Conversations with Institutional Investors

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  140: Frontier Advisors' Charles Wu and Elie Saikaly – Launching an ICIO Business 02.08.2026 35min

  In episode 140 of the [i3] Podcast, Conversations with Institutional Investors, we speak with Charles Wu, Director of Investment, and Elie Saikaly, Head of Liability-driven and Government Investors at Frontier Advisors about the recently launched Independent CIO service, not to be confused with outsourced CIO services. We delve into the background of establishing the new service, the backing by State Super, the potential market size and why this services is needed now. Enjoy the show! __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights  __________ Frontier Advisors: ICIO Podcast – Overview [00:15] Introduction – Wouter Klijn frames the episode around Independent CIO (ICIO) services vs. outsourced CIO (OCIO), with guests Charles Wu (Director of Investment, Frontier Advisors, formerly State Super) and Elie Saikaly (Head of Liability-driven and Government Investors, Frontier Advisors). [02:00–06:37] Origins of the deal – Charles explains that State Super's investment team joined Frontier in a "win-win-win" arrangement: State Super de-risks by handing over portfolio management while retaining continuity; Frontier gains institutional-grade implementation capability and people. He details why State Super's situation is complex – a 100+ year-old scheme in decumulation, with average actuarial cash outflows around 7 per cent annually, creating major liquidity forecasting demands. [06:45–10:34] Frontier's motivation and custody issues – Elie discusses Frontier's 31-year history adapting to client needs, and why smaller asset owners struggle with key-person risk, operational risk, and custody access (partly due to the closure of NAB Custody Services), creating an opening for Frontier's expanded service. [10:34–13:35] Defining ICIO vs OCIO – Charlie distinguishes ICIO by its independence and non-conflicted, tailored approach (no predefined product suite), contrasted with more standardized outsourced models. Governance benefits like stock lending and balance sheet management are passed to clients. [13:35–16:43] Service integration and structure – Elie describes the combined offering (strategy through implementation) and lessons learned from merging Charlie's tactical asset allocation process with Frontier's advisory teams. They discuss the managed discretionary account structure and the governance partnership with Ironbark, including an investment management committee. [17:19–20:09] Target market – Referencing KPMG research showing a fragmented market (no player over ~10 per cent share), Elie outlines target clients: insurers, universities, charities, endowments, small-to-medium super funds, and family offices – emphasizing deeper transparency on reporting and costs as a differentiator. [20:09–22:45] Japan expansion – Charlie discusses a recent trip to Japan, Frontier's local office (established ~4 years ago) and partnership with Mitsubishi UFJ Asset Management and interest in partnership models rather than full portfolio outsourcing. Expansion plans remain APAC-focused rather than global. [22:45–24:35] Current status – State Super is confirmed as the first client, with regulatory steps nearly complete and significant inbound interest from prospects citing key-person risk, operational risk, and performance/custody concerns. [24:35–27:26] Scope of services – Charlie explains services extend beyond portfolio construction to strategic guidance (e.g., specialist help building hedge fund or real estate platforms), tailored case-by-case to each client's governance maturity. [27:26–28:11] AI capabilities – Charlie confirms new clients can request an AI roadmap/governance framework, drawing on State Super's earlier AI work. [28:11–29:23] Sydney office – Charlie discusses the new Sydney office (with room to grow) supporting Sydney-based clients, plus light banter about Melbourne/Sydney rivalry. [29:23–31:17] Next steps – Elie outlines finalizing regulatory approval, change management efforts (a December immersion day, training sessions, governance/risk work groups) ahead of official launch. [31:17–33:25] Insurance sector potential – Elie notes insurers are a strong candidate client base, particularly those without the resources or desire to fully in-source investment management risk. [33:25–35:00] Addressing suboptimal portfolios – Charlie acknowledges it's a widespread issue that off-the-shelf products don't suit varying risk appetites, and notes Frontier is investing in internal technology to balance scalability with tailored service. Full Transcript of Episode 140: Wouter Klijn  00:15 Welcome to the [i3] Podcast. Today, we're going to talk about Independent CIO services as opposed to the outsourced CIO services, and we'll go into this distinction later. But I'm here today with Charlie Wu, who is the Director of Investment for Frontier Advisors. So Charlie leads the former State Super investment team that joined Frontier Advisors at the end of last year, and established the ICIO office. We also have Elie Saikaly, who is Head of Liability-driven and Government Investors at Frontier Advisors. Charlie, Elie, welcome to the show.  Charles Wu  01:57 Happy to be here.  Elie Saikaly  01:58 Great to be here.  Wouter Klijn  02:00 Excellent. So, Charlie, maybe we start with you. From what I understand, the conversation about this started a few years ago, and and we're partly tied to sort of you know projections about the future of State Super. State Super is in runoff. Obviously, over time, this this will pose some issues. Can you walk us a little bit through why State Super was interested in this partnership?  Charles Wu  02:24 Yeah, sure. Well, maybe let me put that in a bit of the context. I think if you look at State Super, it is not unusual. State Super actually has a really long history of coming up with innovative structure. So all the way back in the 1980s 1990s we're talking about Stay Super being one of the in in house investors. The funds manager like DB Reeve and Axiom is all coming out from State Super. So this is, I guess, the most recent iterations of the the innovation that has been in STC's portfolios for a very long time. And just to again set that context correct, so the way to look at this is State Super effectively has exchanged the investment team and I to Frontier or an equity stake. Subsequently, hire Frontier to manage Stay Super's DC portfolio, and this is really a rare win-win-win situation. And what I mean by that is, in many ways, State Super wins by de-risking the portfolio management activity by appointing Frontier, and you get that continuity of services. Frontier wins because this acquisition brings on board an institutional grade implementation and operational capability, and the people for the people that's involved is actually really the core component that the discussion that we're talking about. We win because we get we now get to expose either in my term horizontally, like the breadth, such as like me being exposed to different client segments, or vertically going all the way from the formulation of investment strategy down to the implementation, and those are all group potential. So the outcome of this is, like you said, ICIO offers that provides a non-conflicted service offering. There's a strong synergy between the two different investment teams, which we're in the part of bringing them together and the growth potential for everybody.  Wouter Klijn  04:25 So, at the announcement of this transaction, I spoke with John Livanas, the CEO of State Super, and he told me a little bit about the importance of sort of retaining access to adequate resources from an investment perspective, and he partly related this back to the fact that State Super is in runoff, but it has quite a complex sort of structure in place that you know you can't just have like one or two guys looking after it and take care of it until it's completely run off. Why is that? What what's sort of the complication there?  Charles Wu  04:59 Yeah. So for most people that don't know, State Super, State Super is one of the oldest schemes in New South Wales state government. I think the inception. I still use the word "we" every now and then. Like you know, the inception for State Super is back in the early 1900s and so it's more than 100 years old. The scheme was closed in the later end of the 1990s, and so what that created is a very aged member demographics. It has a very complex scheme dynamic. We're talking about various conditions, including reverse due spouse and so on and so forth. But the key thing from an investment perspective is it created a portfolio that is the in decumulation mode, and I'm not just talking about you know one or 2 per cent that you that that's in line with the the state the spending policy of an endowment. We're talking about on average, it's a 7 per cent actuarial projected cash outflow every year, and depends on where you draw that line because, like I said, we have age member demographics, so depends on where you draw that line. That instantaneous liquidity shock can be quite high, and so it's not a simple. By no, I mean it's not a simple investment, but in this particular case, because it is unique, we have to pay a lot more attention in terms of ensuring that the liquidity there, like we we do forecasts not just the member in our flow, so to speak. We're also talking about how do we ensure that we have enough liquidity to pay the member benefit payments. We have sufficient liquidity to meet the investment drawdown, so on and so forth. And all of those isn't as straightforward.  Wouter Klijn  06:37 Yeah, yeah, for sure. So Elie, State Super obviously had some incentive to look at this deal. What's in it for Frontier?  Elie Saikaly  06:45 Yeah, great question, Wouter. So, Frontier and State Super have known each other for a very long time. There's a lot of comfort between the two organisations, so that's important to to bear in mind here. Also, as our clients have evolved, our services have evolved with them, and in Frontier's 30-one year history, we'd like to think we've adapted to the changing needs of that client base. And as you'll also know, our clients range from large, complex super funds all the way through to much smaller asset owners such as charities and foundations. And over the course of that journey, Frontier has wanted to be alongside those asset owners who are looking for services outside of just advice, and in an environment where it is becoming more challenging to invest portfolios, and the burden of investing those portfolios from a compliance and regulatory point of view is ever increasing. Frontier understands better than most that those those demands on those organisations is is becoming a challenge for them, and that if Frontier can step in and provide additional services over and above advice, then we remain a very relevant partner for those organisations, and I'll give you some examples which are relevant to us today, and also based on market feedback, we we understand that key person risk is a challenge for a number of smaller asset owners that are struggling with retaining an investment team. That is particularly relevant outside of the large capital cities like Melbourne and Sydney.  Wouter Klijn  08:25 Yeah,  Elie Saikaly  08:26 the operational risk burden is also one that is challenging for organisations, and that sits alongside the custody challenge, where smaller asset owners are struggling to retain custody, and we observe these trends in the industry. And Frontier wants to be a consultant that sits alongside our clients and helps them solve those challenges. Yeah. So all in all, there's a there's a range of events that have taken place in the industry in Australia, where Frontier feels like it can provide a solution, and bringing the best of what we do today in the advice space, and what Charlie and his team does today in the portfolio management implementation space, gives us an interesting proposition for the industry.  Wouter Klijn  09:20 So you briefly mentioned there custody as well, and from what I understand is that it was important to get support from a large custodian to sort of get this deal offline. Why is that so important? Do they just not want to deal with the smaller clients anymore?  Elie Saikaly  09:36 The challenge that that we observe, Wouter, is that smaller asset owners, and particularly outside the superannuation space, don't offer those larger global custodians scale, and also are going to struggle offering those services at a reasonable price, given the sizes of those portfolios, and. This is not just an Australian phenomenon; it's one that's also happening globally, but one that really was seeded by the closure of NCS (NAB Custody Services) a number of years ago, and that had a cascading effect on the rest of the industry. And as some of the global firms are looking for much larger minimum sizes, it does leave a gap in the market for asset owners who want to retain an advisor on an independent basis, but also are struggling with the back end of their investment programs.  Wouter Klijn  10:34 We got a little bit ahead of ourselves, but you know, I opened up this podcast with the comment that independent CIO is not the same as outsourced CIO services. Can you tell me a little bit about you know the difference and why it's important to make that distinction? Yeah, maybe Charlie, maybe you can give that a go. Do we need another acronym in the industry?  Charles Wu  10:55 We're always short of acronyms, right?  Wouter Klijn  10:56 Exactly.  Charles Wu  10:57 Yeah, like this. This topic is actually really interesting because before this, I'm probably quite oblivious in terms of the different operating model that they are to provide such a service, and we've just done a trip, really leveraging our connections to assess the different operating model across different outsourced CIO service provider. So let me touch on that, and then we'll come back to the ICIL, and it's not just a play on words. There are there really many different models that we're talking about, and they really range from your standardise everything for all the way to the other end of the spectrum that would be spoke everything. And this shouldn't be a surprise, but you really should look at all these operating model from the lens of organisational strength, the governance strength, the investment sophistication, and so on and so forth. And so this is how we look at that operating model and pick what is right for Frontier. Now to bring it back to what Frontier has decided to offer to our clients is the whole independence, and that's the I in the ICIL. We're not just talking about our source. We're not talking about you giving us the whole lots of the portfolio. We're talking about independent, unconflicted. We don't we we don't have a predefined product to put you into our product suite. We provide tailor-made solution flexibility and that tail to clients, and that's quite important. And Elie, by all means, jump in as you see fit. And this is important because as we see the increasing, I guess, requirements from regulatories and not regulatory, but client preferences such as responsible investment need. We see all those things are just if you provide a predefined product structure, it's just not going to be enough. And in addition to that, we're also talking about governance, governance and organisational strength. So we also bring on board the strength of so for example managing the balance sheet, stake lending. We do believe that those benefits are the one that we should pass on to the clients and not retain within us. And so that again is where the term independent independence come in.  Elie Saikaly  13:12 Yeah, yeah, that's right. And in addition to that, it's clear from the clients that we talk to and other asset owners in the industry that the the independence angle is critical for them, and in some cases, they feel they don't have a choice in the in the offering that's out there in the market today. And Frontier is determined to remain the leading independent advisor.  Wouter Klijn  13:35 So, can you tell me a little bit, Elie, about where they sit within the existing services? Because I remember I spoke to Andrew Paulson a while ago and he said we used to have like 60 odd deals that we were looking at and we couldn't really implement it because that was not really part of our service offering and now with this ICIO office we should be able to do that.  Elie Saikaly  13:57 Yeah, absolutely. The reality here is that the team that comes across to Frontier is complementary to what we do today, and so that allows us to provide the full set of services within an investment program that asset owners may require, and that starts with policy and investment strategy advice all the way through to portfolio construction, it might be DAA or TAA manager selection, and then operational efficiency and excellence to really drive better outcomes for those portfolios. So even the coming together of two teams has taught us a lot.  Wouter Klijn  14:40 Can you give an example of one of those lessons?  Elie Saikaly  14:43 Yeah, absolutely. So, for example, Charlie's team runs a process around asset allocation that might be more tactical than what some of our clients might be used to, and that informs us. The consulting teams of the opportunities that potentially lie in front of us in terms of providing advice from a strategic perspective, a dynamic perspective, and also a more tactical perspective. So there's a lot of work that's commenced and also continues to determine how best we can bring all these capabilities together, and most importantly, what are the needs of asset owners going forward? What would they expect from an organisation like Frontier, and what adds true value at the end of the day? And that's that's really important to us, and that's a process we're still going through as we speak,  Wouter Klijn  15:41 yeah, and I think as part of the setup, you have explored sort of the model of the managed discretionary account structure. I believe there's a partnership with Ironbark as a management around that. Why have you chosen that structure?  Elie Saikaly  15:54 Well, that structure, Wouter, gives us the flexibility to tailor portfolios for clients. It gives us the framework and infrastructure to implement the advice that we provide those clients, and working with a partner like Ironbart gives us great breadth. It gives us again complementary skill sets, but in essence oversees the delivery of the service and aims to ensure that what clients receive from us and the outcomes clients expect is exactly what they they have signed up for. And I embark so far have been a great partner, and they've supported our our ICIO capability so far. And we look forward to how that partnership grows in the future,  Charles Wu  16:43 And to this last point on the partners Ironbark being the partner, just to be very clear, like you know, take a more tangible example, like on the governance structures, we set up this investment management committee which oversees the portfolio activities, and Ironbark representative will be sitting on that committee to give that additional governance support, and they also holding us account very accountable to the investment due diligence and operational due diligence as we do something. And all of those should be taken as a strengthening of the governance requirement in order to provide this this service offering.  Wouter Klijn  17:19 Yeah. So let's talk a little bit about the potential market. I understand that Frontier has done some work with KPGM on on what potential the market is for independent CIO services. I think one of the learnings from that exercise was it's a very fragmented market. There's no single player with more than sort of 10 per cent of of that market, can you describe a little bit in who you see as the key sort of client for for this service? Is it family offices? Is it private wealth? Charities? Who are you targeting?  Elie Saikaly  17:56 As it stands today, the the market is fragmented. You are correct. There is also wide scope for opportunity, not just in Australia, but also in New Zealand, in the Pacific, and as we expand our reach into the region and utilise our presence in Japan, we would expect that those conversations will also take place outside of the domestic market, but in essence, the the clients who have shown the most interest in this service are those that are looking for an organisation like Frontier to manage their investment programme, and they could be insurers, they could be universities, charities, endowments, they could be small to medium super funds, all the way through to private wealth and family offices. The types of asset owners you would expect that would use a consultant's capability. However, the reality here is that given that those asset owners still need to retain responsibility for investment policy and strategy, that those asset owners that we would look to service and would be comfortable with a partner like Frontier taking care of manager selection, portfolio construction, rebalancing portfolios, helping them around activities such as proxy voting, building mandates to account for RI exclusions, for example, and that's the focus for us: is what are the activities and needs of those asset owners, regardless of who they are, and whether Frontier can provide the support that those asset owners expect. And one of the key points of difference for us here is that we are offering a much deeper level of transparency than the industry is used to, and that's very much around reporting. It's very much around costs, and it's very much around what's in the portfolio driving returns, driving risk to those assets. Have a reasonable amount, if if not a sufficient amount of comfort around the activities in those investment programmes.  Wouter Klijn  20:09 Charlie, I just mentioned Japan. I think you've been reasonably on a trip to Japan. Did you go there for the for these services, or did you go for investment research?  Charles Wu  20:20 Well, well, how did you know that?   Wouter Klijn  20:22 I'm well informed.  Charles Wu  20:25 I was definitely there to to see some prospects, and I guess Japan is one of those. If you speak to any funds management business person, they'll tell you that Japan is a market that will take easily four or five years to crack, and I think we so Frontier established established a Japan office about four years ago, and and we're definitely working closely with our strategic partner, Mitsubishi UFJ Asset Management. We're growing the revenue there steady and stable, and we're seeing a bit of the crack. And so this trip in many ways is to bring the ICIO capability to to the prospect to see if they're interested, and and and ICIO is one of those very interesting, I guess, service in the sense that we're not talking about just coming in to do the whole lots of the portfolio. Like after dealing with some of the prospects in Japan, we also find that sometimes they just want us to come in and manage a sleeve of the portfolio, and that's easily something that the team can do. So yeah, no, we're seeing opportunity there.  Wouter Klijn  21:33 So a sleeve of the portfolio is that sort of like the Texas Teachers' model, like the partnership model.  Charles Wu  21:38 It is a partnership model, and normally, as you can probably imagine, that in Japan, a lot some of the clients I can't say a lot of clients, some of the clients, some of the prospect, they like our research in the real asset segment, for example. And so the natural question there is, well, I can manage my own bonds and equities portfolios, but you have a lot more experience in real asset,  Wouter Klijn  22:01 so Japan is a natural second sort of market. Is it the intention to make this sort of a global service? Are you looking at other countries?  Charles Wu  22:11 At this stage? No, primarily is still in Japan, Japan and domestic domestically in Australia. Now I can say in due course that's probably more an APAC initiative rather than a global initiative. At the end of the day, there's a very very well developed US markets and very well developed European markets already. Yeah, this initiative was announced last year. I think there were some regulatory hoops to jump through before you sort of could open for business, how's it going? Do you have any clients?  Elie Saikaly  22:45 Absolutely, our first client is State Super New South Wales, and and so the focus the focus at the moment is completing the project and making sure we jump those hurdles, and that's imminent. And then it is about ensuring that those existing clients and prospective clients understand the offering. So we have had significant amount of inbound interest in this service, particularly around solving the challenges that I mentioned around key person risk, operational risk, performance reporting, custody. They are the the real drivers of concern for asset owners interested in a service like this, and we cannot underestimate the challenges around performance in today's market, particularly given the outcomes of active management, in particular asset classes, the desire for asset owners to look into private markets as well and access opportunities offshore. So there's some significant drivers ensuring that asset owners are revisiting their current arrangements, and that Frontier has benefited from those inbound queries. And we we would expect to be in a very good position to bring on additional clients in the imminent future, and that's going to have cascading effects on not only State Super but our whole business in terms of building scale, making sure that our clients benefit from that scale, but but also giving our staff different career paths, making our work more interesting, and also connecting us much closer to the end portfolio or the end client. And I think there's real value in that type of work. And we look forward to the next steps of of this service.  Wouter Klijn  24:35 And will the services focus predominantly on sort of the portfolio construction piece, asset allocation piece, or are you also looking at more strategic type of questions like, should an organisation do TPA, or maybe these organisations are too small for it, but it's a lively debate. Charlie, do you have any views on that?  Charles Wu  24:56 Yeah, yeah. I was thinking where TPA is going. Come up in this conversation. No, no. We can talk about TPA in a in a slightly separate context. But in this particular case, I think it has a lot more to do with what we can offer. And if you look at this in from a business perspective, we're talking about a slightly smaller asset owners and in a challenging environment, not just regulatory, but also the market dynamic that is going. So naturally, you cannot you can see that, for example, if an organisation that wants to establish hedge fund platforms, hedge fund portfolios, or real estate portfolio, the specialist services that need in order to build out that portfolio is quite meaningful, and not everybody has the the budget to develop their internal team, let alone talking about data modelling, so on and so forth. And so those are things where we stepped in in terms of helping them to develop their services. And for some, that is of different path maturity of the organisational maturity, we also we can also be there to help them to guide them through the setting of the policy. If if they want to grow the internal team, then we're there to help them to grow that internal team. They all those are all on the table for people to consider. And I think as as we kind of heading into a more complex environment, every organisation. every smaller SEO owner has the right to to get that type of services, and that's why we're here to to develop. In terms of more just portfolio construction, now I do think we we offer a lot more than just portfolio construction because at the end of the day, and from my perspective, while there is an end-to-end investment process, and we can range from let's call that the SAA down to put the dollars on on the on the road, so to speak, every organisational has a different organisational strength, has a very different governance setup, and some are better and well positioned to play all parts of them. Some are less so. So it's not as straightforward to say, "Yep, let's just go do a TPA or go do a SAI or let's focus on manager selections. It all it's it's all quite independent case by case, in my opinion, and that's something that we can bring as a holistic assessment of that process, and then we focus on the where we can have value.  Wouter Klijn  27:26 So, Charlie, we we've spoken in the past a little bit about artificial intelligence, and you've done quite a bit with that at State Super. Are you bringing some of those learnings now to new clients coming on board? Can they ask for a AI roadmap for their organisation.  Charles Wu  27:43 Ah, they definitely can. They can ask AI roadmap. They can ask AI governance. But what are they like? We started this conversation eight years ago, and back then no one was doing AI or machine learning. Nowadays, if you don't do, if you don't use AI, you're falling behind. So I think the world is in a slightly different place, as you you will know that we're always open to compare nodes and helping people. We're definitely bringing our capability to frontier and assist the clients.  Wouter Klijn  28:11 Yeah, yeah, Charlie, you didn't have to go all the way to Melbourne to to make this work. There's now a Sydney office. What are the plans for that office? And I don't know if you can answer this as well. I understand there's a few spare seats as well, so you can have some growth there in the office.  Charles Wu  28:27 Yeah, yeah. Well, let's start with the senior office. We definitely have few spare seats, and we will grow the the senior office, senior presence. Sydney is really important for for us for Frontier in many ways, we do have many clients that is Sydney based, and so instead of flying everybody from Melbourne to Sydney, which we still do, but now that they have a permanent location, where say Ela, when he comes to Sydney, there's an open arm, a nice cup of tea, you know, being made ready for him to to step in, and he has an office to work on, so all that is good. Now that being said, we still like to maintain like a you know let's let's call that friendly rivalry between our Sydney and Melbourne office.  Elie Saikaly  29:10 I mean, the reality is, Charlie, that that AFL is the permanent football code, so there's probably no argument there. And I'll let you have the benefit of better weather as well, being in Sydney.  Charles Wu  29:21 No comment on that one.  Wouter Klijn  29:23 Fair enough. So, what's what's ahead in the next couple of months? What's on your agenda? Do you need to, you know, are you developing more portfolios that you prepare for future clients, or what's going on?  Elie Saikaly  29:36 We are essentially finalising the regulatory process, and we are not far away from official launch, which which we're really excited about. In the meantime, we are ensuring that we continue with our change management programme, making sure our whole team, our whole business, is on the journey with us and understands how this service fits in with. What Frontier has historically provided to clients, and we've held a number of company-wide initiatives and activities to make that happen. So in December we held an immersion day where everyone joined us in the Melbourne office, and there was a lot of rivalry between Melbourne and Sydney. But at the end of the day, we all came together, and and it was it was a very it was a very energising event for the whole organisation, and we've conducted a number of training sessions across the business around education, and and under and and getting together a real understanding of what this service means and how we deliver that service into the future, as well as a number of work groups which have sought to make some important strategic decisions around our governance framework, as Charlie mentioned earlier, our risk framework, ensuring that our service remains independent. We offer the transparency that asset owners are looking for as well. So there's there's a lot to be done, and and we've made a lot of progress so far. But we are really looking forward to to the official launch of this service for client two and beyond.  Wouter Klijn  31:17 Yeah. Now, Elie, you've built up quite a practice amongst the insurance companies for for Frontier and your title. Are they also potential clients for this service? Is that suitable for an insurance environment?  Elie Saikaly  31:34 Absolutely, it is. There are a number of insurers who have internal teams with fantastic capability and have a long history of adding value for shareholders and policyholders. I'd imagine those insurers will continue to do that internally, and run their own investment programmes. But there is a significant number of insurers who are looking for support around managing an investment programme, and really that comes down to the fact that an insurance company, just like a university and just like other asset owners, have a core business to run. And typically, managing the investment portfolio is not part of their core business. It could be a secondary or tertiary activity, and they may not want to in-source some of the risks that we spoke about earlier. It could be operational risk, could be key personal risk, and so Frontier is in a good position to provide those services. And it's experience working with the boards of insurance companies and its stakeholders that gives it an understanding of the the solutions that they are looking for and the problems that we have identified or the challenges that we have identified that are all part of this service and and essentially a part of our value proposition.  Wouter Klijn  32:59 I think when I was speaking to Andrew last year. He sort of indicated that he's seen some smaller clients, not frontier clients, but people out in the market with portfolios that use off-the-shelf products, where he thought, well, these portfolios are not as well run as they could be. Is that sort of a widespread problem, or how do you think about that? Because that's a potential client base, I suppose.  Charles Wu  33:25 Yeah, sure. It is a widespread problem, and when we're looking at the portfolio, and this comes back to well, again, how do we how do we ensure that we do the right thing by the clients and by providing that flexibility? So again, you can probably get the sense from the way I talk. I come back to a lot about the organisational risk appetites. Like they all have different things. This this is this is not standardised. While this may not be their day job, but I'm pretty sure that they have different type of risk appetite for different company, be insurance or charities. They have they in different parts of their potentially their journey as as they establish their different sophistication, different level of commitments. Then all of those triggers one way or the other about how you can manage that portfolio for more, I guess, sophisticated, higher risk appetite clients, the ability to withhold drawdown is would be a lot larger than you know someone that just started this journey, and so by just applying the same type of portfolio to every single client in that, it just doesn't make a lot of sense to me. Now I'm I'm not going to shy away from saying that. Yes, we do need to address the the problem between scalability and efficiencies, and I'm very aware of that. And that's why we're spending a lot of time to develop internal technology to enable how we can approach this problem in a more, I guess, disciplined and consistent manner.  Wouter Klijn  35:00 Fair enough. All right, excellent. Well, thank you very much for that. Thanks, Charlie, and thanks, Elie, for this conversation and for making the time.  Charles Wu  35:08 Thank you. Appreciate that.  Elie Saikaly  35:09 My pleasure.  
