zealand, you want to do dairy farms, you're going to do them$10 million at a time or$20 million at a time. So I think that one still there's barriers to getting into it for the large institutional investors. When you think about others like private equity, it just feels like there's just more and more allocation to that. And that market, which might have been much more inefficient for unlisted companies in the$200 million to$400 million range a few years ago, just feels like it's much more intermediated now and there's competitive bids for everything. And it just feels like the excess returns in that space have compressed as well.

47:01So that's the thing is for us to be a bit realistic when we're allocating to these things to say, well, where is the real source of excess return? What is it? Is it a manager skill thing? Is it a leverage? Is it a luck? Is it something that there's just inefficiencies in the market that mean that managers are able to find these things? We have to be reasonably honest with ourselves about what the source of that return actually is. So I know that in addition to starting with a reference portfolio and creating these risk allocations and budgets and balancing what's internal and external and all these different levers of return, you also think of themes and pursue themes in the portfolio.

47:38So talk a little bit about how you develop the themes and how you implement them in the portfolio. Yeah, themes are hard, I would say. And actually, in the last few years, we haven't done nearly as much with those things. So where we started with themes was we said, all right, so we think there are some themes which are sort of long run changes happening and things like resource scarcity and things like the development of emerging markets, those types of things. And what I guess you find with themes is that we were using them to say, OK, let's try and help the teams with finding the most sort of fruitful areas of opportunity.

48:17Where are those spaces which we think have a tailwind from a theme and therefore are sort of conducive to us finding opportunities that will get paid more for the risk than the risk that we're taking would imply? And what you find, I think, a little bit is that you can almost back any investment you like into whatever theme you've defined. Because the other danger is that you set the whole portfolio up on the basis of a theme and then some other theme overtakes it. So we haven't really applied those themes that much of late. Probably the biggest one that we've now picked up as an investment strategy is around climate change.

48:52It's a very long run change in markets, but it didn't come out of that theme activity, if you like. But the emphasis on themes has declined a bit because I think in practice, it's quite hard to really implement them. And you go and you look at thematic managers around the place and the records aren't necessarily fantastic, right? I know you spent a bunch of time on ESG efforts. Yeah. And why don't you walk through a little bit of the history, and then certainly there's been a more recent one with the tragedies that happened locally and the impact from social media. So ESG breaks down into two big chunks, the integration piece and the ownership piece.

49:32And so integration is about understanding what the ESG implications of risk allocations are right from the start. So when we're doing that risk budget work, what the RI implications of a particular opportunity are. So we'll factor that into that risk allocation process. Then thinking about what happens at the access point and making those decisions where you're choosing either we're investing directly or we're using a manager, what are the RI implications. So that integration is really important at that end. And then the ownership chunk is about voting and engagement and just being an active owner in relation to those things.

50:08So that's how we sort of think about the two big bits of work. And there's another bit that comes out of really the integration, I guess, which is exclusions. And that's a really small part of ESG, but it's the bit that gets the most attention because people look at it and go, oh, you've excluded this company, why? Or you haven't excluded this company and the Norwegians have, so you must be evil, you know, that kind of stuff. But actually the exclusions are a relatively small part of what we do in ESG. On the ownership side of things, yeah, we've got an active voting program. We brought that in-house last year.

50:43We vote all of our shares globally. And then we also have an active engagement program. We do that directly with companies domestically, and we use a BMO to help us on the global engagements. But the notable one that you mentioned was post the Tragedy in Christchurch, we together with another group of the New Zealand Crown investors, we got together to lead an engagement with the social media companies about the, well, aimed at preventing the live streaming of objectionable content and subsequent distribution. And so that's a program that's underway at the moment. We have, I think at last count, like 81 investors from around the world, a big chunk from New Zealand, a big chunk, slightly more from offshore than domestically.

51:31And those investors, between them, manage assets of about$10 trillion. So a big group of investors who are concerned about this issue, and so that engagement is with the likes of Facebook and Google and Twitter, aimed specifically at preventing that distribution and live streaming of those things. And how has that played out in the engagement so far? That's early days in that engagement. We're in touch with the local entities. What we've been doing through this first few months is getting that group of investors who want to be involved, defining the basis for the engagement and really doing the work from our perspective on what the potential solutions might be so that we're in a good position to sit down and have these discussions.

52:12And that's the next phase. And we'll be getting into that shortly. What are your priorities for the coming year as you look at the things you're working on and how you're going to continue to try to evolve this model? So the government announces its budget in May every year. And so in this new budget, the government announced a new mandate for the Guardians to manage. And that is a mandate for the development of domestic venture capital, domestic venture capital market. And there's quite a chunk of work at the moment going on. OK, well, let's define what that mandate is going to look like. Let's help with the drafting of the legislation.

52:50let's deal with the entity that's going to manage that for us which is a crown entity called the New Zealand Venture Investment Fund and define what the terms of that mandate are and so there's quite a lot of work across the organisation to figure out how to do that because to date we've got the Guardians which is us that's our investment management company and then we've got the fund and the Guardians had one mandate and one purpose and that was fantastic we've now got an additional mandate which we've been given because government regards us as competent investors. So they've said, right, you can do this as well.

