Audio Interview (MTAA super)

Interview Transcript '” Michael Delaney, Principal Executive Officer, MTAA Super and Mike Pascoe
Michael Delaney (MD): Well I don’t know that it’s scary. It’s welcome and having achieved it and looking back over time you wonder if you can keep doing it but we take the view that one might be luck, two might be synchronicity and 5 can’t be either. It’s the product of a thoughtful approach.

Michael Pascoe (MP): What is the approach. What wins?

MD: Well in our case we have two portfolios. We have a market portfolio obviously which is subject to all the vagaries of markets. You can do terrifically, you can do poorly. We don’t think on that first portfolio there’s much success in being no better or worse than anyone else, so we were never very attracted to just being there in the market. We figured that for our employer and employee members they could get that from anyone. What they needed was something different. We thus have a second portfolio which we call our target return portfolio and essentially into that we put things that are not subject to cyclicality of markets and which are highly uncorrelated to market assets. That involves us being pretty deaf and responsive to offerings that come into the market and to buy things that are of a generational investment life because we’re essentially performing for the next generation of our employees and which carry with them known rates of return, measures of protection against inflation, and which have about them the capacity to grow at GDP or CPI at least, and to mix and match them in such a way that they in turn are very uncorrelated and the spread and breadth of such investments are so wide that essentially they’re representing a sort of self insuring asset group as against market assets.

MP: So specifically what are you talking about?

MD: Well we own the building that appears behind you. The R. G. Casey Building which is the headquarters of the Department of Prime Minister and'¦.. sorry, Foreign Affairs and Trade and we own the Australian Geological Survey Organisation. What’s distinctive about both those, is very long leases from the Commonwealth which of course is a triple A rated tenant which is very welcome but we also own Flinders Ports or at least a very large part thereof. We owned a large part of the airport motorway. The [SN] distributor in Sydney. We’ve got substantial shares in Sydney Brisbane and Adelaide airports. We own a large part of the under construction Lane Cove tunnel so there has been some bias to infrastructure in there and we were very early acquirers. We made a judgement about those assets early in the piece but that’s not all there is. We’ve got Timberland. We’ve got a range of one off things. We own the Mildura Base Hospital on a 20 year contract between Ramsay Health Care and the Victorian Government and much much more. There’s about 43 different assets in that target return portfolio that are sort of unlike each other. There are subgroups within it such as when I mentioned infrastructure and the like.

MP: Is that getting harder? Is there more competition in that space.

MD: It is getting harder. The hurdle rates of return that one might set are being heavily squeezed. The flood of money into the market, the investment market at large in Australia on account of superannuation is now at very great proportions and many of our competitors both master trusts and retail trusts and indeed industry super funds are seeing this asset class and so the liquidity that is available is compressing margins but that’s OK because the margins can still be far better than the market margins at large. In general terms this seems to be a view that the equity risk premiums are coming down as you’ve reported on and we reflect that, so I suppose while it’s getting harder we’d say it’s not impossible and if you stand in the market and you’re known to be thoughtful and quickly responsive without sacrificing any due diligence endeavours the things tend to come to you. At the same time the private equity space is opening up in greater and greater respects largely because the yields that the owners of a lot of that private equity can get in the current market. It’s very good that sort of seeing things being brought into the world perhaps for the first time in generations that have not otherwise been there.

MP: Again, specifically, what sort of examples.

MD: Oh well. I can’t name the particular asset but one has come onto the market in Manhattan. It’s been privately held for 55 years with extraordinary results and we look like we should be able to secure a large part of that. There is also another counterpoint to it becoming harder and that is many of the world’s Governments are realising that they really don’t need to hold assets that they’ve built for a long time and they’re privatising them and they’re tending to do it long after perhaps Britain firstly and Australia secondly did it. I would argue though that Australia was actually leading the way in this sort of change in asset holding, so we’ve got things like a large share in Macquarie UK Broadcasting which was the sloughing off if you like of the national transmission towers of the BBC and these are important businesses. We’ve'¦ in a joint activity with Macquarie Bank we’ve just bought the Port of Gdansk in Poland. There’s a couple of other funds in there. And this is an existing port that will undergo half a billion euros worth of expansion and interestingly that’s the most eastern ice free port in winter in Europe so it’s really quite.. well it is highly prospective. So it’s things of that sort. So to finally answer your question, it is getting harder in the sense that there’s more competition abroad but it’s not intrinsically harder because there is much more supply coming in to meet the demand.

MP: And that class of investment, that sort of investment outperforms the stock market?

MD: Not always, no.

MP: But over time you expect it to.