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  139: Neuberger's Steve Meier – Do You Know the Risks You Own? TPA at NYC Retirement Systems 12.07.2026 52min

  In this episode of the [i3] Podcast, Conversations with Institutional Investors, we speak with Steve Meier, who is the Vice Chairman of Neuberger's Institutional Client Group. Before joining Neuberger, Steve was the Chief Investment Officer for the New York City Retirement Systems, the third largest public pension plan in the US, consisting of five different plans. There, he implemented the total portfolio approach (TPA). Steve recently published a paper about the lessons he learned from implementing TPA at the fund, titled 'Case Study: Implementing Total Portfolio Thinking at NYC Retirement Systems', which we will explore in this conversation. Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights Overview of podcast with Steve Meier of Neuberger  03:00 I knew we were heading in the direction of TPA but I didn't want to freak people out with a certain nomenclature 06:00 I think an SAA is compatible with a total portfolio approach 07:00 There has been a lot of work done by CalPERS CEO Marcie Frost to get support from the board for TPA 09:00 My experience is that an SAA is more granular than a reference portfolio 17:30 We hired external managers that could be tactical on our behalf. With a US$300bn portfolio it is hard to be tactical at scale 21:00 We didn't have an incentive compensation pool at NYC, so that wasn't one of the levers that I could pull 25:30 We had five plans that each had their own consultant. The firefighter plan had a funding ratio of only in the 80s, and that was largely because of 9/11. We lost 346 firefighters that day. 28:00 At the heart of TPA, there is an element of being very factor aware 31:30 We put together the BAM university so trustees could learn about how we made better decisions and we had a thought leader speaker series where I interviewed senior figures in the industry, including voting members of the Fed. 43:00 The case of Irene Triplett, the last remaining survivor of a Civil War pension plan. That is 155 years later and the plan is still paying out a benefit. We are long-term investors. 46:30 I do believe we are seeing a convergence of public and private markets Full Transcription of Episode 139 Wouter Klijn (00:00): Welcome to the i3 podcast. I'm here today with Steve Meier, who is the Vice Chairman of Neuberger's Institutional Client Group, and who was previously the Chief Investment Officer for the New York City Retirement Systems, the third largest public pension plan in the US, consisting of five different plans. Today we're going to talk about the Total Portfolio Approach (TPA), and in particular, the NYC Retirement Systems' version of it. Steve recently wrote a paper titled "Case Study: Implementing Total Portfolio Thinking at NYC Retirement Systems." So, let's talk about that. Welcome to the show, Steve. Steve Meier (00:42): Great, Wouter. Thank you for having me. It's a pleasure to be here. Wouter Klijn (00:45): So, when you were at NYC Retirement Systems, you didn't quite call it TPA—that seems to be a bit of a later name or interpretation. Can you tell me a little bit about your thinking around this system and how you referred to it? Steve Meier (01:01): Sure, absolutely. When I first joined the New York City Retirement Systems—and just to be clear, there are five separate and unique investment plans with five boards of trustees totalling 68 trustees, five separate investment policy statements, five separate general consultants, and a matrix of nine specialty consultants. There's a level of complexity just in terms of the organisational structure around managing the public pension plans for the city of New York. We had about 800,000 beneficiaries and participants, so it was a real honour to actually work in and lead that organisation for a little under four years. When I first joined, my first observation was that there was not an appropriate amount of collaboration across the teams. I tried to implement more of a non-siloed mindset to get people to work together, integrate the teams, and flatten the organisational structure. I wanted to give everyone a voice and open up the investment committee. Prior to my joining, the only participants in the investment committee discussions were the asset class heads. I opened it up to the entire 130-person organisation to really get more brains in the game and use it as a developmental tool. I did a number of things organisationally to force the integration of the teams, get the very best out of our tremendous individual talent, and challenge people to think more holistically about the portfolios and exposures. I wanted them to think: if they were the CIO, how would they want to see the portfolios positioned and presented? More importantly, for each incremental investment we put into the portfolio, how would that impact our overall exposure? Wouter Klijn (02:56): Yeah, so in hindsight, when did you start to realise that this is pretty similar to what is now called the Total Portfolio Approach? Steve Meier (03:04): Well, I suspect that all along we were moving on that path. I didn't want to freak people out by giving it a certain nomenclature or name. For us, it was really a journey and evolution of our thinking and capabilities. What I truly focused on when I first joined is the Japanese concept of Kaizen, which means a focus on continuous improvement with the ultimate goal being excellence—which you never really reach. But as fiduciaries, I tried to challenge my teammates into thinking we have an affirmative obligation to eke out every last quarter of a basis point in terms of performance. At every turn, there's a way we can improve how we interact, how we think, how we behave, and ultimately how we invest. Listen, the markets are dynamic, things are constantly evolving, and technologies change. We're certainly in the midst of reincorporating a revolutionary, transformational technology into our thinking and practices, but it was really a recognition that we could always do better as a starting point. Wouter Klijn (04:11): Now, I think your case study is quite interesting because there are a lot of similarities with Australian pension funds here. They have different investment options that they more or less have to stay true to, so a lot of funds here can't get rid of a Strategic Asset Allocation (SAA). Getting rid of the SAA is a model implemented by sovereign wealth funds that embrace TPA, but you can't really do that in a pension plan. I think you had a similar situation where you still had to have an SAA. Can you tell me a little bit about your thinking around that, and how you went about implementing TPA with an SAA still in place? Steve Meier (04:56): Yeah, absolutely. As an American, I'm a bit embarrassed to admit that America seems to think they come up with all the good ideas, but the Total Portfolio Approach—or total portfolio thinking—has been around for decades and has been widely and successfully adopted abroad. For the US, it's more along the lines of an evolution and an awareness that there's a better way to do things. As I said, part of it is artificial intelligence supporting more analytical rigour and quantitative tools. I think about framing decisions analytically versus using an inherited narrative. First principles thinking asks: what can we know that's objectively true about the portfolio? What can we state as a fact, and how can we use that as a building block for constructing and managing portfolios differently? Wouter Klijn (05:54): And in your experience, looking at implementing that in an SAA environment, are there any lessons learned or quick wins that you can share? Steve Meier (06:04): To answer your question more directly, I actually believe that a Strategic Asset Allocation can be, and is, compatible with the Total Portfolio Approach. There's a full spectrum and a bunch of different flavours of TPA that any institutional investor can implement. What's really interesting right now in the United States is the largest public pension plan, CalPERS—which is about a $640 billion plan. They've moved down a path where they are adopting, I believe at the beginning of July, a more full-blown, pure form of TPA. They have a very talented Chief Investment Officer named Steve Gilmore, who has been successful in implementing TPA at the New Zealand Sovereign Wealth Fund and, before that, the Australian Future Fund. There's also been a lot of work done behind the scenes by their Executive Director, Marcie Frost, to win the trust of the boards, secure a high degree of delegated authority, and ensure the right infrastructure is in place to bring in good talent and incentivise them to perform. A lot of eyes are on that, because not only is CalPERS the largest public pension plan in the US, but it also has a great history of being innovative. A lot of folks, myself included, are watching CalPERS implement that pure form of TPA, and to be honest, I'm rooting for them. I believe TPA is the best operating model for institutional investors today for many reasons. Because it's happening in a very visible way with the largest public pension fund in the States, many are watching to see if they're successful and if it can be replicated in different degrees by other US institutional investors. Wouter Klijn (08:12): That's an interesting example, because Stephen Gilmore has been in organisations that have all embraced TPA over the last couple of years. I think one element of the version of TPA he's bringing to CalPERS is that they are looking at a reference portfolio, and we just had a discussion about SAA. The reference portfolio is a big part of the New Zealand Super model. What is your thinking around that? Can you still do TPA without having a reference portfolio in place? That reference portfolio is sort of your base case; it illustrates what you should achieve if you had no skill or talent whatsoever, and challenges you to do better. That's a fundamental approach to investing, so what are your thoughts? Steve Meier (09:04): Wouter, my experience is that Strategic Asset Allocation tends to be more granular. For example, you look at your equity beta exposure, private equity, public equity, and your allocation to large-cap, mid-cap, and small-cap in US developed markets, ex-US markets, and emerging markets. Conversely, a reference portfolio in a pure form of TPA might just be a 75/25 split: 75% exposure to equity and 25% to fixed income. From there, you look at underlying factors like duration, liquidity, and equity beta exposure, and you get very granular in how you view the portfolio. I believe that an SAA is a good starting point. It's something our trustees understand significantly, and it's something we're used to working on with our outside general consultants. It's easy to understand, but it does have deficiencies. The capital market assumptions that go into SAA decisions are typically backward-looking. If you look back 25 years, it takes you back to the dot-com bubble blow-up, the Global Financial Crisis, the European sovereign debt crisis, and the COVID situation. One thing we know with certainty is that the next 25 years are going to be very different than the last 25 years. We also know that SAA tends to be very static in a world that is very dynamic. So, I recognise there are pros and cons associated with SAA. It acts as an anchor and a starting point for decision-making, but hopefully not a constraint when it comes to smartly positioning the portfolio to take advantage of shifting risk and return dynamics. Wouter Klijn (11:13): So what do you see as the key benefits of TPA? You mentioned earlier that there are some really distinctive benefits. What are they? Steve Meier (11:22): Thinking holistically, I'll give you a couple of examples. When we started analysing New York City's portfolio at a very detailed and granular level, we discovered that out of our private real estate portfolio, we had a 12% exposure to real estate debt. Our infrastructure equity portfolio had a 5% exposure to debt. Take infrastructure, for example—one of my favourite asset classes. It's no longer just toll roads, airports, and utilities; it has evolved into data centres, fibre networks, cell towers, battery storage, and renewable power. That asset class has expanded to include elements of real estate and growth equity. It has long-duration assets similar to bonds and offers inflation protection dynamics. The factors and exposures infrastructure brings are very blurred now compared to what they used to be, and I think that will continue as the market evolves. This also recognises the convergence between private and public assets. We're seeing that to a great degree in the US, particularly in fixed income, where managing public and private mandates together makes a lot of sense. I travelled to California last week to meet with some wonderful clients, and two of those large institutions have actually integrated their public and private fixed income groups into one credit group. I think that's the right way to think about portfolios: evaluating duration, liquidity, and credit spread widening exposure irrespective of whether an asset is public or private. Irrespective of an asset's public or private status, it will respond to the same underlying economic drivers over time: growth, inflation, productivity, government spending, and private capital flows. Those are the real drivers of economic outcomes, and they'll impact your portfolio, perhaps with some delays. The value creation mechanism for PE and private assets tends to be longer, but there is a high correlation between what goes on in the real economy and across both public and private assets. I think the blurring and convergence of those markets strongly supports a TPA mindset. Wouter Klijn (14:27): With that difference between public and private assets, it's sometimes said that it's harder to implement TPA in a private market environment because it is more transaction-driven. For instance, if funds here have large airport holdings and a new one comes up, are you going to say no just because it doesn't fit the TPA philosophy? Probably not. Can you give a sense of how TPA integrates with the private market aspect? Steve Meier (14:56): The path we were going down in New York City—and the path that I think makes sense—is to implement portfolio tilts primarily in public assets. Philosophically, I don't believe private or alternative asset classes are areas you can quickly lean in and out of. You need to be more strategic because it takes longer for deals to get approved, and the value creation mechanism takes longer. There are practical aspects like finding managers, performing due diligence, getting board approval, and going through contracting. You need a five-year pacing plan for vintage diversification, or three years for private credit. You need to be very deliberate in those areas, but you can still think about private assets in a total portfolio construct. For example, with secondaries, we were just too big and couldn't turn around continuation vehicle approvals fast enough, so we often just allocated cash. However, upon analysing our private equity holdings, we discovered an underweight to middle-market private equity. We were able to use secondary exposures in those asset classes as completion assets within the overall PE allocation. You can be somewhat tactical while remaining long-term strategic, and adjust annual pacing pipelines to reflect changes. At New York City, we didn't have a lot of delegated authority. We had 68 trustees who were good fiduciaries but laypeople, making it harder for them to get behind dynamic asset movements and statistical risk analysis. Because of this, we hired external managers who had the capability to be more tactical. For example, nearly 50% of our private credit book was in separately managed multi-strat accounts with accordion features. With a one-time board approval, we enabled our managers to be tactical on our behalf and move in and out of asset classes based on risk-reward dynamics. In extreme sell-offs, relying on VIX volatility indicators or spread widening, they could quickly call capital and put money to work. With a $260 billion portfolio, it's hard to be tactical at scale. This isn't market timing or trading; it's tilting the portfolio where you believe you have a better risk-return outcome. Wouter Klijn (18:30): That's very interesting, because we're starting to see that more in Australia as well, where TPA plays out not so much within individual asset classes, but at a higher level with dynamic asset allocation. People take tilts or use completion portfolios to try to eke out a little bit of alpha on top of their allocation and be responsive to the environment. Do you see that as an integral part of total portfolio thinking, or has that always been around? Steve Meier (19:11): I definitely think it's an overlay. You have your SAA, and then you have a TPA approach in terms of tilting the portfolio. I've had the privilege of spending time in Australia, and now in my role at Neuberger, I see that your superannuation business model for retirement planning is far superior to anything we have in the States. As the US moved from defined benefit to defined contribution, many people haven't been vigilant in saving. Your compulsory system produces great outcomes and creates a tremendous pool of capital that influences global flows. Hats off to the Australians; you've set a great example. As baby boomers in the US reach retirement age—many unprepared financially—we are going to face real challenges that are much better handled by the Australian superannuation construct. Wouter Klijn (20:31): When you first came to NYC Retirement Systems, you tried to implement TPA by breaking down the asset class silos. What were some of the first things you did? There can be quite a different mindset between asset classes. Was it a matter of basing remuneration on the total outcome, or how did you effect cultural change? Steve Meier (21:05): From an incentive compensation standpoint, focusing on the total outcome is exactly how you do it, but we didn't have an incentive compensation pool at New York City, so that wasn't a lever I could use. Instead, I tried to win the hearts and minds of individuals by providing an educational backdrop and a sophisticated understanding of why we make collaborative decisions. Winning over teammates who had decades of experience in their siloed asset classes was challenging at first. But as we developed analytical rigour that provided insight into overlapping or cancelling active bets, they recognised things about our portfolio that we hadn't fully intended or appreciated. I give the team a lot of credit for coming around, but it was an almost four-year exercise to clean up our data, build out an analytical framework, implement quantitative tools, and train people on risk management statistics. Then, we had to turn those complex concepts into an understandable narrative for lay-trustee boards focused on their fiduciary responsibilities. Translating these complex ideas into a format people could easily understand was a constant work in process. Wouter Klijn (23:09): I think the other complication is that the pension plan consists of five individual plans. By analogy, we have TCorp here in New South Wales, which manages multiple plans using TPA, and they apply it over each portfolio. Is that how you went about it? Did you have five TPA models, or could you draw it at a higher level? Steve Meier (23:38): If we had gone all the way down that path, we probably would have ended up with degrees of variation across the five plans. In New York City, the Bureau of Asset Management (BAM) reports to the Comptroller, an elected official. Each of the five plans had its own general consultant responsible for their SAA, capital assumptions, and return expectations. We were prepared to be very respectful of those relationships, recognising that no single consultant will be entirely correct because the future will be vastly different than the past 25 years. Because they were different, I suspect we would have had an 80% commonality with perhaps 20% variation at the margin. That also speaks to the fact that one of the five plans had a funded ratio over 100%, three were in the low 90s, and the Fire Department pension plan was in the mid-80s. A lot of the Fire Department's funding ratio challenges stemmed from 9/11, where we lost 346 firefighters in one day, and many more subsequently from related illnesses. That plan had long-lived liabilities turn into shorter liabilities, heavily impacting its funding ratio—at its worst, dropping to around 47% or 49%. It has bounced back to about 85% or 86% now due to increased city contributions and a more aggressive investment policy that bore fruit. Wouter Klijn (26:16): You have to have a bit of both: more contributions, but probably also a more aggressive investment target. Does that just mean more equities and private equity? Steve Meier (26:30): Yeah, a little bit more private assets. The one fund that is funded at 102% actually de-risked by taking some chips off the table, reducing exposure to alternative or illiquid assets, and pulling back slightly on non-US assets as a dollar-based investor. That was only for the one fund, which happened to be the smallest of the five, but they are all highly consequential and we care greatly about the outcomes for all the beneficiaries. Wouter Klijn (27:01): It's always the smallest fund that does the best, isn't it? I want to talk about the role of technology within TPA. There's emphasis on knowing what tilts you have at the total portfolio level, but your paper also references the importance of deep analytical skills. Can you explain why that is, and what you expect to see regarding artificial intelligence providing deeper analysis? Steve Meier (27:45): At the heart of TPA, you must be factor-aware and risk-aware, tilting your portfolio where you get the best return for the risks you're taking. Instead of asking "what asset classes do I own," you ask "what risks do I own?" This requires an in-depth analytical framework. For example, many worry about private equity's exposure to software companies given concerns about AI. You need to look top-down and aggregate your total software and AI exposure, regardless of whether it's public or private. Embracing TPA requires market professionals to be more quantitative. In 1983, I actually took a 50% pay cut as a computer engineer to go through a Wall Street training programme. I've always been curious about analytics, being a Certified Financial Risk Manager and a CFA. When I got to New York, my Chief Risk Officer, Ed Berman, built fantastic analytics off the MSCI Barra One system using Python applications we developed. We repurposed positions to hire data analysts with hedge fund and python programming backgrounds to deeply analyse risk. We also heavily focused on supporting and servicing the trustees. We put together a "BAM University"—a two-day annual event to educate trustees on how we made decisions. I also hosted a Friday morning Thought Leadership Speaker Series over Zoom, where I interviewed major CEOs, CIOs, former US Treasury Secretaries, and Fed officials. This mechanism showcased my team's talent through smart questioning, but the huge benefit was educating the trustees. Once they interacted with senior leadership and understood the value creation mechanisms, it was much easier for them to approve deals. Rather than taking an arrogant view of knowing better than the lay-trustees, we collaborated and used our resources to help them make better decisions. Wouter Klijn (33:55): That dynamic between the investment team and the board is interesting. I recall someone who implemented