Prevailing macro and geopolitical events, and challenging market conditions, have drawn into sharp focus the pressure on superannuation funds to simultaneously manage the short-term and long-term investment goals of their members.

Superannuation funds must balance the need to meet shorter-term performance goals, while also managing the responsibility of setting strategic asset allocations over the long term. For most funds this means investing on behalf of members with 20, 30, 40-year investment horizons – which makes the Net Zero by 2030 goals seem quite short-term in comparison. This creates an imperative for funds to build portfolios that are resilient and diversified enough to:

  • attract and retain members in the highly competitive Your Future, Your Super environment, and
  • meet their members’ goals of a comfortable retirement and financial freedom.

To help meet members’ needs, funds need to continue growing to achieve the efficiencies that greater scale brings, to reduce costs and ultimately increase members’ total returns and remain competitive. To this end many funds are pursuing multi-faceted growth strategies which include a focus on continued organic growth bolstered by mergers and acquisitions which bring big jumps in size, but also add considerable time to the process of combining sometimes quite different organisations.

Super funds rethink allocations

Considering world events such as the ongoing war in Ukraine, a slowing global economy and central banks fighting inflation by tightening monetary policy, it is not surprising that super funds are rethinking and resetting their asset allocations.

Your Future, Your Super legislation has led to funds paying closer attention to benchmarks. They rely on benchmarks and tracking error risk to guide their investment choices, balancing the aspects of their portfolios that closely track benchmarks while selectively seeking opportunities to deliver outperformance through active management or more esoteric asset classes.

In the case of equities exposures, short-term rallies have seen some super funds make opportunistic plays to improve performance, however they are more focused on longer-term factors such as inflation, which may require a more defensive approach.

Given that market returns are likely to be subdued in the future, larger institutional funds are increasingly looking offshore for investment opportunities that provide greater diversification and the scope to invest larger pools of money. They are actively seeking skilful managers with diverse opinions that can help them mitigate risk and improve performance through a range of possible economic environments and investment outcomes.

Further, with high inflation, the expectation of lower returns and a long-term investment agenda, super funds are searching for diversified, repeatable returns as well as effective inflation hedges.

Active asset management comes to the fore

The near-term pressures of inflation and high interest rates are creating unpredictable and volatile investment conditions and uncertainty around the outlook for equity valuations.

Against this backdrop, there is a shift towards active asset managers, to help navigate these conditions, as demonstrated by the Future Fund’s recent comments that it has begun a new program of investing in actively managed small cap equities, as well as building more liquidity in to portfolios, to allow it greater flexibility to respond to changes as they occur.

While an active management approach makes sense to most super funds in this environment, the challenge is finding those investment managers who can demonstrate genuine skill in their investments.

Further, with high inflation, the expectation of lower returns and a long-term investment agenda, super funds are searching for diversified, repeatable returns as well as effective inflation hedges.

We believe active management is the most effective way for super funds to capitalise on market opportunities and deliver long term returns that meet their members’ needs in retirement. While passive investments play a role in providing economical exposure to some asset classes, active management is far more flexible. It allows asset managers to respond quickly to market changes and actively seek out the best opportunities to deliver long term value to members.

This is highlighted in asset classes such as emerging market equities and global small-mid cap (SMID) strategies. While passive investments in these kinds of assets are possible, they can be better suited to active managers due to the greater potential for skilled managers to outperform. Many of these less-well-known asset classes have very large numbers of securities to invest in, with a lack of sell-side research and significant barriers in place due to geography, language, time zone and access to company management. This often leads to greater inefficiencies in markets which skilled managers can take advantage of. For example there are around 8,000 companies in the MSCI ACWI SMID Cap Index, including more than 760 companies over A$10 billion. This creates a myriad of opportunity for investors to diversify beyond the materials and bank-heavy ASX index, while investing in companies of a similar size to Australian large caps.

While funds are focused on delivering strong returns to members, they also want to contribute positively to the environment in which their members live, work and will retire.

ESG integration is in progress

Super funds are at different stages of incorporating environmental, social and governance (ESG) investments into their portfolios, depending on how far along the pathway to Net Zero they are. For the most part, funds are taking a holistic view of ESG and are actively looking for cost-efficient investments to help them meet their Net Zero targets.

While funds are focused on delivering strong returns to members, they also want to contribute positively to the environment in which their members live, work and will retire.

In practice this means that the range and scope of ESG investments which institutional investors are considering is evolving, with larger super funds deploying capital toward more specific impacts. This can mean very specific criteria in investment mandates as funds strive to make a difference in particular geographic locations on issues including biodiversity, land neutrality and social housing – of course while also achieving a particular return target. It can also involve looking for partners to co-invest with in order to achieve greater impact, whether this is active managers, private wealth or philanthropic funds.

Super funds are keenly aware of ASIC’s focus on greenwashing and are seeking authentic, measurable ESG strategies with good governance to incorporate into their portfolios. While greenwashing is a relatively recent term, misleading and deceptive conduct isn’t, and nor is the need to report to ASIC on ESG requirements. Super funds are engaging with their members to seek their views on climate issues to ensure their decisions best meet the needs of a diverse group of people. They also recognise that, as company owners, it is up to them to challenge companies to be the best versions of themselves they can be.

Governance is a key point of difference that is emerging in ESG investing as funds recognise its importance at the apex of the ESG triangle, as well as the economic value ownership rights can deliver through driving better business performance and so better investment returns.

The way forward

Geopolitical, macro and competitive forces are shaping the investment universe for super funds and while it is difficult to predict what will happen, preparing investment portfolios for a range of possible outcomes is a must.

Being defensive and simply reacting to market volatility will not be enough. Resilient investment portfolios consider market conditions but are diversified and nimble enough to respond to change and manage short-term shocks while continuing to navigate long-term trends and progress towards long-term goals.

The result is an approach that protects the long-term financial well-being of members by optimising risk-adjusted returns across market and generational cycles.