MD: You do, and indeed we’ve been actively in this space for about 10 years now and we can therefore sort of back test with quite high levels of accuracy. Our long term target in generational terms is to see if we can’t return 6 to 8 net percent over sort of the 10 year portion of the 30 year cycle. We’ve exceeded that greatly and what we are essentially doing is saying well the mix is 57% market, 43 target and that’s derived from arithmetical models and we expect that the target return portfolio over the long run will be double in its return. The market portfolio. And if it follows from that on what I’ve said that we expect the market might do 6 nominal and target might do 12 nominal and you put together in that mix proportionality and it gives you your 6 to 8 over time. So that’s the essential design feature.

MP: What about hedge funds. Absolute return funds.

MD: No thank you. My directors wont have a bar of them. We take the view that.. and I can’t claim to be an expert in any of these things and certainly not in hedge funds but we take the view that the opacity and the secrecy and the apparent absence, as well reported, of anything like ethical standards amongst a lot of them, just disposes us absolutely to stay out of it. It’s not our money, it’s the member’s money and we’re not here to take risks like that.

MP: Fixed interest share of your portfolio?

MD: Quite small. The reason for that is that in a normal efficient frontier portfolio model and in a balanced portfolio you’d have that much for fixed interest so it’s essentially dictated by again the arithmetic. We find with our target return portfolio we don’t need to hold quite the same number in fixed interest because there’s actually in our construct a lower level of risk by holding less fixed interest because of other consequences of the [desired] than there is holding fixed interest.

MP: Can I just take a little detour. You’re a big investor in eastern distributor and other toll roads but not the cross city tunnel in Sydney. Why is that.

MD: We didn’t think that the projections were correct on demand. This is all a bit new. If we take the Hills motorway as the first example of trying to estimate what demand and usage will be, we I think were probably a bit sceptical and ignorant about what that would be. Since then the science and the analysis of the ramp up process which is obviously the opening through to the 100 percent capacity number say, has become much more reliable and knowable and indeed if one uses the right modelling, reasonably certain but for all of the other factors like at what price do you set the toll and what’s the character of the concession in terms of what you need to earn and so on, so no, we stayed out of that one. We’re not deterred by the experience of the Sydney cross city tunnel, it’s just a case of each one has to be analysed independently of any other as to its fundamentals.

MP: And to develop that expertise to do that for a super fund, how hard is that to do?

MD: Well I should quickly say we have some of that expertise internally but we contract in most of it. It’s a matter of happy record that we work very closely with Access Economics which has built a business in advising us and now some other funds and I think it’s fair to say that both by disposition and background I’m inclined to and our board certainly is and supports this, using the sort of quantitative science that I learnt in Government, I have a Government background, and which the principals of Access have as well, which is not to say that we’re unallied to markets or the like but I suspect we spend quite a bit more than many of our counterparts on the highest level of actuarial and econometric work. Part of our process is we don’t just buy assets into the target [return] portfolio and leave them, acquire and forget. Not at all. We take a very active role so we typically wouldn’t acquire something without getting a board seat. We certainly build an acquisition model for everything we acquire, an economic model, business model and we obviously keep that economic and business model absolutely contemporary and a matter of reference point to what’s going on in the business and as an assessment benchmark against the business. I think some of our investees would say we add quite a lot of value to the businesses in that way and that carries with it a fairly significant overhead in the way of cost and a quite significant intellectual task for our board and our directors but they are well on top of it, seem to enjoy it and it seems to work for us.

MP: And you’re doing that as a not for profit. As an industry fund. As a mutual.

MD: Yeah. Well we are a for member profit only fund, not a not for profit, but as I say there’s a measure of self interest in there. The principal sponsor of the MTAA super is the Motor Traders Association of Australia. Now we’ve got 80,000 outlets, $88 billion of turnover, 250,000 employees and we represent just under 16 percent of household expenditure. 95% of the businesses are 5 or less people. They’re utterly atomised. We got into this business to essentially make sure our employers were compliant with the law but we were also keen to build a construct of non wage benefits for our employees because it helps to keep them in the way of an integrated offering so we’re an active member of the industry fund’s affiliations so we don’t just offer the super and the performance but home loans and business loans so the apprentices can buy the businesses from our present members and become members as employers. Very good credit card as you know, very good bank. We’ve got extremely high levels of insurance for our blue collar workers which is a bit hard to buy at very low cost so we essentially find that the employees and the employers think this is terrific and desirable service.

MP: To what extent [of pay] you were captive of the deal makers. For your target fund.