TPA looking at a well-structured bottom-up portfolio and realising it was incredibly hard to explain to a board because it wasn't designed from the top down. It's an interesting problem when you yourself wonder why certain tilts exist as the result of siloed teams doing their own thing. Steve Meier (34:43): Those are unintentional bets. For example, we made the cardinal error of diversifying active managers with other active managers. Individually, they performed strongly relative to benchmarks, but in a portfolio construct, their bets cancelled each other out. We realised you need to be deliberate and partner with the right managers in concentrated positions to avoid cancelling out bets. As we developed our analytical framework, we learned things that might not have been great for outcomes previously, but it wasn't about apportioning blame. It was about understanding what we can prove about the portfolio now and adjusting our holdings to have better outcomes. Wouter Klijn (35:57): How does implementing shorter-term tactical tilts interact with longer-term investment objectives, especially when short-term and long-term goals can sometimes oppose each other? Steve Meier (36:24): Strategic asset allocation assumes markets are efficient, and we know they're not. Markets become euphoric or overly pessimistic, creating opportunities. You want to have the benefits of being a long-term investor while being slightly tactical at the margin to seize opportunities. We're not talking about trading or market timing; we're talking about an elegant framework that tilts the portfolio where you are compensated more generously for risk. It's hard to do, but you can implement it through dynamic asset allocation, overlays, or by hiring flexible external managers to execute mandates meaningfully when opportunities present themselves. Wouter Klijn (38:01): In your paper, you mentioned a rotation programme where investment specialists would sit in other asset class teams. Equity and fixed income people have very different mindsets—how did that work? Steve Meier (38:21): Absolutely. As a former fixed income person, you tend to be more sceptical, while equity folks are more optimistic about growth. The pilot rotational programme applied to junior folks to give them an opportunity to stretch and grow. Working for the city provides great experience but the pay isn't great, so providing a voice, training, and growth opportunities was our value proposition to incentivise talent. We actually moved a senior investment officer from public equity into private equity; he brought a different perspective that became infectious. In my 43 years of experience—including acting as CIO at State Street Global Advisors for 18 years and interim CIO for Connecticut—I thought I had all the answers. But meeting with 200 institutional clients over the last six months at Neuberger has shown me that everyone has something new to teach you. To foster this at BAM, we opened up investment committee meetings so junior staff could learn from the discussions and understand how every new investment impacted the overall portfolio. While we met some initial resistance from industry veterans, a quantitative, data-backed approach usually brought people around. Wouter Klijn (41:44): You finished your paper by saying that despite the changes at New York, it remained a work in progress. What challenges regarding liquidity management, remuneration, or data integration were still outstanding? Steve Meier (42:09): Everything. As senior investment professionals, our job is to move the ball forward and leave the portfolio, the team, and the trustees in a better place. I used to tell the trustees about Irene Triplet from a 2020 Wall Street Journal article. She was the last surviving beneficiary of a Civil War pension plan; her 83-year-old veteran father had her in 1930. Even 155 years after the Civil War ended, the plan was still paying out a monthly benefit to his disabled child. It's an incredible reminder that these are long-term, generational liabilities and promises. With that long-term mindset, everything can always be better. We were still building the analytical framework, educating trustees, and integrating teams. It is always a work in process, but we made great strides toward a TPA mindset, and now it's up to the next CIOs to advance the ball. Wouter Klijn (44:36): In your current role speaking to institutional investors, can you give an example of something you've recently picked up from the TPA discussion that stood out? Steve Meier (44:51): Spending time with Steve Gilmore and Marcie Frost at CalPERS has been exciting. I'm rooting for them because I truly believe risk awareness and factor tilting is the best operating model. I also believe artificial intelligence is accelerating our access to a richer data set for decision-making. It requires us to be fluent in quantitative analysis and risk management. Even at 65 years old, I believe I will see much more convergence between public and private assets in my lifetime, heavily supported by TPA and better analytics. Wouter Klijn (46:32): If AI provides deeper analysis and access to large data sets, will differences in organisational objectives become the primary factor in how people invest, rather than access to information? Steve Meier (47:00): I think so. Information moves incredibly fast now. AI accelerates our access to data and allows us to build powerful tools like Python scripts off of risk management systems. We're in a transformational period in financial history. For example, alternative assets were rare in the 80s and 90s, but now they often dominate portfolio positioning conversations. Wouter Klijn (48:12): And adjusting to these changing markets is aided by total portfolio thinking, especially since post-COVID assets don't fall neatly into traditional buckets anymore, correct? Steve Meier (48:37): Yes, it's the blurring of asset classes. Infrastructure now looks like real estate, long-duration bonds, inflation hedges, and growth equity. Private credit often has equity kickers. As assets blur together, it requires discipline around factor exposure. Utilising technology and sophisticated analytics enables more deliberate portfolio positioning that drives long-term performance. You still need scale to resource all this technology and analytics, but it's essential. Wouter Klijn (49:54): Yeah, you need some scale to have the resources to implement all this technology and analytics. Well, Steve, thank you very much for your time. That was a fascinating discussion, much appreciated. Steve Meier (50:09): Thank you very much, Wouter. I really enjoyed the conversation. I'm incredibly excited about where the industry is going. Hopefully, we'll have a chance to do it again down the road. Wouter Klijn (50:31): For sure. Thank you very much. NYC Retirement Systems (NYCRS) is a current client of Neuberger. Any reference to NYCRS is not an endorsement by them of Neuberger or any of Neuberger's advisory or other services. NYCRS has not approved or disapproved of the @i3 Investment Innovation Institute podcast. None of the information in the podcast is representative of any particular client's experience.  No one should assume they will have a similar investment experience of any previous or existing client of Neuberger.  Any information provided in the podcast is not indicative of the past or future performance of any Neuberger product or service. Mr. Meier's style, philosophy and process is subject to change without notice. His views may differ from those of other portfolio managers as well as the views of the firm. Neuberger paid a fee to participate in the podcast. The podcast provided is for informational purposes only and nothing therein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. The information in the podcast is general in nature and is not directed to any category of investors and should not be regarded as individualized, a recommendation, investment advice or a suggestion to engage in or refrain from any investment-related course of action. Neuberger is not providing the podcast in a fiduciary capacity and has a financial interest in the sale of its products and services. Investment decisions and the appropriateness of the information provided should be made based on an investor's individual objectives and circumstances and in consultation with their advisors. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of the podcast and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Neuberger products and services may not be available in all jurisdictions or to all client types. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Neuberger Berman Investment Advisers LLC is a registered investment adviser. The "Neuberger" name and logo are registered service marks of Neuberger Berman Group LLC.
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  138: From the Archives – JANA's John Coombe 28.06.2026 1u 23min

  In this episode, we're revisiting a conversation originally published on 6 March 2019, with John Coombe, one of the true veterans of investment consulting in Australia. John joined John A. Nolan and Associates – now known as JANA Investment Advisors – back in 1988, as the firm's very first employee. Over three decades, he helped grow JANA from a single client into a business advising on hundreds of billions of dollars for institutional investors across the country. Investment specialist Daniel Grioli sits down with John to talk about the early days of investment consulting, the art of backing fund managers before anyone else will, the biggest asset allocation calls of John's career, and what really separates a good fund manager from a great one. It's a conversation full of hard-won lessons from someone who's seen more than one market cycle up close. Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights  Overview of Podcast with John Coombe Overview John Coombe Podcast 3:20 Got a job in superannuation, because I was the only one who knew how to use a PC 4:30 Spent most of my early days selling equities, because the market was so rampant. 6:30 Meeting some of the great investors two days after the '87 crash 9:00 Backing start-up fund managers 10:30 What went wrong with those managers that didn't make it? 17:00 The biggest asset allocation call in the firm's history 18:40 Shifting 15 per cent out of equities into property 21:23 Allocating nothing to US equities 29:00 If 95 per cent of risk is due to asset allocation, then why do we spend so much time on manager selection? 32:00 Never bet against the central banks 36:00 Do consultants add value? 40:00 Regulatory scrutiny of consultants; "throw them in the Thames and let them all drown" 45:00 Consulting is about making educated guesses. 49:00 Consulting is relationship management; don't kill it with being dogmatic 53:30 90 per cent of returns are driven by a manager's investment philosophy 58:30 There was a ton of money in hedge fund land being run on quant 1:01:00 Do performance fee ever make sense? 1:03:45 Tips for fund managers in dealing with consultants 1:08:00 Discussing the different consultant models. 1:12:00 Is consultancy getting too concentrated in Australia? 1:13:00 John's tips for institutional investors 1:14:00 Are CPI targets set today achievable? 1:17:00 The biggest challenges for instos today 1:18:00 A word of warning Full Transcript of Episode 138 Daniel Grioli  01:12 Welcome to the i3 Insights podcast. My name is Daniel Grioli, and today I am joined by John Coombe. We first met back in 2011, when I interviewed for a job with John at JANA. Fate intervened, and it wasn't to be. My first impression of John was that he's more than happy to call a spade a spade, so I'm really looking forward to this chat. For listeners in Australia, John probably needs no introduction, but for the rest of you, here's a brief intro. John is a 30-year veteran of the investment consulting business. He joined John A. Nolan and Associates – now more commonly known as JANA Investment Advisors – back in 1988, as John Nolan's first employee. JANA has grown from a single client to around 100 institutional clients, with over $350 billion in client funds under advice. The firm also oversees a further $90 billion in implemented consulting portfolios for its clients. We cover so many interesting topics in this conversation, including what investment consulting was like in the early days, the traits the best fund managers share, whether asset allocation is an art or a science, and much, much more. So, without further ado, I'd like to welcome John to the podcast. John, thanks for joining us today. John Coombe  03:14 Thank you, Daniel. How are you? Daniel Grioli  03:16 I'm great, I'm great. So, we usually get started by asking our guests about their background and how they got into their career. How did you get started as an investment consultant? John Coombe  03:28 Well, I started as an accountant at the SEC (State Electricity Commission in Victoria), and I was very fortunate that a good friend of mine, Terry McCreadon – who I think you know, who's now on the board of MLC Super but was also CEO of Telstra Super and UniSuper – phoned me up one day. I'd worked with Terry in the Treasury Department, and he said, "Coombsy, come and have some fun in the superannuation fund," because he was CEO of the SEC Superannuation Fund, which at that time was, I think, something like the fourth- or fifth-largest super fund in Australia. So I joined the superannuation fund, not knowing anything about investments but knowing a lot about a thing called a personal computer. The SEC ran everything off a big mainframe, but the superannuation fund had just bought a new investment management system that required a personal computer, and as I was the only person at the SEC who knew how to use one, Terry thought I'd be ideal for the job. So I started working with Steve Thompson, who's now at Cooper Investors and is a terrific equity investor. Steve taught me a lot about equities, and I used to do some of the bond investing too. Daniel Grioli  04:57 Do you remember what that first piece of software was? John Coombe  05:00 I can't, but it's the one all the custodians used for a very long time as their bolt-on to do Australia, because it had a tax module on the side. I honestly can't remember the name of it, but it was a very interesting time to be in the markets. I joined in '85 or '86, and we were selling equities all the time because the market was so buoyant, trading at all-time highs. I still remember Steve and I used to get told off – we'd go to an investment committee, and John Niland was the chair. John would say, "I told you guys to sell X percent of the share portfolio," and we'd say, "We did, but the market had recovered, and we're back at the same level as before." I think I spent the first two or three years just selling shares all the time. We had a big portfolio, and we got involved in things like the takeover of Fosters by Elders, and all the corporate shenanigans that went on in the late '80s. It was actually quite insightful as a young man doing that. Daniel Grioli  06:27 So you clearly weren't working in a fund that delegated investment management out. Sounds like you were doing everything in-house. John Coombe  06:33 That's the start of – oh, John A. Nolan and Associates. John left the SEC – he was head of finance – and started up John Anthony Nolan and Associates, or JANA, in 1987. It started the day after the crash, and I was fortunate: two days after the crash, John and I went up to Sydney to interview managers, because the SEC had decided to outsource part of their Aussie equities to external managers. I met Rob Maple-Brown two days after the crash, and I met some of the great names of the time – Sedgman and a few others. Two days after the crash, and a 40 per cent drop in the market in one day – we've not seen it again, thank goodness. I can assure you it wasn't much fun that day. Daniel Grioli  07:42 Do you remember what you were talking about at the time? Was it just the crash, or– John Coombe  07:46 No. We talked about philosophy a lot, and John, as you know, has a strong belief that corporate culture and corporate structure matter a lot in investment management – he learned that from Budge Collins in the United States. So when JANA started, we had two relationships: one with Intersec in Connecticut, who were the first to do global surveys of equity managers, and the other with Budge Collins and Associates out of Newport Beach. Budge ended up becoming PIMCO – well, Collins Associates ended up becoming PIMCO – and essentially they used to fund up start-up managers. They always said that was where all the return was, and they'd fund a lot of young start-ups, which eventually led into the hedge fund world for them, though not for JANA. But that's how their business evolved. Daniel Grioli  08:55 Okay, so you mentioned backing start-ups early – that was going to be one of my questions later on, but you raised it, so let's cover it now. John's been quite active over the years in identifying managers early. Do you think that's been a big part of your success? John Coombe  09:14 Without a shadow of a doubt. I think we've helped a lot of managers get started – they've done fantastic jobs for our clients and the members who benefit from that – and it's been really interesting to see the growth in the market, in guys (and ladies, sorry) willing to back themselves and have a go. It started very slowly. Andrew Sisson was one of the first, at BT – well, I suppose Robert Maple-Brown really was the first, wasn't he? Initially we had money with Maple-Brown Abbott. As I say, I think I'm the only consultant who's sacked them twice – there's a long story behind that, we won't go into it – but it has been a big part of our success. Budge was right: if you can get good talent early, when they don't have much money, they make a substantial amount for your clients in the early days. Daniel Grioli  10:28 One of the criticisms often levelled at consultants is that they're afraid to back managers early, because they're putting their reputation on the line when they take an idea to a client, and also that they want managers with a lot of capacity, because they need to get 20 consultants into a manager to get scale on their research. What is it about JANA that allowed you to do something other consultants were afraid to do? John Coombe  10:57 John's very entrepreneurial himself – remember, he started JANA with a little bit of backing from Bruce Cook. John is a starter of small businesses, and he understands that. I think the most important thing from our perspective is that we try to make managers profitable, because the last thing you want – and it happened to me once, won't happen again – is to back a manager who isn't profitable. That's a disaster reputationally, because they end up shutting down, and you end up having to find another manager and lose some credibility with clients. Look, we haven't got every start-up manager right – I'll confess to that – but the hit rate's pretty high. It's not 100 per cent, though I'd like to lie and say it was. Daniel Grioli  11:57 I'm sure there are some stories there – maybe you'd feel comfortable telling us about some of the ones that didn't go so well. You don't have to mention them by name, but what went wrong? John Coombe  12:09 Generally, the one common trait among the ones that haven't worked was the backing and the capital structure of the organisation. It wasn't that the people were poor investors – quite the opposite – it's just that they didn't have the corporate backing, the corporate structure, to get them through that start-up period before they became profitable, and that put too much pressure on them. Speaker 3  12:44 [inaudible] John Coombe  12:45 And then, if you've got a team of four or five, not everyone's got the same financial backing. If you have a person who's, say, got a couple of kids in private schools, etc., they can last for a while off their savings, but after a while the missus is in their ear, asking when they're going to get a real job and start bringing in money to pay the bills. So that's generally the pressure point in that start-up phase – that first year or two. Daniel Grioli  13:21 Okay, so coming back to the early days at JANA – you'd joined John at JANA. What did you do? What did you start out doing? John Coombe  13:31 I did everything. There were only two of us. Daniel Grioli  13:36 But what was consulting like back then? What sort of questions were you helping clients with? John Coombe  13:40 We were trying to convince clients to get out of balanced funds and into sector specialists. I'll give credit where it's due – John basically started the trend of telling clients that managers aren't good at everything: pick them for what they're good at, give them money in that asset class, and build a portfolio from the best managers in each asset class. We were pretty radical early on – well, it was the way the SEC was run; we had a team running fixed interest, a team running equities, a team running property, etc. So it wasn't foreign to us – it was how we ran money at the SEC. In fact, if you went into the bigger balanced shops back then – BT, AMP, Colonial here in Melbourne, National Mutual – they were all run on the same lines, all with specialised sector teams, but the product sold to the marketplace was a balanced fund. Most people had three balanced funds. MLC's whole premise in the corporate super world was, "We will be the median fund in the surveys, and then you can put your hot-shots wherever – but we'll always give you a median return in the survey." It was a very successful campaign; they had a third of all corporate super. So we came in with the idea that you could pick specialist managers and get a better outcome. Daniel Grioli  15:27 Okay, so what was the reception to that idea in the early days? Did people think you were crazy, or did a particular event change minds? John Coombe  15:36 I think we got a bit lucky with the property boom and bust at the end of the 1990s. John had formed a view – and he was right – that property was overvalued, partly because the SEC was a big property owner. The SEC Super Fund owned properties down St Kilda Road, and we'd been selling them to anyone who wanted to buy, but there was all this new property going up on Collins Street – 333 Collins and so on – being built at the time, cranes everywhere. Finance was super competitive, and the banks were lending like crazy. So we told our clients not to own any property. The first three clients we had – if they had property, we sold it; if they were in a balanced fund that held property, we got out of it. They literally ended up with no property. We also started working for Australian Super – or ARF, as it was then – and for REST, and it was a beautiful place to start, because they had all their money in either AMP Capital Guaranteed or National Mutual Capital Guaranteed. We took those portfolios, and all the new cash flow, and put it into asset classes we thought would do okay. The asset class we thought would do terribly was property, so we stayed right out of it. Those clients had a fantastic run through the early 1990s because they didn't own any property. We were probably the first consultant ever to take the National Mutual and AMP property unit prices, graph them, and use that as our proxy for the Australian property market. AMP had dropped their property unit price by something like 20 per cent, and National Mutual had dropped theirs by 5 per cent – there was something wrong at National Mutual in Melbourne, which subsequently there was. So we said, "There's an anomaly here – these property prices are starting to look reasonably cheap relative to the share market." We made the biggest asset allocation call, I think, in the firm's history, with Western