53:24So now we're going to run these two mandates. The new mandate's small comparatively. It's only going to be about$300 million compared to$42 million. So you've got a lot of disparity, but actually it's going to take quite a bit of work to set that up. That's a big one is getting that going. We've got within the investment teams and then more broadly within the support functions as well, We started last year a bit of work focused on our long-term target state. And that's because, go back to December, December 17, the government restarted the contributions. And the restart of the contributions means we're going to grow faster.

54:00So we'll get a couple of billion dollars a year. And touch wood, we'll get some investment returns on top of that. And so we'll grow quite a lot faster. So fast forward six, seven years, we could be$80 billion. so then we've got a question which is okay what does that mean for our active investment strategies at the moment what does it mean for the likes of portfolio completion can we scale these things because not all these things scale well direct investment is a challenge to scale some things are strategic tilting is easy to scale but some things aren't and so we've been working a lot on that and that's that's leading to a discussion with the board which is around investing in our strengths?

54:35Where do we want to add resources in the next two to three years, which will support that growth in assets under management and allow us to continue to generate the active returns that we've enjoyed in the past? And then, of course, with that growth comes the impact on the support functions, on operations, on IT, on finance and all of that. So there's a conversation going on around that at the moment. The other bit of work that we've been doing that we've been active on for a long time is around culture but more recently since I took over we've run a values project to I guess be clearer about what our values are as an investment organization which was quite a neat project where we got we just gathered stories we said to everyone give us a story about a time when you've been proud to work for the organization or you haven't been proud to work for the organization or you've you've had some difficult decision to make and how you've done that we got this really great set of stories 120 120 stories out of 130 people 100 something like that and we were then able to go through that and pull out the themes from those which which revealed the value so you're not going to someone saying oh what are you value you're going to someone say tell us a story and those stories are really powerful and we got great engagement with it and came up with a new set of values for the organization because ultimately we rely on being able to attract really good people into New Zealand, which is a long way away from the big global financial markets.

56:00And we've got to provide a really good proposition for people to come here. And so that culture is fundamental and is an ongoing part of what I'm looking to do. What are those values? The values are we stand strong. And that goes a little bit to the way we use frameworks, the basis of our approach, our long horizon, our ability to withstand the swings of markets. Our decisions are principle-based. We support each other, which is just a humanistic value. We're future-focused, which is really focusing on the long run and, again, the swings and roundabouts of markets. And Team Not Hero is the final one.

56:40So that our focus is on the broader team and Not Heroes. And actually what we've done is we've created a set of cartoons that go with those because those cartoons are evocative And so also what those cartoons do is provide a little bit of constructive ambiguity because these things mean slightly different things to different people, but ultimately are really important to how we all operate. So that was quite a neat part of the continued development of our culture that we went through last year. Yeah, well, let's turn to some closing questions. What's your favorite hobby or activity outside of work and family?

57:14Snowboarding. The deeper the better. Yeah, definitely snowboarding. when you get some deep snow and i have done a little bit in the last few years of heli skiing so in alaska when you get left at the top of a ridge and the helicopter goes away and it's all silent and you've got this completely untouched pitch in front of you it's just fantastic it really is marvelous what's your biggest pet peeve this is funny i was talking to my wife about this and she pointed out that my biggest one is the absence of the keys from where they ought to be. So the keys not being in a consistent place when you go looking for them.

57:56Yeah. How about your biggest investment pet peeve? I think it probably comes down to when you're receiving pitches, people have what I think of as kind of imaginitis around the lack of volatility of private market assets. So you get this bit, which is, oh, these things aren't volatile. It's like, okay, well, why is that? Well, the best evocation of that I've seen is, if you imagine a bat flying and the bat is quite jerky and it's flying all over the place, then it flies into a pipe and then it flies out of the other end of the pipe and what these people who think about this volatility of illiquid assets would have is that the bat is actually flowing in a straight line from one end to the other because that's where they've measured it at the start.

58:38I think you'll really find out how volatile those things are when you're going to try to sell them in a difficult market. And that's probably my biggest one. What reading do you almost never miss? I am always smarter for having read something from Cliff Asnes. And I think he, especially he's been, over the last year or so, his value has had a hard time. In fact, he's had a difficult time. And he's written some really good stuff that has been quite pithy. That's quite useful for dealing with the board, I find. some good ones which are around how do you assess strategies which aren't performing well?

59:16What's the process you go through? What are you trying to achieve? You're trying to achieve resilience. You're not trying to achieve some level of sort of disinterest. And how do you do that? What teaching from your parents has most stayed with you? Destroy the evidence. If you're going to take the last biscuit in the packet, get rid of the packet. and then no one will know that the packet was over there. So that was just be careful. Last one, what life lesson have you learned that you wish you knew a lot earlier in life? The first year of work after you get out of uni is really not that important for where you end up.

59:53So don't feel that you've got to rush into, you know, whatever is the first job that you managed to get. Go and spend some time overseas and get some life experience. And I would strongly recommend that to my kids and anyone else to just get out there and live a little because you'll find 10 or 20 years down the track that actually whether you've done that or not doesn't make any difference and in fact might enhance where you've ended up because you've learned a bit more about yourself. Terrific. Well, Matt, thanks so much for taking the time. Really appreciate it. No worries, Ted. Thanks for listening to this episode.

1:00:28I hope you found a nugget or two to take away and apply in your investing and your life. If you'd like what you heard, please tell a friend and maybe even write a review on iTunes. You'll help others discover the show and I thank you for it. Have a good one and see you next time.