MD: No, I think it’s the other way around. I noticed Don Argus in Fin Review this week saying that he wasn’t concerned about the recent downturn in the market because there was some fundamentals in the Australian economy that were quite different to the rest of the world and one in particular was the 9% mandated saving scheme and that he felt in our market that that was a very important element. That’s a view with which I agree so that’s just below background to my.. to this comment that the liquidity in the market, the amount of money chasing the investments and indeed the growth in wealth over the last 15 years is such that sure, there’s a lot of people competing for a lot of deals but as against that, the velocity of the deals has, depending upon you use velocity either gone up substantially or gone down. I choose to say the speed at which the deals has to happen is now so much faster than it’s been in our experience which means that the transactions times have gotten shorter and shorter. For the deal makers that puts them in a bit of a bind. I mean, they have to be able to find parties that can sign on quickly and commit because they’re all going to address their capital [ ] [road shows] and their balance sheets and so on, so they need really solid pre-commits. We don’t operate in the market for that target return portfolio in any way at retail. We simply won’t. We used to operate at wholesale which is to say we’d like to be a foundation party with the deal makers but we don’t do that much anymore. We now want to be in manufacture and we have some very good deal makers that we work with who we’ve worked with for a long time and who we trust and they trust us and so what tends to happen is they’ll have an [icio] come and say look we’re thinking of having a look at this, what do you reckon. Would it fit within your policy, might you be attracted to it and so on. And our answer is derived from looking at where it would fit in this wide spectrum of different assets in the target return portfolio which is to say if it’s one we’ve not been in and if it’s market and duration and inflation protection and lack of correlation to the others is there, we’ll say terrific. It is something in policy terms we’d like to explore. Now the other feature of that is that if you’re in there with manufacture you are able to become a party to building the business case investment model. So the deals are there. We were offered yesterday about 4 really really highly prospective things that may or may not have come off. I suppose I should offer that that does carry with it a pretty significant overhead which of course sits within the MER so you have to be alive to it. But in the scheme of things I suppose you could propose it’s a fixed overhead. The trick is really to make sure that as a fixed overhead what you’re spending it on has a very high conversion ratio from prospect to actuality. They don’t always work out. I mean we don’t take risks such as merchant bankers take. I mean we can’t. We’re not in business in fact, we’re a trustee and we’re very conscious that we’ve got to keep our volatility number low. Our standard deviation and for a portfolio like ours you would probably think that it might be 10 or 12 percent or something like that. Well in fact it’s not. It’s half that, and it’s half that because of this absence of correlation and the arithmetical effect of the two portfolios working alongside.

MP: At some stage does your team think, if we’re doing this other own brand, call ourselves MacBank or something, we could be charging several percentage points fees taking home millions of dollars a year in our back pockets. Why are we doing this. Like a bunch of socialists.

MD: No, the team doesn’t think in that way. The team absolutely believes in what it’s doing, and not because it’s a bunch of socialists, far from it. Everything is capitalistic about the motor trades. I just don’t think that there’s any thirst for that. One of the nice things about our team I suppose is the fact that they never planned to do this. It sort of emerged and we all grew with it over time. They’re hugely energised by the idea of doing something that’s morally good and actually practically good. They like doing it. On the other side of the ledger they’re probably people with a thoughtful bent who don’t have about them a wish to be entrepreneurial out there in the way your average risk taking merchant banker has to be. We pay them pretty well but I don’t think they’re wildly excited about wealth. Look it’s a pretty neat model. It’s enjoyable. And it’s got a by design, indefeasible advantage. We have no capital on which we’ve got to get a return. We never will have which is the beauty of mutuality and it means that you know, you get a head start on a for profit operation. That’s the way it is. It also means that we can keep our operation very small and unbureaucratic and quick and responsive and enjoy on account of that the intellectual excitement of saying what else is out there and whether it can be acquired.

MP: Do you ever look over the other side of the fence and say why are these guys being paid so much?

MD: Yep. A lot. Don’t you? We’re not just doing this in intellectual isolation. It’s actually got a deep history. I have to say we weren’t aware of it at the time. We now are and that we’re not on our own with this model. That book on the table there by David Svenson the chief investment officer of the Yale Foundation in the US describes their model and operation and it’s the same. Same as what we’re doing. In fact I haven’t seen it reported but if you look at our model and as I say, it wasn’t derived from this and compare it with the half a dozen great University foundations in the US, it’s exactly the same. If you look at Harvard for example, Harvard’s returned 15% for the last 15 years and over 20 years it’s returned about 12, 12½ and essentially they’re doing the same thing. And rather after the model of Warren Buffet’s annual essay and sermon, each of the chief officers of those great foundations does the same thing. I’d say there’s lots of essays out there saying this is what we believe in and what we don’t believe in and this is the science we employ and that’s why we do it and this is what it produces. And so we’re pretty pleased that it was belated learning. We did come to learn that we hadn’t invented this in isolation. That it actually had its counterparts in similar thoughts occurring at the same time. We started 10 years ago. Harvard I think started on his version of this so it would be 18 years ago now. Yeah.