Mining, which had no property. Don Morley was the chief financial officer. John went on holidays in mid-January to go fly-fishing, because that's what he loves to do, and I was left with instructions that if the stock market kept rising to a particular level, I was to call Don, and we'd switch 10 per cent out of equities and into AMP property, all in one day. The stock market hit that high – I think it was the 18th of February, I'm not 100 per cent certain of the day – but it was up 73 per cent in twelve months. I think that's historically the highest one-year rolling 12-month return. Anyway, it was up 73 per cent, and I phoned Don. I still remember the call – Don said, "Are you certain, John?" and I said, "Yes, Don," with all the conviction I could muster. Daniel Grioli  19:30 You were on a rocket ship – about to go to the moon. John Coombe  19:34 I suppose we were lucky, because the '87 crash was still fresh in people's minds, so it wasn't that hard a sell, though it wasn't an easy one either. We shifted something like 15 per cent in the end, out of equities and into property, and to be blunt, it was timing from heaven, because – I don't know whether you remember – in 1994 Alan Greenspan started raising interest rates. Daniel Grioli  20:07 I was in primary school. John Coombe  20:09 You were in primary school. But he started raising interest rates, and that was the only year the bond market had ever lost money – ever, in history, because we'd reconstructed all the index history back over time. So it was fortuitous: here we were in property, which had been hammered, and out of equities, which were getting absolutely slaughtered as bond rates rose. It was a lovely call. Daniel Grioli  20:43 I had the pleasure of interviewing Jeremy Grantham in his office back in February, and one of the things we spoke about was his early career and some of the early calls he got right. Speaker 3  20:54 Yeah. Daniel Grioli  20:54 In that conversation, we discussed the importance of getting a big call right early. Do you think that's been a big part of JANA's success? Would JANA be JANA if you hadn't? John Coombe  21:08 If we'd seriously got that wrong... it's hard to say, in hindsight, but at the time it was – the stock market's up 73 per cent, everything looks rosy, interest rates falling – none of it felt like a big call. I think the next biggest asset allocation call we made was coming into 2000, in the tech boom. We were working for Wesfarmers, and one of the premises we had from Michael Chaney – he was CFO at the time, before he moved into the CEO role – was a mandate to maintain their surplus for as long as possible. They were our first client, back in 1988, and we'd kept the surplus. Coming up towards the tech boom, we convinced Michael that he should have virtually no US equities – none whatsoever. The market was frothy, but that was a year and a half before it peaked. You were probably still at school then. Daniel Grioli  22:48 I'm starting to remember this period. John Coombe  22:50 The peak happened in March 2000. Daniel Grioli  22:55 So what was that year and a half like? John Coombe  22:58 It was painful. At REST we'd gone down to 10 per cent in global equities, the lowest they could go, and I remember saying to John, "We can't go any lower in global equities, so let's be smart about it – why don't we hire a value manager, because they've cleaned up and aren't buying any of this rubbish?" We went to the REST board and said we were going to hire a global value manager – the best of the worst, because the value managers were all terrible, underperforming the index by 10–15 per cent. We hired the best of the worst, which was Brandes in those days. The following year, the US stock market was down something like 35 per cent, and that portfolio was up – it was magic. About 65 per cent of stocks hadn't risen in the dot-com rally, but the following year that 65 per cent rallied, while the other 35 per cent, trading on enormous valuations, plummeted – some of them ceased to exist. So the market was down a lot overall, but by number of stocks, 65 per cent actually rose the following year. As long as you were in the value manager, you did okay. That was really interesting. I remember going along to events – I'd shifted up to Sydney by then – and we'd put together 20 pages of presentations for clients to prove why all this technology stuff was just smoke and mirrors, and that it would always end in tears. I'd go along to present at BT, and they were buying everything we were saying was rubbish. I remember a conversation at an AMP function with Jeff Rogers – you know Jeff – who was firmly in the camp of "you should be in global, you should be in tech." I said, "Jeff, so you're willing to give up franking credits and tax benefits" – because the full franking regime was in vogue then – "just to go and buy something that has no earnings?" It was quite a funny little exchange at that meeting, and I remember Michael Lillicrap from REST sitting next to me. I don't know who won, but at least the point was well made – it was entertaining. Daniel Grioli  25:54 I can't help thinking, as you talk about these shifts – and the question of peer risk comes to mind – were institutional investors far less concerned about what other funds were doing back then, when making those sorts of shifts? John Coombe  26:10 Yeah, a lot less, but the biggest change in super came when the Coalition came to power and introduced choice. Choice, by its very nature, takes the asset allocation decision away from trustees and puts it onto the individual investor. That, in my opinion, was the biggest change in the super industry, because prior to that, everyone just ran their own balanced fund based on the membership profile – and in a lot of cases, defined benefit liabilities, etc. By the end of the 1990s, choice had been introduced, and by its very nature, once you introduce four or five different options, you've narrowed the range within which you can move the asset allocation – because a balanced option can't look like a growth option, and it can't look like a capital-stable option either. You've really narrowed the range, and I always said to anyone who'd listen that this stymied asset allocation. Ray King and I used to talk about how everything in a fund's outcome came out of its asset allocation. I said that's history now, because once you've introduced choice and narrowed the range, the amount you can get out of asset allocation, in terms of its impact on your portfolio, is also narrowed. So choice was the biggest change. Daniel Grioli  28:02 Did choice also have an impact on the way trustees approached their roles? John Coombe  28:09 Yeah, because they also introduced licensing of trustees, which is partly why JANA sold the business to MLC/NAB in 2000. We were about 80 per cent corporate funds back then, and all of them were talking about moving into a master fund, or getting out of super altogether. No corporate fund we worked for wanted their executives doing 30 hours of training to keep a licence – they just wanted to offload it, which was a real shame. Daniel Grioli  28:54 Well, it sounds like it was quite an interesting and dynamic industry before everybody decided to give it away. John Coombe  29:03 Yeah, it was, and there were lots of funds. APRA probably didn't like the fact that there were so many corporate funds, but back in those days, super was part of the whole package you offered employees. Government funds offered higher contribution rates in some cases; there'd be a staff superannuation fund where staff were given bonuses and additional contributions into their super, and then the wages employees were in a separate scheme, and so on. It was really seen as part of the HR benefits regime – much less so today. Daniel Grioli  29:53 You touched on the topic of asset allocation, and it's something I've always wanted to ask about. There have been various studies, and the number varies from study to study – some say it's 50 per cent, others 75 per cent, 90 per cent, or 95 per cent (usually it's risk, but sometimes return) that's determined by asset allocation. If that's the case, and you look at what a typical institution spends on trying to find active managers to pick stocks, the fee budget is probably somewhere between 20 and 50 times what they spend on consultant advice for asset allocation, depending on the size of the fund. So I've always wondered: if asset allocation is the most important part of the investment decision, why are you paying 20 to 50 times more for the other stuff? John Coombe  30:49 Because history tells us it's the hardest game in town – and Jeremy Grantham would have touched on this. Daniel Grioli  30:57 Absolutely. John Coombe  30:58 Mean reversion works, but sometimes it takes a long time, and sometimes you get regime changes. I don't know whether you talked to Jeremy about the profit-share component. Daniel Grioli  31:16 We did, but– John Coombe  31:17 GMO always argued that the stock market was over-earning, because the share going to shareholders was higher than historical norms – and that hasn't come down. Whether that's a permanent shift, I actually do think it is. A lot more people are remunerated nowadays through share ownership – if you work for a bank, part of your bonus is in shares that get issued. So there's a higher percentage of people whose remuneration is linked to the stock of the company they work for. But with asset allocation, there are a lot of times when you shouldn't do anything. Sometimes I go along to clients and think, "What am I going to tell them?" because markets are a little expensive at the moment. In the longer term, whether you look at EPS, PEs, or free cash flow – none of the metrics look cheap. No market does, but then it becomes a relative game. Am I going to take my money out of the stock market and put it in cash at zero – or, if I'm overseas, negative, paying for my cash to sit in the bank? How crazy is that? Or put it into a bond market and get negative real yields after inflation? Or stay in the stock market and earn a yield, even though I know there's going to be volatility around that capital? Well, I've learned one thing in 30 years of consulting. Daniel Grioli  33:07 Just one? John Coombe  33:08 There's one lesson you should learn, Daniel. It's a very simple lesson. Daniel Grioli  33:12 Please, enlighten us. John Coombe  33:13 Never bet against the central banks – you can go out of business. I learned that from Tim Hughes. He bet against the RBA back in the 1990s, running bond portfolios in his own little business. He bet that inflation was going to get high and that the Reserve Bank of Australia wouldn't control it. He put duration positions on for that outcome. Three or four years later, he was out of business – his clients had given up on him, and he was never right. The Reserve Bank has kept inflation in its target range pretty much ever since it got that mandate. So if central banks are pump-priming the world, or their own economies, you don't want to go short equities. You seriously don't want to be short equities. You might take a little off the top – be one or two percent underweight because valuations are high – but you wouldn't punt ten. Did you ever consider repeating– Daniel Grioli  34:22 –your trick from the tech bubble, maybe hiring a value manager here or there to fade the valuations? John Coombe  34:30 Yeah, obviously, if one part of the market is doing things that you hope are smart – so if part of the market's trading at a 25 per cent discount to the rest, what do you do? You should go and have a real, hard look at it. There might be a structural reason you shouldn't be there, but if there's no structural reason, you probably should buy it. So you should be looking within asset classes for the cheapest, least risky way to invest – but at the broad asset allocation level, you'd be a very brave person to bet against the central banks. I love risk models, but everyone knows 90 per cent of all risk comes from the equity market, so it doesn't matter – as soon as I own one equity, I'm in strife from a risk perspective. It's a matter of looking even within equities: is there somewhere in the market that looks much more attractive than somewhere else? Daniel Grioli  35:34 I'd be interested – because you obviously deal with more trustees than I have – but in my experience, I've found it much harder to convince trustees to make shifts within asset classes than between them. It always seemed easier to say "we're taking money from equities into bonds" rather than "we're shifting between investment grade and high yield," or "between emerging markets and developed markets," or something like that. John Coombe  36:00 Well, I think– Daniel Grioli  36:03 –I've never understood why. John Coombe  36:06 I think our trustees are getting more sophisticated, and the fact that they've got internal teams means they look to them, and if their internal team agrees, that reinforces the decision – it's not so much them making the call as backing their team. It's about the meeting of the minds between your internal team and your consultant; there'd have to be a very big differential between those for trouble to start, because no trustee wants to see their consultant fighting with their internal team. Daniel Grioli  36:47 Well, there goes their legal protection, if that happens – what do they tell the judge? John Coombe  36:52 Don't know. Daniel Grioli  36:53 So, I'm going to put you in the hot seat now. There have been a lot of studies – I saw one recently that came out of Oxford Business School– Speaker 3  37:01 Yep. Daniel Grioli  37:02 –calling into question the value investment consultants add by picking managers. John Coombe  37:07 Yep, I read the article. Daniel Grioli  37:09 I'd love to hear your take on it. John Coombe  37:11 Maybe they're right? I look at our results across our client base, and we do have mixed results, but in general, in Aussie equities, our managers have added value. In global, they have too, but it's been less consistent – more about style, and us calling different parts of the market, like emerging markets. When we've called EM right, our clients have really benefited, but we've probably stayed in too long, if I'm honest, and that's dragged returns down. Value has been very difficult over the last five years in global in particular, and since we have a value-oriented philosophy, that's been hard, though we've still done relatively well compared to others. My criticism of that particular study is that it looked like they were looking at retail returns, not wholesale returns. If you look at retail products, some managers have six or seven different products in them, ranging from growth to value to core– Daniel Grioli  38:40 –different share classes, and– John Coombe  38:42 –all that sort of stuff. So I worry about that. They haven't narrowed the field to one manager, one product – you know what I mean – they're comparing apples and oranges. Some of those funds have a million dollars in them, and some have billions. I know which one matters most for the outcome of most investors, so I read it with a lot of interest, but I struggle with academics looking through performance tables and coming up with conclusions – they might well be right, but the article also highlighted that the really big international consulting firms have a process where they rank managers, and if you're a client, you're meant to end up with the top three or four. If you're one of those big firms, advising, say, $500 billion or a trillion dollars worth of assets, and you're trying to put it all into the same manager configuration, you're going to cause massive issues. We don't do that. Daniel Grioli  40:06 Well, you'd give up the edge we spoke about earlier – backing interesting managers early. You pretty much rule that out. John Coombe  40:14 We'd never do that anyway. We don't believe four managers should always make up the lineup, because it doesn't take into account the client's risk profile, etc. Some of our clients couldn't stand having some of the small-cap managers we use, where, yes, they add value over time, but they can be five or six percent under benchmark in a given year. Or really aggressive, high-octane, concentrated portfolios, down five percent in a quarter but up ten over the year – wonderful when they're up ten over the year, terrible when they're down five in a quarter. So you've got to have managers that fit the client's profile as well. Daniel Grioli  41:02 So you've mentioned you're not entirely convinced by academics looking into investment consulting – what about regulators? Consultants have received a lot of scrutiny in the UK. John Coombe  41:13 Yep, and probably justifiably so. I actually made a comment after the 2000 tech bubble that I'd throw all the UK consultants in the Thames and let them drown. I think they did an appalling job – the average UK pension fund had something like 85 per cent in equities, global and domestic. The interesting thing was, having had Wesfarmers with no US equities, we'd actually have been better off with no UK equities and no German equities either, because those two markets performed even worse than the US, since the big telecom companies in both went to extraordinary valuations. Daniel Grioli  42:09 Vodafone – a huge part of the UK market. John Coombe  42:12 I think it was 15 per cent. And News Corp. Daniel Grioli  42:15 And Nokia as well, in Finland. John Coombe  42:18 So you would have been better off getting out of the European markets entirely. Anyway. Daniel Grioli  42:26 Well, that moves me on nicely to my next question. How is consulting different in Australia compared with other countries? John Coombe  42:35 Well, having never consulted in another country – other than New Zealand. Does that count? Daniel Grioli  42:42 It counts. We'll say it counts for the New Zealand contingent. John Coombe  42:44 It is completely different, let me tell you. They're much more internationally oriented and focused on absolute return in the way they think about markets, which is quite refreshing. There are no surveys over there – they don't care. Daniel Grioli  42:59 Would you end the surveys tomorrow if you could? Do you think they help? John Coombe  43:03 They don't help. Daniel Grioli  43:04 I don't think members ever read them. John Coombe  43:06 Members never look at them. Speaker 3  43:07 Yeah. John Coombe  43:07 The only people who look at them are trustees and consultants. Daniel Grioli  43:11 Where I get really scared is when I see people's variable compensation linked to a survey – I've seen that a couple of times. There are some large funds that do that, and I think it's a real issue. John Coombe  43:23 Yeah, but I do think it's an issue – though you could argue the survey is the collective wisdom of all participants in the super industry at a point in time. I'm not 100 per cent certain about that, but it could well be. I had a colleague, Rob Clark, who was CIO at Rothschild, where their asset allocation for their balanced fund was set to be the average of all the other funds in the surveys. He and I had wonderful debates over glasses of red wine about how stupid that was, in my view, and how correct it was from a business perspective, in his. So it depends whether you're running it as a business – if you are, you do have to be aware of where your competitors sit, because you don't want to be out on a limb for too long and have it cost you the business. Daniel Grioli  44:34 What qualities make a good investment consultant? John Coombe  44:39 A questioning mind, willing to ask really stupid questions at times. Daniel Grioli  44:46 What's the dumbest question you've asked? I can remember starting out not knowing what tracking error was – that was probably my dumbest moment, trying to figure out tracking error. I still don't know that the answer is particularly useful, but– John Coombe  45:05 I asked a bond manager about convexity once – clearly didn't know what I was talking about, even though I'd managed bonds myself, which is funny in hindsight. But no, I just think a consultant should have a view, while realising their view isn't necessarily right – it's just a view. There's nothing right or wrong in investments, really; you've got a view, someone else has a view, and you can use that to question them and gauge the strength of their conviction and knowledge. I used to ask people about Wesfarmers all the time – they were our first client, and I got to know them really well. I even bought shares in it, because I thought they were the smartest people around. I'd go along to fund managers and ask them about Wesfarmers, and it was clear I knew more about the company than the people I was paying to manage the money, because they clearly had no idea what management was doing inside it. That, to me, was a real knowledge point. We also worked for Mayne Nickless, and I remember the company secretary at the time – I won't name him – telling me something that made it clear the company was in trouble. I'd go and talk to friends in the funds management world, and they'd say, "Oh, it's a wonderful company, going fantastically." Three months later, it profit-warned, but everyone still loved them. So sometimes you get insight through your contacts – you can't obviously go and share that, but you can use it to test people's knowledge about things. Daniel Grioli  47:01 Okay, talking about fund managers – do ex-fund managers make good consultants, or is it a different skill set? John Coombe  47:10 Consulting is a really funny art, because you come up with ideas, you listen to a whole lot of people, then you have to put it into two words on a piece of paper, hand it to somebody else, and debate whether you're right or wrong about the future. Daniel Grioli  47:30 Because you're not really doing anything other than offering opinions, are you? John Coombe  47:33 Correct, at the end of the day. That's why I worry about people who are so sure of themselves that they think they actually know what's going to happen. We're in the game of looking into the future and making educated guesses about what might happen, then building portfolios that can hopefully survive through those scenarios – but you really don't know which scenario will play out, you have no idea. I can paint you a picture of doom and gloom, and I can paint you a picture of rosiness – it's all in the delivery. Daniel Grioli  48:16 I think that's a really important point about making educated guesses – you see it in lots of different ways in investing. A stock manager might get less than half their picks right and still make a lot of money, because the ones they got right, they backed heavily. John Coombe  48:35 Sure. There's a value manager I asked this question of: their hit rate on the first dollar they put into a position was less than 50 per cent. Their hit rate on the second dollar was 52 per cent. Their hit rate on the third dollar – in other words, when they were doubling down – was 75 per cent. So you think you got it right when you put your first dollar in, you still think you're right when you add to it, but you only get really brave on the third dollar, when you're more confident. Generally, if you're right, that's the position you make the most out of. Really interesting studies. Daniel Grioli  49:19 Yeah, I've seen similar dynamics with growth managers. There's a tiger cub I'm thinking of whose hit rate on stocks is less than 40 per cent, and yet the alpha has been phenomenal, because where he's backed something with a larger position, his hit rate has been much higher. John Coombe  49:39 I'd bet he starts slow, and as his conviction builds, he puts more and more in. Daniel Grioli  49:47 You're probably right. So my question is: if so much of investing is about testing educated guesses, how do you make that easier