MP: Does your construct inevitably mean a lot more investment off shore now?

MD: It does. That’s unavoidable. You’d be aware that there’s much debate about where the equity risk premium is properly set these days. I leave that to the economic scientists. I’m [ ] the answer on that but yes, the liquidity is such that you really do have to look offshore plus you have to just consider you know the tightness in the Australia market. On one view there’s an infrastructure crisis. On another there isn’t. If there is an infrastructure crisis well it could be really solved by super funds investing in it, so it doesn’t seem to be a lack of capital. It seems more to be the character of regulation and in the face of that, well in infrastructure for example, yeah you do look offshore because of lots of interesting stuff coming through. In our case we increased funds under management by 37% last year. And that’s a big lick of dough to be getting away. The one unhappy business of being in this business is there’s nowhere to hide. You can’t stand still. You’ve just got to move that money and that's your unavoidable duty so we are overseas now and looking fairly widely. We’ve got some policy constraint settings. We wouldn’t go into any non OECD country. We wouldn’t go into any country that didn’t score above the necessary percentile on the UN rankings on sanctity of contract and a functioning court system and redress and the like. So that confines you to the developed world, but it does mean you can be in Korea and now Poland where there are significant opportunities. It carries with it though quite some other risks. You’ve always got the currency risk and we think we’ve got a pretty sensible currency hedge policy setting. We don’t hedge everything and we have a quite sophisticated mix of currencies reflective of relations between currencies and the character and disposition of the assets and the currency they’re denominated in so that’s one risk. We haven't got overseas property yet because that just looks to be very hard and we are looking but very hard. Certainly we’ve got infrastructure and we’re looking for more of that. And there’s quite a bit of private equity coming through. Sort of very mature established businesses with still really good potential that seem to be being liberated by globalism and the very low yields at which things are selling.

MP: How do you tap into that. How do you get a knock at the door of that sort of international private equity [ ].

MD: Well look, this will sound chauvinist or xenophobic. Not xenophobic, chauvinist, indeed, well nationalistic. I reckon the Australian merchant banks led by Macquarie initially but now also by Babcock and Brown and Allco and the others, I think they’ve just built the worlds best model in a lot of this. What Allan Moss and all those people have done is remarkable and I think the last figure I saw was Allan said he has 6,000 people overseas. They’re scouring the world constantly for opportunities and they’re bringing them back to home base and they’re looking for foundation investors. Our model [on/and] Macquarie say for example fit together very well. I mean, they lock and key [for sale] approach. We don’t take as given or even correct what Macquarie thinks about these things, we test them ourselves. So that’s how we do it and that’s where it comes from. We’re invested in Babcock & Brown. We’re invested in Macquarie. We’ve got some of the biggest private equity managers in the world wanting us to enter into collaborations and they’re very aware of our policy settings and the way we think. So that’s where it comes from. We clearly don’t have the resources or even the time to be out there trying to source it ourselves and the [ ] say that it’s important that it be remembered that under the superannuation statutes, we can’t be in business, we’re not a business and we can’t be in business. All we can do is be a trustee that outsources questions of that sort to reliable parties. We can’t delegate our responsibility away but as I say, we’re not in business. So we wouldn’t want to do that anyway. We sort of essentially have to be that agent or agency contemplated first by the development of trust law. And it’s hundreds of years old. So we’ve got to put our faith in a lot of the managers. And then constantly measure and.. or test and measure their performance.

MP: You don’t have to pay their big fees though. You’re getting in at a very early stage with them. Do some of their fees at the other end, at the retail level, concern you?

MD: Well I don’t want to bag them and I don’t know what their overheads are but privately I get a bit astonished at what some of the retail asks are. Look fees is interesting. I mean, we’ve got some products that I can’t go into, we [in a] pay [fees]. And basically if the outperformance is there as contracted for, then we will. It will be a performance fee but there’s no flagfall. And on the other side of it. The deal manufacture, well there’s no fee there. There’s our own significant overheads. We reckon that we have secured very great alignment between their interests and our interests but pity the poor punters who sign on for what’s left over at some of the margins that are in there. I’m not sure they really know what they’re doing a lot of them. So.. but we don’t pay anything like that. I mean, ours is at market or lower for that level of early start in the hierarchy with the rest of it all in outperformance and we don’t care if everyone gets rich together.

ENDS