to do in a highly regulated, bureaucratic, committee-based, consensus-driven environment like super? To me, all of those things almost get in the way of forming and testing hypotheses. So how do you manage the tension between the two? John Coombe  50:17 By admitting that you don't know everything – and I learned this from John early on – sometimes you give way on the little things that really don't matter. It's like, "They might be right, I might be right, I'm not going to fight over this – you can have that one." But, a bit like Jeremy and his – what does he call them – his points– Daniel Grioli  50:53 His blue chips. John Coombe  50:55 It's like career points. You don't want to throw them all on the line – keep a little bit back for the big day, when you really want to take a big swing and convince people to buy the best manager in the worst part of the market, because that's when you'll make a lot of money. But you're going to need career points to get there, so give up on the things that don't make any difference at the end of the day – the 1 per cent manager that doesn't change anything – but on the big one, be ready to stand up and fight hard. Daniel Grioli  51:39 Okay, so those moments only come along– John Coombe  51:42 –every now and again. Daniel Grioli  51:44 So it's a bit like Warren Buffett's punch card – you've got about ten career calls, and if you thought of it that way, you'd be much more careful about making sure that you– John Coombe  51:55 Well, it's like today – at JANA, we probably haven't changed our asset allocation views for nearly three years, and you could say, "Aren't you being weak?" But the reality is we've been in this hiatus of easy money for nearly ten or fifteen years, and basically you're punting against the Reserve Banks of the world. The regime's starting to change, but it's still easy money wherever you look. So it's right to be cautious about taking big asset allocation calls – sometimes. Other times, no – you've got to stand up for your convictions and hit the table – but that's not very often. Daniel Grioli  52:44 So how do you learn when to play it safe and when to swing the bat? Is that just experience – getting belted up a few times? John Coombe  52:54 Having a few chairmen phone you up and say, "John, that didn't go so well today." Look, it's an art – it's relationship management, and you have to be careful not to kill the relationship by being dogmatic about something where you might have a nine-out-of-ten chance of being right, but you might still be wrong. So, humility. Daniel Grioli  53:31 I think there's some great advice there. So, you've been privileged to meet some of the best fund managers around the world. John Coombe  53:41 Yep – one of the great highlights of my life, actually. Daniel Grioli  53:45 I'm glad to hear you say that. So you're the perfect person to ask: what makes a good fund manager? What are the common traits, and on the flip side, what are the red flags that mean you're out of there as soon as you see them? John Coombe  54:04 It isn't humility, interestingly enough. The really great fund managers I've come across have an investment philosophy they truly believe in, live by, and are 100 per cent wedded to. It can be growth, value, or quality – but they have a philosophy. At the end of the day – my colleagues hate me saying this – I think 90 per cent of returns are driven by a fund manager's investment philosophy, and about 10 per cent comes from their skill at picking the better stocks within that philosophy. Daniel Grioli  54:52 I agree – it's markets that pick managers, not the other way around. John Coombe  54:56 Yeah, but it's the conviction in the manager to stay the course. The other thing is they've generally been successful somewhere before – school, sport, or otherwise – and have this desire to win. They know what winning feels like, and they want to have that high again. A bit like a runner who keeps running marathons for the adrenaline – they know what winning is like, they like it, and they keep wanting more of it. Daniel Grioli  55:30 Okay, and on the negative side? John Coombe  55:32 This is probably one of the reasons Australian fund managers aren't too bad against the rest of the world – Australians are actually very competitive. But I'll be honest: the worst ones I've come across have come out of broking. They know how to sell a story, but they're not investors in any real sense – they moved to the buy side because they got sick of the sell side, but they listen too much, and they're not great investors. The other red flag is a bit of hubris. I remember walking out of one fund manager meeting – he'd told me he and his team were the smartest people in the world and worked the hardest, and I said, "How do you know that? I've been a consultant for 20 years – tell me how you know you work the hardest." You should have seen him trying to bluster his way around it. We see straight through that now – they have no idea. Daniel Grioli  56:45 It's funny you say that – it never ceases to surprise me how little fund managers really know about their competition. John Coombe  56:55 No, I was– Daniel Grioli  56:56 –constantly amazed at that, and it's worse– John Coombe  56:58 –when you go into the big financial centres, like New York and London. I'm amazed in London – it's not that big an area, let's be honest. Daniel Grioli  57:10 A square mile, or thereabouts. John Coombe  57:11 Yeah, but it's pretty concentrated. You go and ask a fund manager in London who their competitor is, and they don't know. Daniel Grioli  57:24 You'd think they'd be running into them– John Coombe  57:25 –around the corner. Daniel Grioli  57:26 Oh, you'd think they'd be running into them at AGMs, seeing each other on the register, or at least looking at who else is on it. John Coombe  57:32 No, it's funny – they just don't care, and they focus on their own business. Speaker 3  57:37 Which is– John Coombe  57:38 –I don't really understand that. Daniel Grioli  57:40 It's the ultimate irony – their business is to be students of business, and if they're not applying their skills to their own business, in their own industry, what are they doing? I do laugh– John Coombe  57:51 –at fund managers who tell me how they've advised company management on how to run their businesses, and I'm thinking, "Boys, you don't know how to run your own business – telling someone else how to run theirs, I'd have a little more humility." But honestly, fund managers generally aren't great at running their own businesses. I quite like the ones who know that and hire a business manager, or have an equity partner who handles all of that, because most of them are good at the investing side. Daniel Grioli  58:26 That's an interesting observation. So, in terms of funds management, it seems to be becoming more and more quantitative. Do you think that's a good or a bad thing? John Coombe  58:42 I actually think it's been this way for a long time, and a lot of people haven't noticed – screening by style and other quantitative techniques have been going on for at least 20-odd years, so the fact that it's now gone the whole hog and taken analysts out of the loop doesn't mean it's any bigger overall. Ian Patrick was the one who pointed this out to me, and I should have listened to him harder: around 2007–2008, there was a hell of a lot of money in hedge fund land being run on simple quant strategies, particularly in Asia. It had all built up over the prior three or four years – long-short, Asian equities, Aussie equities, a bit of global – and the number of people doing it had exploded, as had the dollars behind it. Even the internal prop desks were running quantitative processes. So I'd argue it was bigger then than today. The biggest phenomenon today is passive– Daniel Grioli  1:00:37 –smart beta as well? John Coombe  1:00:39 Well, not really– Daniel Grioli  1:00:42 –not big by size, but it's growing. John Coombe  1:00:44 Yeah, and there are a lot of techniques being used – long-short, alt-beta, and so on. Don't get me wrong, but I don't think it's as big, in aggregate, as it probably was back in '07/'08. We actually took our medicine and got out of nearly all our quant exposure around 2008/2009, because I felt the regime was wrong for quantitative techniques at that point – too much volatility in style rotation. We didn't really get back into quant until 2011. So quant isn't a process that works all the time, in my view – it works most of the time, but it can get crowded, and value signals are classic signals; if value's getting hurt, your quant strategies will get hurt too, because– Daniel Grioli  1:01:52 –the Fed has its hand on the scale? John Coombe  1:01:54 Well, quant always gets hurt when value and quality get hurt, because that's the backbone of probably half the strategies out there. Daniel Grioli  1:02:07 Do performance fees ever make sense for clients? They're great for managers, but– John Coombe  1:02:19 I've worked with a fund that wouldn't hire a manager unless they had a performance fee – at one stage, 80 per cent of all their equity and bond managers were on performance fees. They thought it incentivised better outcomes. I don't think it changed the outcome at all – I don't think a manager tries harder just because of a performance fee than they would running a standard fee structure. That's talking about long-only managers. In the hedge fund world, I think performance fees drive everything, but I think they're structured wrong – performance fees calculated off a cash benchmark just– Daniel Grioli  1:03:14 –are totally wrong, because it's a benchmark that doesn't reflect the risk. John Coombe  1:03:18 It just feels wrong – it feels like a transfer of wealth that, in hindsight, history will look back on as one of the greatest transfers of wealth from the people who had it to the people who wanted it, without giving much back in return. I'm not talking about performance fees for a private equity manager doing returns in the high teens or low twenties – that feels fair. I remember at the SEC, when I first started in super, we hired some of those "baby tiger" managers you mentioned earlier, because Collins had introduced us. I remember – and this is my memory – back in 1986, we wrote out a $21 million cheque to one of those tiger managers, and the trustee board hated it so much that we sacked the manager the following year. It's terrible, but– Daniel Grioli  1:04:24 –it stuck in their throat? John Coombe  1:04:24 It stuck in their throat – they couldn't stomach it. I think it was a 20 per cent take, so he'd made $120 million for us and we paid $20 million in fees, but they couldn't stomach paying the 20. It's funny, isn't it? Daniel Grioli  1:04:41 It's a very behavioural thing. Some of our listeners are fund managers – what tips can you give them before they talk to you again? Speaker 3  1:04:51 I don't know. Daniel Grioli  1:04:53 I would– John Coombe  1:04:54 –come with a good business case. Don't walk in with a wish list – you need to know certain things before you present how you're going to operate. What does my capital structure look like? What's my investment philosophy? In which markets am I going to make money, and in which am I going to struggle? How much do I need to break even? What does my team look like if I'm successful? You'd be surprised how many people, when you ask that question, have no idea. You might operate in the early days on the smell of an oily rag, but if you're successful as a fund management business, you're going to need more people, and that should be built into your plan. How long can I last before it really hurts, if I'm funding it myself? How long is my funding partner going to stay with me? Those fundamental questions have to be answerable – maybe not in the first meeting, but definitely by the second. The first time, you might ask me a few questions about what you should do. The second time, you'd better have answered those questions and come in with a business plan, because you can't walk into Ian Patrick at Sunsuper and say, "Look, Ian, back me – I've got no backers, I don't really know what I'm doing, I just want to do this." You've got to go into a big fund like Sunsuper, or REST, or anyone like that, with a plan for how you're going to make their members better off. You've got to have a value proposition. Daniel Grioli  1:06:47 How often would you see managers come in with a half-baked business plan? John Coombe  1:06:51 It depends whether it's the first meeting or the second. Usually, by the second, they've got it worked out – the first might be a bit iffy. We're in a privileged position, because, as you mentioned earlier, we've backed a number of firms over the years, and a lot of young people who want to start up come and ask for a bit of advice. I give it for free these days, so they don't have to buy me a coffee anymore, which is good – I'll let them off the hook. But yes, you've got to understand what the business will look like in its growth phase and its mature phase. It's interesting – people generally know what the growth phase looks like and how hard it might be, but they haven't necessarily worked out the economics of the mature phase. The backers of boutiques are sometimes in a similar boat. Some have got it right now, but in the old days, the backer would take a cut all the way through, and when the manager becomes really successful, that cut becomes a big number, and the people running the money don't like it. Daniel Grioli  1:08:10 Yeah. John Coombe  1:08:10 So there has to be a recognition of what a mature business looks like, as opposed to a growing one. Daniel Grioli  1:08:16 That's a really good point. If things go badly, the backers have generally risked money they could afford to lose, but the person – or people – having a go have lost a lot more, because it's all tied up in their– John Coombe  1:08:30 –career, for a very long period. Daniel Grioli  1:08:33 So they're the ones really taking the risk. But as you say, the arguments happen when things go right, because that's when everybody's unhappy about their respective slice of the pie. John Coombe  1:08:43 Yeah, no, it's a real issue. Daniel Grioli  1:08:46 You touched on this early in our conversation, and I wanted to come back to it in more detail. JANA started out as a privately owned firm, then became part of a much larger public company, and now it's a private firm again. John Coombe  1:09:01 Part-private. Daniel Grioli  1:09:02 Part-private. So some of your competitors are divisions of public companies, and some are owned by their clients. Do you think the business model of a consultant matters? John Coombe  1:09:15 I do, though I'll hedge my bets here. If I were running a big multinational – and we all know who those firms are – I'd want to be part of a big organisation, because I'd be going into markets where I'd need some financial backing, since I might be in those markets for three or four years not making any money – in fact, losing money, because I've hired people. I've seen my contemporaries in places like Hong Kong, Seoul, and Japan go five years without coming close to break-even. So if you're really global, you do need to be part of a big organisation with deep pockets. And let's be honest, the big firms nowadays are part-owned by insurance companies, fund managers, or life companies – those owners have deep pockets. Daniel Grioli  1:10:30 But their consulting arm is generally a rounding error on the parent company's revenues, and not– John Coombe  1:10:36 –necessarily, not if they're into the outsourced-CIO model. Having just– Daniel Grioli  1:10:44 So then in the US– John Coombe  1:10:47 If you think the UK has done it, it's nothing compared to what's happening in the US, where you've got small government funds outsourcing the CIO function, and it's not just the consulting firms – it's Vanguard, Morgan Stanley, Goldman Sachs, everyone's in the game. It's a very, very competitive space. Daniel Grioli  1:11:11 Is that going to happen here in Australia? John Coombe  1:11:13 No, I don't think so. Well, it sort of already has – that's what's been called the exodus of corporate super, left, right, and centre. It happened. No, I think we're in a consolidation phase here. My answer is, it depends on how big you want to be. If you want to stay in your own market and just be excellent at what you do within your own hemisphere, you can probably get away with employee ownership, and that's probably the best model, because you get buy-in from all the senior consultants. But then there's always the point of changeover from one generation to the next, and whether you've got that right – whether the next generation is building up equity over time as they become more important in the business, so that, in the end, you can take the senior consultants out in an orderly fashion rather than causing a corporate event. When you look overseas, whether at fund managers or consultants, that's generally what's happened: one generation hasn't filtered the equity down to the next. Daniel Grioli  1:12:32 Hasn't filtered it down? John Coombe  1:12:34 Hasn't filtered the equity down over time, so they end up as massive equity-holders who need a corporate event to extract their wealth, because the people underneath can't afford to buy them out. Daniel Grioli  1:12:46 Okay. John Coombe  1:12:47 So it depends what you want to be. If you want to be the biggest consultant in the world, you'd better have somebody with a big chequebook behind you. Daniel Grioli  1:12:56 In terms of consultants, there used to be four main ones in Australia institutionally – a lot of smaller ones too, but– John Coombe  1:13:04 In the 1990s, there were 20. Daniel Grioli  1:13:06 There were 20. Now you could argue there are almost only two of any real size – we won't say who they are. But whether it's two, four, or some other number, is the market getting too concentrated? Is there enough diversity of views? John Coombe  1:13:23 No, it's nowhere near that concentrated. I'd argue there are 20 consulting firms today if you count the 15 or so sitting inside funds like AustralianSuper, Sunsuper, etc. Daniel Grioli  1:13:43 Because people are internalising the function? John Coombe  1:13:44 Yeah, they've internalised part of the consulting function. So it's not just the four or five of us – we're an add-on to internal teams now, helping them and providing breadth, while they provide the depth. So I don't think there's only four – I think there's something like 15, once you count the internalised teams. Daniel Grioli  1:14:15 That's an interesting take on the concentration issue. So, moving on to the home stretch, I have a couple of quick questions– John Coombe  1:14:24 –make it hard? I've got five seconds to answer each one? Daniel Grioli  1:14:31 You can take longer than five seconds, but I'd like to finish on a note where we have some practical tips for institutional investors, whether they're your clients or other institutions. What are some common mistakes you see institutions making that they should avoid? John Coombe  1:14:53 I think the sole purpose test is a wonderful one – don't get distracted by all the other things around super. Concentrate on delivering member returns. You can get a little distracted at times by the peripheral stuff. Daniel Grioli  1:15:16 I think that's good advice. Most institutional balanced funds target CPI plus 4–5 per cent. Is that realistically achievable, and if so, what can funds do to achieve it? John Coombe  1:15:31 It's more like three to three-and-a-half for a balanced fund, near enough, but it's achievable on average – though we don't need any big mistakes along the way. Look, the margin over inflation we're going to achieve over the next decade is going to be lower than what we achieved over the last ten years, because of where we're starting from. If we'd had this conversation in 1998, I'd have said the returns out of a super fund over the next decade were going to be lower than the decade before, because of the starting point – and I agree with Jeremy here, the starting point is vitally important to what you can expect over the next decade. We're starting relatively expensive, in a historical context. If we stay expensive over the ten years, we'll probably get a balanced return of CPI plus three. But if we go from expensive to cheap, the next decade could be quite difficult, because we're starting from an expensive point. Daniel Grioli  1:16:54 Okay, and how can they achieve it? John Coombe  1:16:54 I wasn't a great believer in private equity in the old days – I was a bit sceptical – but when you look at what our funds have been able to achieve owning businesses in the infrastructure space, and I'd add owning property in the property space, if you do private equity well – doing a lot of co-investments and things like that – I think owning businesses, owning the capital structure, and controlling how and when you allocate capital across it puts you in control. If you really do that well, there's a lot of money to be made. Daniel Grioli  1:17:42 Aren't you worried those businesses are getting more expensive than public equities, with a lot of money chasing them? John Coombe  1:17:48 Yes, of course. But if you own a great business, with good management that you've incentivised properly, the fact that you control when to put more capital in to help it expand, and when to draw out your dividends – you're in control. And if you do it really well, I do think these are wonderful ways to generate wealth. Daniel Grioli  1:18:19 Okay, so what would you say are the biggest challenges facing institutional investors at the moment? John Coombe  1:18:26 Getting set into the assets we just talked about, because you're right, a lot of people have reached the same conclusion I've just articulated, and a lot of them are trying to get into that space. Many of them are saying, "For the next decade or so, we're in a growth phase, and after that, a mature phase," so in the growth phase they're getting set into these businesses and paying up to do it. Only time will tell whether they've paid too much – it'd be lovely if you could buy these wonderful businesses at half of what we have to pay today, but we're in a competitive space. The one warning I'd give everyone is that the world has much more savings today than it has ever had historically. Look at China – you took 500 million people out of poverty and turned them into capitalist savings machines. They're looking for investments, looking for places to put their money – as are hundreds of millions of other people – and that doesn't even account for all the extra wealth the average Australian, the average person in the UK, or the average American has generated. Every one of those people is looking for somewhere to put their money to generate a real rate of return. We're in a world full of money looking for investment returns. Daniel Grioli  1:20:07 Okay, final question: what are three things institutions can do to improve their investment decision-making? John Coombe  1:20:16 We talked about philosophy before – be very clear about what your investment philosophy is. It will serve you in all circumstances. If you have a belief system, it will stand you in good stead going into the future. You won't get everything right, but you'll have a story to tell your members: "We're managing the money this way, for these reasons." As long as you're disciplined about that, you will win in the longer term, whether your philosophy is growth or value. You win in the end if you're disciplined. It's the ones who waver between what they believe one minute and the next that get into trouble. Daniel Grioli  1:21:02 Okay, John, it's been an absolute pleasure having you on the podcast. Hopefully we can have you back as a guest in the future. John Coombe  1:21:10 Thank you, Daniel. All the best.
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  137: Aware Super's Simon Warner – Investment Strategy as a Perspex Box, TPA and the Changing Role of CIO 14.06.2026 52min

  In this episode of the I3 Podcast, Aware Super CIO Simon Warner joins us to discuss how his unusually broad background across fixed income, equities, public and private markets shapes his approach to investing. Simon explains the realities of implementing a total portfolio approach within Australia's DC superannuation system, balancing risk, liquidity and cost while empowering specialist teams rather than imposing top‑down macro calls. He also talks about Aware Super's evolving organisational structure, its global expansion via London, and the changing role of CIO in today's superannuation industry.   Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights Overview of podcast with Simon Warner, CIO of Aware Super [02:00] Simon's career path: Simon outlines his journey from JP Morgan balance sheet risk management (rates and FX) to AMP Capital and then to Aware Super, spanning fixed income, equities, multi‑asset, and private markets. [04:36] From trader to investor: He reflects on moving from being a trader in highly liquid markets to a broader investor, stressing how this built a rigorous risk‑management ethos that underpins his work today. [05:50] Total Portfolio Approach (TPA) in super: Discussion of TPA and why implementing it is different for Australian super funds (with member choice and labels) compared to sovereign funds like the Future Fund or NZ Super. [06:55] Constraints of the Australian super system: Simon explains key constraints: DC structure, direct B2C member relationship, liquidity for switching/redemptions, and dual focus on net returns and costs in a competitive market. [09:30] "I sometimes wonder whether commentary on TPA isn't code for top-down decision-making?" [10:33] Practical TPA and risk premia vs idiosyncratic risk: He describes building a common language and philosophy around risk premia vs idiosyncratic risk, using infrastructure as an example to think about embedded factor exposures across the whole portfolio. [15:33] Active vs passive and future of data in private markets: Simon talks about using analytical frameworks to separate what should be cheap beta/factor exposure from what is truly idiosyncratic alpha worth paying for, and how better data in private markets will enable more scientific portfolio construction. [17:14] Restructuring the investment team: He explains recent organisational changes: grouping property and infrastructure under private markets, creating dedicated accountability for liquidity and implementation, defensive assets, and having public equities report directly to the CIO. [23:31] Internal vs external management: With ~30% of assets managed internally, Simon discusses when Aware chooses internal management versus external managers, stressing competitive edge, proximity to assets, and reserving higher fees for true idiosyncratic opportunities. [28:48] Global expansion and the London office: He outlines the rationale for the London office—access to deeper global markets, managing domestic capacity constraints, building trusted co‑investor relationships, and carefully embedding Aware's purpose and culture offshore. [31:00] "We are at our SAA in terms of illiquid asset classes, so there is no urgency [to increase]"   [35:29] Role of super funds and member expectations: Simon positions Aware as already vertically integrated, with large non‑investment teams focused on member engagement and advice, and discusses balancing performance, cost, and responsible investing for a diverse 1.4m‑member base.   [40:18] Lessons, mentorship, and the CIO as 'director': He shares lessons from mentors like Mark Beardow and Adam Tindall on process, humanity, and psychological stability, and describes the modern CIO as akin to a movie director: setting vision and culture while empowering specialists rather than micromanaging decisions.   [41:30] Make your investment process a perspex box that you can describe to yourself, to people around you and to the people that will occupy your position in the future   [49:00] The role of an CIO is somewhat akin to a [movie] director: you have to have some level of consistency of vision and consistency of what you are trying to achieve Full Transcript of Episode 137 of the [i3] Podcast Wouter Klijn  00:00 Welcome to the [i3] Podcast. I'm here today with Simon Warner, who is the Chief Investment Officer of Aware Super, which has now become a 235 billion superannuation fund. Simon, welcome to the show.   Simon Warner  00:14 Thanks, greatly appreciate it.   Wouter Klijn  00:17 So, you took on the CIO role at the end of last year, and I was looking at your background. I spent a long time at AMP Capital, long time at JPMorgan Chase, but you have both had very senior roles in the equity side and the fixed income side. That is kind of unusual for a CIO. Can you tell me a little bit about how that came about?   Simon Warner  00:41 Yeah, well, so a lot, a lot of my career is a story of serendipity, and maybe me being active about making loads of opportunities that have come my way, but a lot of it is about a embracing the path that life has put out for me. I started, I started my career at JP Morgan, as you say, or one of the prior banks that now makes up JP Morgan, and my first job there, and the job that I had for 11 years was working on a on the balance sheet, managing the strategic interest rate and currency risk of the bank, which in many ways was sort of an internal hedge fund, so operating in, you know, the world's most liquid, most highly arbitraged markets to try to add value that then parlayed into a move into the buy side where I worked at AAP Capital, first within the fixed income team, and then my last job at AMP Capital was running equities, fixed income, and the multi-asset area, so the part of that business that used to manage the superannuation monies, but the last job I had there included the front office, but it also included all the support staff and all of the distribution product technology, etc. I then took a break and re-entered in this role under Damian Graham, my previous boss, and the old CIO here, where I took a role for him, looking after private equity, public equities, infrastructure, and property, and so over the course of that journey, I've been very lucky to have been either a direct practitioner or very proximate to decision making across pretty much everything that we do here now at Aware, that certainly I would emphasise, has not made me an expert at all of it, arguably an expert at not any of it, but it has given me a level of proximity and a level of understanding and a breadth that I do think is like you say, it's a bit unusual.   Wouter Klijn  02:36 Yeah, so do you see yourself today as more of an equity guy or a fixed income guy?   Simon Warner  02:41 You try not to label yourself, because they tend to be a little bit of rivalry between those two simple camps, and I think one of the things that I would, I would probably frame it differently, I think, I think you know my time at the start of my career operating in those markets that I described, I think that creates a level of rigour around risk management that is a really strong foundation for any individual within investment within the investment industry, and so I made not only have I made this journey from fixed income into equities from the public side into the private side, but I suppose I've had a bit of a journey from being a trader to being an investor, and that training I do think creates a very strong risk management ethos that to my mind is a critical pillar for a great investor as well, and so I would not proclaim myself to be a great investor, let me be clear, but I do think that foundational skill or foundational approach has been one of the things that I do hold on to.   Wouter Klijn  03:50 So that's interesting. So there's the equity side, the fixed income side, and then the trading side as well. And I was sort of thinking of it. You mentioned briefly JP Morgan was sort of like an hedge fund type approach. All of those roles seem to filter quite well into, you know, what is very popular today is the total portfolio approach, where you know you look at the total portfolio and see where the gaps are, and we've looked into this recently a bit. Obviously, within a super fund environment, it's very different to implement that than say the future fund to New Zealand super, where they can get rid of a strategic asset allocation. Super funds can't really do that, they have to be true to a label in their investment options. So, what we've seen is that funds try to do more of sort of an overlay, or completion, as Canadians call it, and that seems to translate sometimes in a little bit of a hedge fund type of techniques, and we see relative value, we see global macro trade, is that something what you're thinking of as well, and what are your thoughts on TPA in general?   Simon Warner  04:55 Yeah, yeah, so as you allude to there, I think. Think understanding our context and understanding our task within our context is sort of foundational for understanding about what the best way of going about our business is, and without wanting to repeat what you said, one of the features of the Australian superannuation industry, or the two features that I think are really salient, is one is that we are a DC system, and secondly, we are B to C entities, and so we operate with a direct relationship with our customer base, or our member base in our case, and they can switch at any time. We have a, we have a really tactile and close relationship with the beneficiaries of our capital, of the capital that we're lucky enough to manage for them that brings to bear a few constraints and a few features of the way that we have to operate the portfolio. One is we have a risk tolerance, obviously, but most investors would have that. Secondly, we have a binding liquidity constraint, so we have to maintain liquidity across the fund to meet those redemptions that our status as a DC and B to C entity come with say, and finally we operate obviously in a competitive system, and so we not only have a net return target, but we have a separate and discrete cost target, because the nature of the marketplace is that the member base or the potential customer base cares not only about not just about net returns but independently of that they also care about cost and so those give us some hard key constraints and and for my mind TPA is at the very headline level How do you create an environment, a culture, a system, a method of sharing information, and a method of deploying capital, such that you're optimally managing to those two constraints. So, not thinking about, you know, competition for a liquid capital, for example, on that liquidity constraint, but thinking very clearly that every time we deploy into an asset that is illiquid, it is drawing upon a scarce resource and creating environments, not only, as I say, the softer stuff around culture, but also, you know, the harder stuff around investment process and a consistency of approach that allows you to make those trade-offs in a mindful way. The thing that I would fall short of, in terms of the way you framed your question, is that I sometimes wonder whether commentary around TPA isn't code for top-down decision making. That is absolutely not the way that I would approach my task. You know, I think my role is to create an environment where, where the all of the 180 odd people on the team are being their best, and that we are creating an environment where the expert is making the expert decision and empowered to make that it's not about trying to get everybody to think in top down macro terms, it's about trying to get people to be empowered to deliver on their sphere of expertise.   Wouter Klijn  08:05 Yeah, so how does it translate into sort of practical changes if you're not trying to sort of manage things from the top down? How does that translate in how you think in sort of your approach to these completion strategies, or is it more a question of active versus passive? Is it more just enabling the asset class heads to do their job? How do you think of it in practical implementation?   Simon Warner  08:33 Yeah, so you know, the first, the first thing I'd say here is that, you know, a bit of what I'm about to say is me thinking out loud, it's something that we, as a group, are thinking through. What's our best approach to it? As I said before, it's we're not in a position I think where we can take a cookie cutter approach that someone's worked well elsewhere and just apply it, because our circumstances are slightly different. You know, our starting point is to try to think in terms of how do we create a commonality of philosophy and of language that is giving us a level of consistency, but not constraining each individual team to give us breadth and diversity, as well as to be able to deploy and invest in the way that is best for their sphere, and simplistically, what we've tried to do in that respect is to be really clear about thinking about individual assets, asset classes, and the whole portfolio as clearly as we can in risk premia versus idiosyncratic risk terms, acknowledging that in practical, in practical terms, it's very.. it's often impossible to separate the two, and in mathematical terms, it's almost impossible to scientifically decompose it. But what we can do is at least talk in principle, you know. Infrastructure is a good working example for some of this, but it definitely applies across the board for me, where you know an infrastructure asset that has more equity. Risk and is in a particular sector and is in a particular jurisdiction and is one of the very best assets that we can think of, given all of that, that's a cascade of a combination of risk premia that we would expect to get rewarded for over the medium term and more asset-specific idiosyncratic risk, return risk, risk elements, thinking about that clear headedly, or even just having a framework where you talk about those that combination openly has been a way to unlock a level of holistic thinking, so to what extent have you got a an infrastructure or property portfolio that has embedded in it risks that are not that were not incorporated in your capital market assumptions when you did your SAA, for example, and then what does that mean, thinking about where you've got either diversifying or reinforcing risks across the portfolio rather than just thinking about them in one sector, now to support that language is a good, is a good first step, and then to support that with some level of consistency around your analytical framework, so thinking about, you know, your ex ante IRR models within private markets, for example, as being a waterfall of different risk-free country sector and equity risks, and then that there are parts of the business case that you might want to, the ex ante business case, that you, you label very clearly idiosyncratic risk, it's a particular efficiency uplift within the asset, it's a merger plan, maybe, or it's a divestment of part of the business, so just thinking about that in those terms and having some level of consistency, so that you can create a conversation around those trade-offs.   Wouter Klijn  11:48 So, in that example of the infrastructure investment, are you looking to pull apart the different drivers of risk and return within that investment, where you look at what comes from factors, what comes from idiosyncratic risk? Is that how you look at it?   Simon Warner  12:02 I think again, acknowledging that we don't want to be the tyranny, we don't want to have false specificity because we're putting a number against something, it's not necessarily mean it's scientific. So I want to be very clear about that. A lot of this is about directionality and about intent rather than trying to break things down in a scientific way, but that's absolutely right. Yeah, so I think in terms of, you know, what are the characteristics that we wanted that we're seeking from infrastructure when we think about the SAA, what are those correlations in normal circumstances? What are those return objectives? What are those, you know, in the case of infrastructure, what are those defensive characteristics as well? Then getting quite clear about how individual assets and then the portfolio as a whole is mapping back to those characteristics, to what extent through quite appropriate risk-seeking behaviour are we layering in other factor exposures that might be optimal ways of allocate of accessing those factors, by the way, and then on top of that, being really clear about where idiosyncratic sources of return come in, the reason that this is important from not only a portfolio risk point of view, but coming back to that other constraint that we have around cost, is because at least in principle, borrowing from the more scientific environment in public markets, you prefer to have your external pay aways dedicated to idiosyncratic sources of return that you can't replicate, you know, so you can't create that scientific separation, obviously, in most private asset classes, you can create a conversation that helps you make better decisions.   Wouter Klijn  13:33 So it's not, you know, a clear scientific separation, but does it change the way that you think about the role of active and passive strategies and passive enhanced strategies in the portfolio?   Simon Warner  13:44 Just sticking with private for a moment, so you know, one of these, or this conversation that we've had up until now, that's part of the reason that we bucketed private equity, property, and infrastructure under one banner of private markets, under my colleague Jenny Newman, to create an environment where we can make some of these trade-offs. It's not quite your question, but let me just go on this tangent for a moment. You know, I do think that over the next 15 or 20 years or so, as data becomes more available and more granular and more and more trustworthy in private markets, you'll be able to create the environments where you can be more scientific about some of the portfolio risks, and so thinking in these terms is, I think, a prerequisite for taking advantage of that forward-looking data world, where you're going to get a better sense of individual assets and their risk exposures, and the performance of them, and what is really driving them. So, that's that's one of the things that we're seeking to do. I do think, as you say, a lot of it does come down to are you creating analytical frameworks both within asset classes and then across, where you're being as optimal as you can be, acknowledging that it's ultimately something of an art and something of a science about passive or factor exposures you'd rather not. Pay for, and you'd rather you'd rather label that explicitly, that we're trying to just get some sort of benchmark or beta or factor exposure, and then we've got this other part of the portfolio, which we're very happy to pay up for, that is giving us things that are really unique.   Wouter Klijn  15:14 Yeah, so as part of that, getting that clearer picture on the portfolio, and you alluded to this a little bit earlier, you've made some changes in the structure of the investment team, where you basically have now the asset class heads reporting directly into you. Can you tell me a little bit about the thinking behind that decision?   Simon Warner  15:34 Yeah, so you know, thinking about the key strategic challenges that we have, which is to perform in a competitive industry and to deliver at a competitive price. What are the key challenges, or the key, the key problems that you've got to solve for in order to deliver that? Well, it's delivering optimal returns for risk, it's delivering optimal returns within a liquidity constraint, and it's delivering, it's allocating your, your cost of the cost to construct your portfolio optimally, that was one of the principles around the organisational design. The second principle was a level of representation for major parts of the portfolio as direct report of the CIO, and thirdly, we wanted to create an environment where that leadership team did have a set of really diverse perspectives to solve the difficult higher order problems that we have, both as portfolio managers, but also as business leaders of the investments team, and so the key changes we made there were one to bucket infrastructure and property under one overarching organisational design, creating a lot of freedom within those to be this for the specialists to carry on being those specialists. So we have terrific sector heads across those three, and they are still responsible for investment performance within those sectors. It's Jenny's task to create an environment where the holistic is better than just the individual health. The second piece we did was to create a level of dedication and focus around implementing the portfolio as optimally as we can, so internally we call that implementation alpha. The way that that manifests itself in the organisational design is to create focus around liquidity and markets under Mike Clavin, so really, go against making sure that we are optimally implementing all the changes that we need in the portfolio, deploying cash when we can, minimising our cash drag, making the most of our balance sheet, interacting with the marketplace in the optimal way. You know that that's appealing to us, because it's it feels like lower risk and more stable sources of uplift, or at least avoiding slippage, seems like the first thing we should be trying to do. The second piece was creating a level of dedication around defensive assets under Sonia Bailey. You know that will be an increasing part of the portfolio as our member base ages, and we move more of our cohort into more defensive or pension-like options, and then finally creating public equities as a direct report of the CIO, you know, public equities is the biggest single source of liquid of capital allocation for the fund, it's the thing that drives outright performance the most, and it can often be one of the things that drives relative performance a lot as well, so having a direct line of sight was important for me there.   Wouter Klijn  18:22 Yeah, now before those changes took place last year, Aware Super also codified its investment beliefs for the whole team to have a consistent framework to basically follow. Of course, a lot of those things were already more or less informally ingrained, and it's sort of split out in four different parts. Some of it we talked a little bit about already: active management, the belief in active management, understanding risk, and getting compensated for risk, being a long-term investor, and operational sort of implementation. If you look at those ones, how does that sort of inform your investment philosophy today? Is that you equal weight those investment beliefs, or what is driving your, your investment philosophy?   Simon Warner  19:12 Yeah, so you know, one of the features of taking this, this role at this time is that I'm really lucky to be standing on the shoulders of giants, so I inherit a team that has been, that has been built over a long period of time by my predecessor, Damian Graham, and the leadership team are all people who were part of the team prior to me taking this role, and so I feel very privileged to have taken on a great team with great bones, and many of the much of the difficult building work of getting an investment capability off the ground has been done by the great people before me. So my core task is to try to optimise that that blessed position that I've inherited in terms of these investment beliefs. As you sort of allude, many of them have existed for quite some time, and there's quite a lot of flexibility to interpret those in a number of different ways, and to be honest, that was one of the features of creating them as investment beliefs, because we do believe that, as a, you know, as an asset owner, as a universal owner, but also as a team that has that internal capability, we not only have breadth where we are assessing the whole of investable universe, but we also have depth where we've got the top-down more macro decision-making capability, but we've also, at the coalface, got India, you know, stock selection capability in equities, for example, obviously across our private market suite as well, and so we want to create a set of principles that are fit for purpose for that whole canvas. It's not very easy, and we've complemented them, as I say, with a level of focus that builds, I think, upon some of the language around being clear about alpha and risk premia, about being clear headed about how we are getting the most for anything that is scarce, whether that's liquidity or fee or risk, and that over time I'm hoping and expecting will create an environment where we all talk the same language, but we are all empowered, like I say, within our own areas of domain expertise to really go off and get the best opportunities for our members.   Wouter Klijn  21:31 So, one thing that it doesn't talk about is internal management, and I think Aware is currently at about 30% of assets are managed internally. What are your thoughts about internal management going forward? Is there sort of an ideal number, a magic number? Is it a 5050 split?   Simon Warner  21:50 Yeah,   Wouter Klijn  21:50 What is your thinking there?   Simon Warner  21:51 I think in many ways it's a, it's a bit of a copy of before, so we, when I think about across the board, we've got the ability to deploy through third party managers or directly ourselves in pretty much every major asset class, so that that basic capability build has been done, and we're now in a privileged position to make a really informed and and discreet choice about under what circumstances, either within or across those that opportunity set, we're better off doing things ourselves versus giving it to an expert or an external expert. I suppose there are a few dimensions that that I try to bring, or we as a team try to bring to the table when we think about that. One is a level of humbleness around what our competitive advantage is as an investor in any given investable universe. What's our proximity to that investable universe? What's our kind of innate competitive advantage or edge versus other participants? So, you know, simplistically, I suppose Aussie dollar cash might be something where you think, well, we've got quite a high level of adjacency, but quite a high level of proximity, we should be able to think that we've got a similar information set to the very best actors in the marketplace, and so that's something naturally I think we could do ourselves, mostly same is true, maybe of core property in Australia, there are some other activities that we're either a long way away from the ground when it comes to what's being invested in, or the very nature of the activity is so diffuse and so also specialised that we've, it would be, it would be hubristic of us to claim to have kind of a natural competitive advantage, so you know, VC global VC, or global mid-market PE, just a huge and broad investable universe, you know, a lot of it, a lot of it, a long way away from where we sit for this conversation in Sydney, and the bulk of our team is still based in Australia, and so we've got a level of humbleness that that's something that we would prefer to partner with. Now, there's a whole raft of stuff in the, in the middle, so the other, the other spec, the other dimension that I would bring to that is the same as before, and that is, you know, again, I often come down down to infrastructure as an example, because it's just such a rich asset class that illuminates that it's not because it's always on my mind, it's just it illuminates a lot of these principles, you know. We would much rather, we would much rather, in principle, partner with an external manager and pay them really heavily aligned economic fees for an asset that's got lots of idiosyncratic risk that we can't access without them in principle, if we can access it without them, and it's largely beta or risk premia that we can get our head around on a desktop. We'd rather not pay that fee. We're not necessarily doing that to save outright cost from our current position, because I feel like we've got the ability to manufacture. The portfolio very economically, but it's about making sure that we're rigorous about allocating that scarce resource fees as optimally as we can. You know, we pay away a lot of money to external managers, and it's one of our core responsibilities is to make sure that those are allocated really effectively for the benefit of our members.   Wouter Klijn  25:19 Cost is always an important driver in that debate, but one of the benefits, as well, or one of the problems that you're trying to solve with internal management, also has to do around capacity constraints, and especially as the fund grows larger and larger and larger in places like Australian equities, it becomes increasingly more difficult to allocate in an active external way, are you at one point forced to just take on more internalisation?   Simon Warner  25:47 I feel like we're quite a way off. I think in terms of being able to get risks set in the market in a way that is manageable, is diversifying, and is accretive to the whole portfolio, we're not yet bumping up against some of those considerations. I feel like it's less of a, it's less of an internal external conversation necessarily than more being increasingly scientific about where capacity constraints might bump up against expected information ratios, and where in one particular domain do you hit a capacity constraint? I mean, the most obvious one, I suppose, in our domestic environment is it would be small cap equities, where you know to what extent is there a capacity constraint there, but that's that's the same philosophy I think we can apply elsewhere as well. At the moment, we're a large investor in the Australian superannuation context, but we're still a medium to large investor in the global context, and so there's plenty of space, I think, for us to grow.   Wouter Klijn  26:48 Yeah, yeah, fair enough. Talking about that international context, Aware has opened an office in London and made some commitments around deploying money there as well. I think the number of 10 billion has been thrown around, obviously. That is constrained by, you know, your fiduciary obligation to your members. It has to make sense. It has to stack up as an investment. But what is your, what is your idea about the role of these foreign offices to the fund and future plans to expand the footprint outside of Australia,   Simon Warner  27:23 So you know some of it interfaces with the question you just raised about about capacity constraints domestically, so I do think it is true that the system and ourselves as one of the larger investors will continually continue to seek pools of liquid capital markets where the liquidity is there for us to be able to deploy without so much cost, and so without so, so much consideration of capacity constraints, and so global allocations, I think, over time are going to creep up as we find the domestic market becomes more saturated. So that was a big reason for launching the London office with that we did about three years ago. We again are very blessed to have inherited a situation where that London office has been, you know, formed by two great leaders, Damian Webb and Jenny New March, who went over there and helped form that office, helped him help higher up the private equity infrastructure and property teams that are there, as well as the spine of support functions that we have in London. I think our task there, and that has yielded results already for members, so we're getting good pipeline. I feel like the Australian, the Australian investor base in general, is well thought of in Europe, and we're well known now as a cohort, so we're getting good access to, I think, we, as aware, are trusted counterparties and trusted, trusted co-investors, and so we're getting good access to good deals, and we're beginning to deploy, I think our task in the next two or three years, at least, is to consolidate on that, both from a business point of view as well as from an investing point of view. We are at RSAA, broadly speaking, in terms of most of our illiquid asset classes, so there's not the urgency that we've had in previous years, to get capital deployed, we're really thinking about optimising these portfolios from here on out. That's not to say that we can't add extra strings to our bow in London in the next few years. You know, there are some obvious areas where we think we might be able to put people on the ground there to give us better, better capability and scope for better, better outcomes for our members, but it's, you know, any business that makes its initial foray into a different time zone, into a different culture, especially, I guess, for us and our system, you know, we are in, we do have a unique ownership model, and that comes with it, a relatively unique culture as asset owners, as part of these bc entities that we spoke about before, as part of a member of profit for member organisation, you know, how do you create sustainability in foreign jurisdictions around the nature of who we are as an employer, of who we are as an investor, and the nature of our beneficiaries, who are very, you know, they're unique. Relative to others, and making sure that we really embed that in a sustainable way, we want to do that in a really considered and focused and thoughtful way. Now that we've now that we've built that office off the ground and up and running,   Wouter Klijn  30:14 So does that mean that you want to be largely maintain an Australian-based organisation with its staff, the majority still based in Australia, and I asked that in particular because you mentioned you might have to look beyond liquid assets within the London office, see what other opportunities are there, and obviously we have the example of Australian super having moved pretty much their entire global equity capability to London, building out an internal team there, is that something that's on the cards as well?   Simon Warner  30:48 So, you know, I think the fund is going to be around for 100 years, well past me, and over that period of time, it would seem natural to me that we become a more globalised organisation, it will be the decision, the decision rights of people who follow me, probably about the pace of a lot of that. I think my task in this, at this stage of our historical evolution, is to create a legacy of very strong foundations around how we take a domestic business and make it a global business. I suppose my perspective is that I think that that's not that is not a trivial task. It's a difficult task. It's a difficult task to thrive in environments that are not, not, not close to a home base, especially when you've got an organisational identity that is very much you, you know, I think that aware is aware as a profit for member Australian Superannuation Fund, and that makes it different from other investors and other employers in as we go into these other jurisdictions, you know, one thing I think that is non-negotiable in investing and in business more broadly, is real alignment with purpose and culture, and we need to be really clear that the alignment that we create around purpose and culture is really enduring in those foreign offices, because they come with enormous opportunities, but these, these initial forays, at least, when you're still forming and haven't necessarily been stress tested, it comes with some risks as well. It comes with risks around individuals, it comes with risks around around how you deploy. It comes with reputational risks that we might not have full visibility into at the moment, and so it's a careful, considered approach. But I think over the very long term, it's natural that we're going to be heavily, heavily populated with folks outside of Australia, just not in the next two or three years.   Wouter Klijn  32:47 Yeah, yeah, fair enough. That expansion is still sort of along the lines of super funds as basically managers of asset expansion, assets for members, but as funds grow and as we head towards more, more people shifting into retirement, the argument can be made that super innovation funds will have to become more like full service organisations, and sort of thinking about your background at A and B and at JP Morgan, do you think, do you see at one point, where super funds are no longer just investment houses, but become more, you know, fully vertically integrated financial services companies.   Simon Warner  33:29 Well, I think we are already vertically integrated in the sense that we have that direct relationship with our customer. What really differentiates us from other institutional investors, you know, sovereign wealth funds, European insurance companies, or the UK pension cohort, or the public schemes in the US, is that we do have that direct relationship with the customer. We've spoken about what that means for the management of the portfolio, but what it also means is something about the entity itself. So, at Aware, we've got, you know, 1700 odd people, about 10% of them work in the investment team. The rest of them are focused around the other activities of the fund, obviously administration, but also very much so around connectivity with the member base, about ensuring that they are, you know, well informed, well cared for, and that we're helping them with their journey through accumulation into retirement, as you say, and so in many ways to my eye we are already there. I wear different hats in this role in different contexts, but one of the hats that I'm wearing very frequently is as a member of the executive group. You know, I'm very lucky to be working for the best CEO in the industry, but we at the executive level have a, you know, we're not focused on the on only on the fund and on investment performance, we're focused on all sorts of other metrics around the health of the organisation and the benefit that we're delivering to members and the sustain. The long-term benefit that we're delivering to members, and so in many ways we're already not purely an investment house, we are a, you know, a member, a member service organisation that is obviously, we do know this sole purpose test that our core purpose is to deliver, deliver income in retirement for our member base, but doing that is not just about buying low and selling high, it's about creating the environment and the connectivity that we're assisting that group through not only accumulation into retirement, but then also as they go through retirement, how do we make sure that they're in a position where they're making the most out of their hard-earned money.   Wouter Klijn  35:36 And I think Aware also is unique in that situation where it said for many years a strong base in financial planners and employs its own financial advisors. Do you sort of do you get feedback from the member base on ways that influence the portfolio in terms of how they think about investment options, and you know what they understand of investing in how to translate in how you can communicate it?   Simon Warner  36:04 Yeah, well, you know, working as a, as an investor within aware, you know, one of the wonderful things is the connectivity with the end beneficiary. So, the end beneficiary for us in our situation is not, you know, a member number on a, on a spreadsheet, or it's not a, you know, a pool of capital that's for the benefit of a, of an, of an unnamed set of cohorts that are made many steps away from you. You know, we, we can hear about the human stories of our members on a daily basis, and we really go out of our way to expose ourselves to that, and we go out of a way, our way as an executive group to really share some of that, in terms of your question. Absolutely, we get, we get real, real time feedback on the way that we are performing, both, which we welcome, both in terms of our outright performance, our relative performance, but also the kind of way that we go about our business, you know, one of the things that we haven't articulated so far in the conversation is, is member expectations that are beyond that price and return target. There's also a general expectation upon our member base that we operate in an ethical way, and we do the right thing, acknowledging that the right thing means different things to different people, and on our member basis, 1.4 million Australians, and that represents the gamut, the spread, and a spectrum of opinion on on any matter we might want to put on the table, and so we're not in the business of of ethical investing, we're not in the business of aligning to an ethical framework, we are in the business of managing responsibly and managing to their long-term benefit, but fall short of, you know, some of the more active impact style investing that others do. Although there are parts of our cohort who would like us to do that, we're lucky enough to be able to provide investment options for them, which are a little bit more along that part of the spectrum, and so they're welcome to invest with us through those kinds of options, but we've got to be respectful for the for the big lump of co of members who are not daily engaged in their balances or the way that we're operating, and we're doing the right thing by them as well.   Wouter Klijn  38:18 Yeah, yeah, so we started this interview discussing your very background in equities and fixed income, and even sort of the hedge fund type strategies. If you look back across sort of the very different organisations that you've worked for, are there any lessons learned that you could share with our listeners?   Simon Warner  38:38 What I mean, I again, I would lead with I feel remarkably lucky. I feel remarkably lucky for the organisations that I've worked for, and remarkably lucky for the people that I've worked for. You know, the very best organisations and the people that I've worked for. It's been, it's been a real alignment of culture, it's been an alignment of personal development, it's been an alignment of principles to me. Those are really sacrosanct. I think I've been given, you know, I owe a lot to Mark Beardow, my first boss at AMP Capital, in one specific professional way, and then one personal way, which I'm also happy to share, but his level of rigour around an investment process, articulating an investment process, making your investment process a perspex box that you can describe to yourself, that you can describe to other people around you, and that you can sub, you can describe to people who will occupy your seat into the future creates a lasting legacy for the organisation, and creates a lasting asset for the organisation, and that's one of the primary things that we're tasked with doing, is not just delivering returns today, but institutionalising the way that we operate into the organisation, not so that the way that. Operate today can persist forever, but so that you've got a framework for improvement, for improving it, and enhancing it. And Mark really, really drummed that into me. The other thing that he drummed into me was a level of humanity and a level of care for me was I was going through difficult periods in my personal life, and he was always there for me. And through those sorts of experiences, you, you know, you really breed loyalty and more, even more motivation.   Wouter Klijn  40:26 Yeah, Mark is a great guy, and I think a lot of his background has dealt with investing in sort of an insurance context, which, of course, places a lot of emphasis on risk management. Has that sort of influenced you?   Simon Warner  40:39 Yeah, that's right. I mean, so, so that time I spoke about when I was with First Chemical Bank, then then Chase, and then JP Morgan, you know, the in that sort of very liquid, very fast moving, you know, more dynamic hedge fund space. Frankly, I found that very difficult. You know, I think that that is a very difficult task within, within of the spread of things that you could do in financial services, trying to figure out where interest rates and currencies are going. You know, the most highly arbitrage markets in the world is not an easy task. It forces you to be really rigorous about the way that you're thinking, and it forces you to be really rigorous about risk management. Interplaying with that, it forces you to be really rigorous about your own personality and how you create an approach to your task of investing that is congruent with who you actually are, what your risk tolerance is, and what your strengths and weaknesses are, and be really scientific and open about that. There's just not a lot of room for ego in that space. It will find you out very, very quickly, you know. Mark really embedded that into me as well, and I, like I said at the start of the conversation, I really hope that's one of the things that I've brought to throughout my career is a real focus on thinking about our role, whether it's if you are a trader or if you are an investor, the thing that you are as well is a risk manager, but that's the core lens that you should bring to the task of your role every day, in terms of deploying the capital in the portfolio,   Wouter Klijn  42:03 So Mark was one of your mentors. Do you try to fulfil that role for others within Aware? Do you have sort of a more or less formal structure for trying to develop mentorships?   Simon Warner  42:14 So you know one thing he was very good at, and then my final boss at ANP Capital Adam Tindall was just a master at it was, how do you, how do you toggle between being a teacher, a coach, and a mentor, stroke sounding board, maybe just a sympathetic ear. It's easy to drop into one of those roles, but being that the right persona for the right conversation at the right time is is extremely important. So, I had an early boss today at Chemical. He was very supportive and a total expert at what he did, but he was completely hands off, right? He was like, 'You go away and the best way for you to learn is to make your own, your own mistakes. I think, in hindsight, I would have probably preferred him to be more of a teacher than a coach. At that stage in my career, I needed somebody who said, 'Look, this is the way I do it. It might not work for you, but this is the way that I do it, in specific detail, and I encourage all of the folk on the investment team to be that person in some circumstances, then in other, in other circumstances, you're going to be well, look, this is the way that I would, I have approached in the past, it doesn't seem like it maps directly onto this situation, and indeed, you know, my, my approach is probably stale relative to the way that you could perform it, these are some of the principles you might use. I'm here to help you assess whether what's good or bad. I'm here to coach. And then there's the other end of the spectrum, where you're, you know, you're the psychologist or the sounding board or the mentor, if you like, where you're there to help create psychological stability within the person to be the best that they can be, because it's a hard game, isn't it? It's a hard game because you can't be blind to investment performance, that's ultimately what you're here for. And there are a cohort of members in our case who does, who do deserve and demand us to be delivering returns for them, and yet, if in investing you are focused on returns, you will lose the game. You have to be in a, in a position where you're relentlessly focused on the method, that relentlessly focused on the process, relentlessly focused on your inputs, acknowledging that in many cases that is going to lead to things that you regret doing, you know, if you're not making investments that don't go 100% according to your, your preconceived plan, you're probably not doing enough, you know, and even if you're even if you've got a perfect, a perfectly conceived investment pro. Process, it's going to be wrong a lot, and how you create an environment where you're able to manage that specifically within the portfolio, specifically within an asset that you manage, but vitally within yourself. How are you able to create a level of dispassion and detachment that's not at the expense of some of the gut feelings that we all have. I'm not suggesting we become automatons, but I am suggesting you need to create an environment where you are turning up to be your best every day, and that is a unique question for all of us. You know, some of some people just kind of have it, don't they? Some people, and I would, I would confess that I was one of them. And when I was younger, I would, I would feel my mood, my heart rate by my P and L, and that is not a sustainable position to be in to make good decisions. And so, so a large part of my job now is is to create, making sure I'm creating those environments where not only the leadership team but everybody in the team has that psychological stability to be their best.   Wouter Klijn  46:12 It's interesting that you say that, because we had a discussion here at [i3] in the last couple of months about the role of a CIO: are they still investors, or have they moved on to become more managers? Yeah, it seems that you're thinking about that same sort of sort of plan, where you're basically moving more towards the management style rather than a pure investor.   Simon Warner  46:34 Yeah, so you know, I don't often have conversations with people that last more than half an hour, I don't start bringing up movies, so I do think that the role of a CIO is sort of akin to a, it's sort of akin to a director, where you do need to have some level of consistency of vision and consistency of what you're trying to achieve, but you've got to have the light touch that allows that acknowledges that the task is extremely specialised and probably becoming more specialised as we speak, and that the worst possible thing is for a generalist to come in and try to replicate or second guess a specialised task, and so what I'm trying to do is do both of those things at the same time, me with the leadership group creating a level of consistency about what we're trying to achieve, how we show up, what we really believe in, what are the key principles that we really believe in, and what's our intent here. We're not, we're not acting without intent, but we're acknowledging that the extremely diverse and specialised expertise that we have here on the floor, and then one level of separation around where we go down into our manager base, we're in the privileged position to try to maximise that, not to go in and question it, and not to go in and try and try to replicate that level of specialised knowledge, but not to disempower you by, you know, fall into the trap of being disempowered. You've got to have your hand on the tiller, and you've got to know the direction you're sailing, but you can't make every call.   Wouter Klijn  48:12 Yeah, yeah, fair enough. So, CIO is a movie director.   Simon Warner  48:16 Oh, don't, don't quote me on that. Come on,   Wouter Klijn  48:17 You're on the record. I think that's a good title for my next project. Simon, thank you very much for your time. I see we've run out of time, but thank you for your insights, and it was great talking to you.   Simon Warner  48:31 Thanks a lot. I really appreciate you, and I appreciate everything that you and [i3] do. You play a really important role in our community, so thank you very much.   Wouter Klijn  48:38 Thank you.
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  136: Circle the Square – Environmental Risk and the Repricing of Stability 31.05.2026 1u 12min

  In this special episode of the  [i3] Podcast, we're partnering with the University of Technology Sydney for the Circle the Square roundtable discussion. Today's topic focuses on environmental risk and the repricing of stability. For most of financial history, the environment was treated pretty much as a given, stable enough to model around, reliable enough to insure against, and predictable enough to build on, but that assumption is now under pressure. Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights Key Takeaways The foundational assumption is breaking. Finance, insurance, and infrastructure planning were all built on 12,000 years of environmental stability. That stability can no longer be taken as a given, which undermines actuarial models, long-duration asset valuations, and infrastructure design. Insurance is the canary in the coal mine. Insurers were among the first to feel climate risk directly through claims. APRA has flagged that one in four Australian households may soon be unable to afford home insurance — effectively making the taxpayer the insurer of last resort. Disclosure isn't the same as resilience. Reporting frameworks like TCFD are a useful starting point, but simply mapping risks doesn't mitigate them. True resilience requires collective, systems-level investment — not just individual firm-level action. Short-termism is a structural problem. Pension funds have long-term liabilities but face peer-comparison pressures that punish near-term deviation, creating a mismatch between the time horizon of the risk and the incentives of the managers. The Monday morning question: Are the assumptions underlying your portfolio — on insurability, asset longevity, and gradual linear change — still valid, or are you already running on outdated models? Speakers Martina Linnenluecke, Director, Centre for Climate Risk and Resilience, University of Technology Sydney Kristy Graham, CEO, Australian Sustainable Finance Institute Rob Prugue, Lecturer, University of Technology Sydney, Anchor Fund Wouter Klijn, Host, [i3] Podcast Overview of Circle the Square podcast 06:00 The world has seen a stable climate for the last 12,000 years. What happens when we move into a new regime? "We've assumed that environmental stability was a freebie, but the last 20 years has shown that is not necessarily the case. And the markets are beginning to take notice." 09:00 "Climate and environmental risks are no longer abstract externalities; they are felt across sectors." 11:30 We are seeing that in some countries, climate change is factored into infrastructure planning. Does that happen in Australia? No, but it should 13:30 "Climate science has become a political debate. As a result, policy is set based on the political climate not the science itselft." 16:00 We are seeing increasing standardisation of tools or frameworks across asset classes and providers and that matters because it enables you to look across your portfolio 17:00 "It often starts in an ESG function, which develops a centre of expertise, but in the organisations we work with now it sits right across the whole organisation." 24:30 There seems to be a disconnect between the way in which the investment industry assesses climate risks compared to how climate scientists assess it. "We do see more sophistication around how scenario modelling is used. But there is certainly a communication issue" 25:30 "It certainly is not just a temperature increase; it is a much broader, systemic issue." 29:00 "For a pension fund, to walk away from your long-term liabilities when it comes to climate risk doesn't really add up." 35:30 "APRA is concerned that one in four households will not be able to afford insurance in the future. In coastal towns, it is 50 per cent." The rise of insurance deserts 37:30 The silver bullet is building models that support resilience, rather than the current model, which is disaster recovery after an event has occurred. 50:30 "We don't have DCF (model) for opportunity cost" Full Transcription of Episode 136 Wouter Klijn 00:00 Welcome to the i3 podcast. In this special episode, we're partnering with the University of Technology Sydney for the Circle the Square roundtable discussion. Today's topic focuses on environmental risk and the repricing of stability. For most of financial history, the environment was treated pretty much as a given, stable enough to model around, reliable enough to insure against, and predictable enough to build on, but that assumption is now under pressure. Environmental risk is moving through the financial system in a way that is becoming harder to ignore. Insurance premiums are rising and cover is narrowing. Infrastructure built to last decades is now decommissioned ahead of time, and capital is being asked to fund a transition whose policy settings keep on changing. So, this is not an ESG conversation. It's a question about the structural foundations that finance has always taken for granted, and what happens when those foundations start to reprice. Today we have three speakers who are well placed to assess where the pressure lands in this discussion, who absorbs it, and what the response could look like. We have Martina Linnenluecke, who leads the Centre for Climate Risk and Resilience at UTS, and has spent a career examining how environmental change reshapes companies, industries, and financial markets. She was also a key contributor to the Intergovernmental Panel on Climate Change's sixth assessment report. We also have Kristy Graham, who is the inaugural CEO of the Australian Sustainable Finance Institute, an independent body that works with Australia's largest financial institutions to realign the finance sector and ensure capital flows to activities that will create a sustainable, resilient and inclusive economy. Kristy, I think you were also involved in the establishment of the first Australian Government Impact Investment Fund. And, of course, we also welcome back Rob Prugue, who is honorary industry lecturer at UTS and one of the driving forces behind the UTS Anchor Fund, an educational investment fund managing real money managed by students. The question we're here to explore today is, what does finance do when the assumption it was built on is no longer holding? Rob, maybe I can ask you to set the scene. Has environmental risk moved from externality into something that investors now have to price, underwrite, and perhaps insure? What do you think? Rob Prugue 02:37 Thanks, Wouter. And thank you for this opportunity. I guess, like the rest of us, I too have been wondering for quite some time now about the impact on the environment, not just in my everyday life, but as an investor thinking about capital markets, pension funds and superannuation, and how they manoeuvre around these highly heated discussions around environmental science. What triggered it for me was some years back when I did the Camino de Santiago, and had the good fortune of meeting many people, one of whom was a professor at Oxford, a palaeontologist and climatologist, which is an interesting mix. Naturally, it raised a few eyebrows, and I asked, "Please explain." He said, "Well, we study the environment through studying Earth's history," and he reminded me that, of Earth's 4.5 billion-year history, roughly the last 12,000 years have been the most environmentally stable, and humanity, as we know it, thrived and flourished under that stability. Of course, we had storms, of course we had volcanoes erupting, of course we had floods, but for the most part the environment and the seasons were predictable. That allowed farming, agricultural growth, town growth, and a level of prosperity that humanity had not necessarily seen before. So that got me thinking. If that's true, what happens if we start moving into a new regime, and how will we adapt? We're so accustomed to that stability and predictability that it flows through everything from actuarial science and the pricing of insurance products through to assumptions on long-duration real assets. The generator is going to be there. The airports are going to be there. The assets are not necessarily going to be damaged in ways we haven't priced. For many decades, if not centuries, we've assumed that environmental stability was a freebie, a free get-out-of-jail card. The last 20 years, or even 15 years, has shown that is not necessarily the case. So, while politicians and others debate the science behind environmental science, there are movements afoot. The markets are beginning to take notice. Wouter Klijn 05:22 Yes, Martina, if I can move to you, do you already see a realisation of this entire strategy and potentially more on the operational side of businesses? Martina Linnenluecke 05:35 Yes, I think we are definitely seeing that climate risks are increasingly factored into decision making, and the science is clear. We are going to see very fundamental changes in environmental conditions. We are going to see massive shifts in temperature. We are going to see changes in extreme events, which are going to be very impactful, and in the conversations that we have with leaders in industry, we can definitely see that these risks are already felt. Certainly not across every sector to the same degree or extent, but we do see that some sectors are starting to be very concerned, especially when we look into changes in extreme events and how that affects everything from supply chain, cash flows, asset values, insurability, financing costs and operations, but also strategic viability. So, there's now a real question around where should we invest, how are we investing, and what can we do to protect these investments in the long run. In many sectors, especially those with long-lived assets, these are very difficult considerations, because some assets have lifespans of 30, 40, 50 years. We can't just go in and replace all that infrastructure all at once. That also means it's very important at this point in time to really see how we can make those decisions going forward, so that they last us for the next 20, 30, 40 years, in a way that is climate adapted. So, from my point, climate and environmental risks are certainly no longer abstract externalities. They are felt increasingly across sectors, they're already impacting strategic decisions, or have at least started to in many sectors, and we also see that these risks are becoming more visible generally across our communities as well. Examples include flooding, bushfires, and heat stress. In particular, we're getting more and more days with extreme heat. We see supply chain disruptions as a result. We see water insecurity concerns, also around food supply and food supply chains. But that's only the impact side. Then we also have the transition risk on the other side. What's happening in terms of changes in regulation and technology is certainly very impactful in some sectors as well. In Australia, now we've got mandatory climate-risk reporting, which to some extent is more of a reporting than an adaptation exercise. But I think it is definitely raising awareness that there are physical risk and transition risks coming in. In other markets, we already see carbon being priced in, but also investor expectations are changing. So, yes, we see that these environmental risks are starting to become more visible, and they're starting to be integrated. Environmental change is definitely starting to matter from an economic perspective. But in particular at this point in time, the question is also, how can we adapt to these changes, and adapt to them in a way that makes sense, while factoring in the very significant environmental changes that we're seeing. Wouter Klijn 09:01 Yeah, so you mentioned that some investments have longer term horizons, 30 years. What does that mean when you look at it by asset class? Infrastructure often has a very long lifespan. You can take that both ways, either, well, we won't divest from this investment for another 30 years, so we have time, or you can think, well, we're going to hold this for 30 years, we have to start now to understand what's happening to this asset over the longer term. Do you see any approach to that? Martina Linnenluecke 09:33 What we definitely see is that in some countries climate change is very much factored into infrastructure planning. So when infrastructure is built now, there needs to be a provision, for instance, for sea level rise. When we look at road infrastructure, bridges, especially in exposed and vulnerable areas, they are being built with a certain consideration for flooding, for sea level rise, and for other types of extreme events. Has that necessarily happened here in Australia? Perhaps not. Should it? I think so. But that includes every type of asset that is longer lived. We've got power stations, transmission infrastructure, transportation infrastructure, road infrastructure. Even things like housing are also, I think, a very big area where we need to see changes in climate adaptation happening as well. A lot of the housing stock that we've got here, when you look locally here in Sydney, is not really adapted to climate change. These are not really infrastructures that are built for a changing climate, so I think there's a lot of work to do. The smartest way would obviously be to start factoring in these decisions right at this very moment, so that we are not unprepared 10, 15, 20 or 30 years down the track from here. Wouter Klijn 10:55 Yes, it's a very sort of, I think, already tangible issue, because I was just reading an article about Tuvalu, and they have one international airstrip, and they're trying to raise the land around it, because it's already being affected, not just from high tides, but also from water coming in from the ground because of the rising sea levels. Rob Prugue 11:16 I know that well, because I was meant to be in Kiribati as well, and Kiribati and Tuvalu are going to be among the first climate refugees. But that aside, in long-duration assets, particularly real assets, there's another factor above and beyond what was just mentioned, and that's policy. For some reason, in the last 10 or 15 years, science has become a political debate. We see that in health science. We see it in economics as well, including the idea that tariffs are somehow a straightforward revenue earner, which contradicts what we know. The same is true in environmental science. Policy settings can now change depending on the political agenda, not necessarily on the science itself. Generation is one good example, whether it's coal, gas, nuclear, solar, or in the case of the US, wind farms that were nearly finished and then became too green, so let's turn it all off. Policy is another situation that needs to be considered. Wouter Klijn 12:35 Yep, for sure. Kristy, if we may turn to you. You speak with a lot of the financial institutions here in Australia. Do you see them starting to build tools and frameworks around this problem? Kristy Graham 12:47 Yeah, absolutely. And I would add that it's not new for the finance sector to be thinking about and integrating some of these environmental risks. Just this morning I was at the 20th anniversary of the UN Principles for Responsible Investment, so that is an initiative that has been going since 2006. It now includes in its signatory base over half of the assets under management globally. So it is not just the longevity of long-term investors thinking about and integrating these issues using a range of tools, but also the uptake, particularly in the last five to 10 years, and the penetration right across the financial system. I would say insurers have also been very acutely aware of these physical risks because it impacts very directly on their business models, and banks are increasingly recognising and using a range of different tools and approaches. Where we've got to now is that there are industry-wide standard tools and frameworks, which is very helpful, because previously you could assess transition risk or physical risk in a range of different ways, and it depended on the advisory firm or the expertise you were able to have access to. What we saw with global frameworks like the Task Force on Climate-related Financial Disclosures, and now the ISSB taking up those standards, is that there's a much more standardised way that not just investors and the finance sector, but also the corporate sector, can use to assess and mitigate the risks, but also identify the opportunities. The finance sector are obviously aggregators of information from the real economy, and that consistency and standardisation really matters, so that you can aggregate and look across your whole portfolio. We're not only seeing standardisation of the tools and frameworks, but also a much more sophisticated way of applying them and taking decision-useful information to inform strategy and the future direction of these institutions. Wouter Klijn 14:45 Yeah, we started in the beginning by saying this is not an ESG conversation, this is a much more systemic financial stability discussion. Do you see this as well in the way that organisations approach this? Is it very much like these are a series of ESG tools or ESG framework taxonomies, or is there more a growing sense that this affects everything we do throughout the organisation? Kristy Graham 15:12 I think what we're seeing, as organisations become more mature in their understanding of the commercial realities of all of these risks, is that it becomes integrated into core business, whether that's investment teams, risk teams, product development teams. So we see in lots of the organisations we work with that it will often start in a responsible investment, sustainable finance or ESG function, and they will develop a centre of expertise. But where lots of the organisations we work with now are is that that's integrated right across the organisation. Its reporting might sit under the CFO or the finance function, but there are inputs and expectations that the investment teams and right across the different product teams will all contribute to both mitigating risk and identifying opportunities. Wouter Klijn 16:02 Yeah, now environmental risk doesn't fit neatly into financial models. I was thinking we had one time a conference where somebody stood up during one of these discussions about environmental risk and said, well, one of the reasons why it's hard to deal with is because it's an unaccounted for risk. We don't really know how to incorporate it into our system, and that has to do with different sets of information out there, no standardisation, but also because when you model this out, there are a lot of assumptions that you have to make. These are long-term trends, very far into the future, and it made me think, I was talking to Rob about it, Peter Drucker, the management consultant. He said, "What gets measured gets managed." He didn't say it exactly like that, but close enough. And this is hard to measure. Maybe, Martina, I can ask you, is it possible to build a comprehensive framework around this in a way that is easier to deal with? Martina Linnenluecke 17:03 We've definitely seen the attempt to build a framework with the TCFD recommendations, and now also the adoption of climate-risk reporting here in Australia. I think that's provided a starting point. Organisations are exposed to different categories of risk, and they are guided through a process to assess those risks, looking at physical risk, transition risk and other risk factors. Importantly, it also changes the outlook towards the future. This reporting is no longer about past performance and past financial risk. It's really about assessing what is going to happen going forward. How does our exposure look when we factor in different climate scenarios? In my view, this is the most interesting part of the reporting exercise, but also the most challenging to implement, because it requires a lot of expertise in understanding climate risks and modelling. That is not necessarily expertise that has traditionally been held by companies, or traditionally factored in. There's still a lot of sense-making going on around how best to do it, and a lot of uncertainty around how to make scenarios that sometimes seem very abstract more tangible. How can we operationalise them for the company? What do they mean for specific sectors, locations and assets? There are all sorts of different ways to downscale them, but more importantly, it is forcing exposure to a changed reality. We no longer have business as usual. There will be a different reality, and the question becomes, what does that reality look like? The impacts will be felt differently across sectors, firms and locations, based on exposure, operations, infrastructure and indirect exposures such as energy costs. So there is definitely a lot to think through. It really requires an understanding of future change, and how future change is going to have consequences. There are indicators that companies can now use to report, and under the current reporting structure there are categories that need to be reported on. But in my mind, the interesting part is where we see that there's still a lot of expertise needed to fully engage with future scenarios and what they mean. There is uncertainty in these scenarios, which obviously we have to acknowledge, because the scenarios are not a given. They are changing as we are changing as a society as well. Factoring in different types of policy changes and different types of physical risks will lead to different future scenarios. Sometimes it's confusing when it comes to selecting the best scenario, and there is not necessarily one best scenario to select. That creates uncertainty around what future we should look at or prepare for. But again, it forces exposure and engagement with a changed future. It also requires companies to think through how to address it. For instance, two firms may disclose the same type of exposure to heat or extreme weather, but ultimately it comes down to who has the operational flexibility, resources and capital required to adapt. In my mind, those are the interesting questions that we get into with these types of reporting exercises. Wouter Klijn 21:25 Yeah, so a while ago I looked into the criticism around integrated assessment models and the tendency to look at a very isolated environment and not necessarily take into account trends that move across countries, across jurisdictions, and it struck me that when I looked at the literature that's out there from climate scientists and the way that the finance industry incorporates it is quite different. To give you a tangible example, I've looked at a couple of superfund reports, and they do these scenarios where they say, okay, this is the impact on our portfolio at two degrees, three degrees, four degrees, five degrees, six degrees, and even I think at six degrees it was like, ah, we think it's about 1.2% lower than what it is now. Then I showed it to the climate scientists, and they were like, at six degrees we're dead. So there's a big difference in how they deal with these forecasts. Is there any improvement on that, or what do you think about that? Martina Linnenluecke 22:26 Yeah, look, I think sometimes the scenarios that we see coming out from the sciences are used in a very instrumental fashion when they are incorporated, like you just mentioned, in a report, in a straightforward way, without looking at the bigger picture behind it. We do see more sophistication around it, which is part of this evolution in how companies are engaging with climate risks and future scenario analysis. Part of the issue is that these fields have traditionally not really connected to each other. Climate science was never started with a view towards informing finance, and finance was never started with a view towards needing to be informed by climate science. So, there's definitely a communication issue at the intersection of these fields. But there's also where people like myself come in, with the work that we are doing within the Centre for Climate Risk and Resilience, where we are really looking at ways to communicate those risks, visualise them and make them tangible. The point is to bring them to life rather than have them remain an abstract risk that is just factored in as a number in a modelling exercise. It is definitely not just a temperature increase. It is a very systemic, comprehensive change that we are going to see, affecting all levels of society. If we've got a six degree rise, just to take your extreme example, here in Sydney, there will be parts of Western Sydney where areas might become uninhabitable, or where it will be very challenging to provide enough cooling and shade in some communities. So all of that creates a much bigger systemic issue. Water stress, how do we get enough food on our plates under such a scenario, and other risks like that. I think the systemic nature of the risk is a really challenging part to fully incorporate and fully understand, but I think we need to engage with those questions. Wouter Klijn 24:37 Yeah, and Kristy, what efforts do you see to convert these types of risks into action? Kristy Graham 24:43 Yeah, I think this point that you were making, Martina, about the capability that is needed, and that being probably developed in other disciplines, is something that we work with across the finance sector quite a lot. There's a multidisciplinary approach that is needed for financial institutions to understand these risks, to make sense of them, and to apply them in a business context as well. So we see that being a huge unlocker of not just better mitigating risk, but also capitalising on those opportunities, and being able to forecast, not predict, but to look at the range of potential future scenarios and what that would mean for business models and strategy. At that point, what we do see, and this is across business and finance, is people, because they don't necessarily have the technical capability, find tools and frameworks that make it very clear what and how you need to do as a base level. That is really important and a really critical way to get started in better understanding these risks. As I said, the tools and frameworks are growing, both in sophistication, but also importantly moving from a risk to an opportunity lens, and that's where taxonomies come in place. They identify what sorts of investments and economic activities will support the climate transition. So, rather than needing to understand how different sectors may evolve, and crunch all the science on an individual investment level to see whether a particular technology or activity will support the climate transition to net zero, a taxonomy outlines those activities and measures, so that it's much easier for capital to flow towards those measures that are supportive of the transition. And we see now the taxonomy being adopted across the market. I think we're up to the sixth or seventh taxonomy-aligned transaction in the debt capital market space, and a number of sub-sovereign, as well as bank sustainable finance frameworks, are now aligned with the taxonomy. So, it is something that the finance sector both supported the development of, and now is finding really useful as a tool. Rob Prugue 26:57 Yeah, what I don't understand, because I've heard that before as well, Wouter, is that other than maybe endowment funds, pensions have a long-term liability that we're trying to immunise. So, by definition, we have a long-term outlook. Some of the biggest investors in unlisted real assets are pension funds, because they say we like the long tail of it, and it matches our liability. So to then walk away from the long-tail implications of the environment doesn't really quite add up. I'm not really sure about that. Secondly, I think we need to differentiate between inputs and outputs. The output is that we're seeing the numbers firsthand because many super funds are large investors in insurance companies. Even catastrophe bonds are now an asset class that they're looking to invest in, so they are investing in these asset classes. They have access to this information. Whereas the data may be difficult to model, not trying to model it or understand it is an active bet. It's an active bet that may or may not pay off, but if you look at the numbers, it probably won't pay off. Lastly, I think it's true that most boards and ICs don't necessarily understand the full implications, and I respect that. But do they understand the billions of dollars going into data centres? Do they understand what the payout is going to be? Do they understand that the shelf life of many data centres is five years, yet the amount of money required to build them runs into billions? So the irony is, we have a long-tail outlook, we invest in long-tail and long-duration assets, but when it gets complicated, even though the numbers are right in front of us, we claim it's too difficult and put our arms in the air. That's where I would challenge trustees and IC members. Wouter Klijn 29:03 There is that inherent tension between the short term and the long term within the finance industry, because you obviously saw that when Russia invaded Ukraine, there were a lot of funds here in Australia that had moved to low carbon indices as benchmarks and got hit more severely than other funds, and that caused a little bit of a rethink with some of those funds. So you will have these types of points during the next couple of years as well. How do you deal with that short-term tension where we have to be the best fund over the next five years versus the longer term systemic issues that this is referring to? Rob Prugue 29:46 Complete mismatch, and it starts from the top. You've heard me numerous times bickering about heat maps, where it's a race to the middle, where if a pension fund moves in a certain direction, and for a short period of a long-duration portfolio objective it is not meeting that relative to peers, they get penalised. So what almost requires, in your example, is everyone has to do it, so therefore there won't be financial consequences and regulatory consequences for veering into something that's in front of us. The regulatory system around many super funds requires all or none, that everyone has to move in that direction. To do that in the world of investments, where there's always a buyer and always a seller, is very challenging. Wouter Klijn 30:46 You brought insurance up with catastrophe bonds. I think we've seen some of the insurance companies becoming probably first aware of climate change and the impact on their business, just by the nature of it affecting their claim experience, and affecting how they price their coverage. But ultimately they can't carry all of the risk, and that will filter through at the same time. Some insurance might become impossible, and I think it's sometimes said that for any economic activity to occur, you need to have insurance first, otherwise nobody's going to take any risk. How do you see that moving when environmental risk becomes too much for insurance companies to carry, and it filters through? Does it filter through to other companies, to members? What do you think around that? Rob Prugue 31:35 Well, let's look at insurance and why it exists in the first place. It takes away the sting of the unexpected. If we date back to insurance roots, or Lloyd's and shipping, through to modern day, as investors, as lenders, obviously we want to know that there is an exit where a return is not only generated but at least the capital is returned. The reality, though, particularly with insurance, is that while politicians debate the science around the environment, right beneath them is a situation where households are feeling it immediately. Ask any household what their home insurance was five years ago versus what it is today. APRA itself is concerned that in future, one in four households may not be able to afford insurance, with some rural and coastal communities facing even higher pressure. So who insures these homes? Who insures these farms? Who insures these businesses that exist up and down? We know here in Australia, 90% of our population live within 100 miles of the coast. I think it may be even higher than that, but regardless, we are a coastal community. Whether we're talking floods, bushfires, or any other type of environmental damage, these rural communities are feeling it immediately. The challenge, however, is that even though we see these numbers, it's become politicised, where the rural community is now concerned about sustainability of their livelihood. I'm not talking about their actual homes or businesses, but employability. Whether there's an affront against carbon energy, whether it's coal mining towns in the Newcastle area, or whether it's LNG in WA, these communities are very vocal about climate issues, and politicians, particularly populists, are grabbing into that. Regardless, insurance is an environmental risk that has now become an input. It's now visible. It's not just visible in portfolios, it's even more visible in households. And so now we need to understand that insurance affordability is creating these insurance deserts where people can no longer get insured. Do we honestly believe that the government will let these people go uninsured if a catastrophe occurs? If not, then the ultimate underwriter is the taxpayer. And before anyone gets overly up in arms, we've handed out more billions to corporations that were on their knees because it was necessary, so-called. Ask yourself that same question. When a large portion of rural Australia is unable to insure themselves, who is the ultimate underwriter of that insurance package? It's you and me. Wouter Klijn 35:10 For sure. Kristy, when we talk about insurance, it's more or less like an expectation that an event has occurred, and insurance is dealing with the aftermath of that. How do you look at models that firms come up with that try to anticipate these things from happening and potentially direct capital towards mitigating these risks? Kristy Graham 35:36 Yeah, and I think that is the absolute silver bullet in this adaptation resilience space, shifting the investment to build resilience in advance rather than the current model, which is supporting disaster recovery and rebuilding after an event has occurred. Governments have that model of funding as well, and that is the insurance model. That said, a number of insurance companies are working much more proactively with their customers to support them to build resilience at the household level, but there's still a lot more that can be done in that proactive space. There's been lots of research that has demonstrated the economic payback of that. For every dollar invested upfront, you save $9.60 in recovery costs. The Australian government is already spending 38 billion annually on natural disasters, across governments in Australia, and that's projected to go up to 73 billion a year by 2060 if there's not a huge amount invested up front in adaptation resilience. So the numbers are very clear and compelling. There's a range of reasons as to why that value is not able to be captured in investment models at the moment, and why it's difficult for both governments as well as private businesses and investors to make that case for those upfront costs and expenditure. That said, there's a range of things that the work we've done with other players right across the finance sector shows will help to shift that dial. One is around valuation approaches and frameworks, and the Actuaries Institute has done a huge amount of excellent work on the relatively small tweaks that you can make to the way valuation frameworks that the public and the private sector use to shift that business case, to make it much more compelling to make the investment upfront rather than the recovery investment. The other issue often with adaptation resilience investment is the benefits or the avoided losses don't necessarily accrue to the same actor that is making the investment upfront. So if you're investing in community-based infrastructure, a local council whose source of revenue is from all ratepayers, there will be only a certain small portion of those ratepayers that will benefit in terms of reduction in their insurance premiums, for example, those that are most flood affected if it's flood resilience works. So there's a range of interesting models that are being used internationally to try and use various different structuring approaches and multi-stakeholder collaborative co-design processes, so that you can solve some of those issues. The other issue often is that there are projects at small scale, and so for a commercial investor, that's not necessarily at the scale or the aggregation that makes it attractive for them, and they're not always able to capture the commercial benefits. Again, structuring and project preparation facilities can support with that, and blended finance is another approach, where it's combined public and commercial capital, so that you can put those investments at a risk and return that's acceptable to a commercial investor over time. Wouter Klijn 38:53 Yeah, on this list is also adaptation finance. What's that? Kristy Graham 38:58 Yeah, so all of those models that I was talking about are a version of different types of adaptation financing structures. There's also when you've got existing assets and you're a long-term investor in an existing asset, increasingly those equity holders are seeing value in improving the resilience of an asset to reduce operational expenditure over time, particularly when there is a disaster. So, there's a number of fund managers and others who very actively work with their assets, whether they sit on the board or they're a minority shareholder, but a significant shareholder, to improve not just the understanding of the risk but to invest capital to improve the resilience of those assets, which will over time reduce operating expenditure and insurance premiums for those assets. Wouter Klijn 39:47 Yeah, Martina, we often talk about disclosure is not the same as resilience. You can show where all the risks are, but what are you doing about it? Can you tell me a little bit from your perspective, what does real resilience look like? Martina Linnenluecke 40:02 That's a big question. I'm not quite sure if I can answer that in the time we've got available, but I'll try. When we look at resilience, and I've done a lot of work around resilience, there is this common understanding that there is a negative impact, be that on a company, on a household, or on some other type of entity, and then the effort is always to go back to where we used to be, to bounce back to previous conditions. That is what we typically understand as resilience. The challenge with climate change, or the added challenge we are now facing, is that simply building back to where we used to be is often not the answer anymore. For example, when communities are flood affected, there has been a negative impact, and if this community builds back in exactly the same way, it could be seen as resilient, because we go back to exactly the same state we were in. But that is not really creating any type of risk mitigation or insurance against future events. If we're exactly in the same position, exactly in the same spot, doing exactly what we used to do, it's not really preparation against future risks. So the added challenge with climate resilience is that we need to think about ways to build back that factor in the future risk that is unfolding. We need to see resilience in relation to a changed future. Simply bouncing back, or building back, is often not the answer in these situations. Disclosure alone, as you said, does not necessarily lead to resilience. I can disclose all sorts of things. It doesn't mean I'm resilient when the time comes. I think what is very important with resilience is that resilience is a collective effort. With mitigation, let's assume I'm a high carbon emitting company. I can look internally for solutions. How can I emit less carbon by innovating, or by looking into more energy-efficient infrastructure investments? With resilience, it becomes much more difficult, because resilience does require a much more concerted effort within society. For instance, if I'm a company affected by sea level rise, it's often not sufficient to build my own seawall around my own assets. I'm part of a broader societal problem. I'm embedded within broader infrastructure that's affected by sea level rise. Consequently, if I'm not located in a resilient community, or in a community that at least has some level of adaptation in place, then it just means I can't be resilient under those circumstances. So it is much more of a systems issue, which means it's also much more of a coordination challenge and an investment challenge, which creates real questions around who should be paying. Kristy, you already said who is benefiting from this, who makes these types of investments, and it often does require public-private partnerships to make these types of changes that pay off. But there are also real difficulties in seeing the payoffs, because we are very bad when it comes to recognising avoided losses. Everyone sees the big impact that a disaster has and how quickly we can build back, and that's often seen as the success story. The faster we can go back to normal, the better it is, and that's often equated with success. But where we do not look for success is in avoided losses. We can't see them. They don't feel like we've accomplished anything. It's invisible, and this invisibility is a real challenge. People can't really see what would have happened if we hadn't made those types of investments, and that's often stopping these considerations. It is much more impactful to act when something has happened, rather than prevent it from happening. I think these are big considerations here, but one additional important point is that resilience is not just about having defensive infrastructure in place, or defensive assets. It's a proactive approach around how we absorb shocks, adapt operations, be flexible and recover effectively. Sometimes it requires a transformation of business models. It requires a much more multi-level way of thinking as well, and obviously does not just relate to climate change alone. We've had many other shocks, and a lot of them are really impactful. Resilience is definitely something that should not be developed just with one particular threat in mind, but as a capability that allows a lot of flexibility, no matter what the extreme event or adverse condition is that we are facing. Wouter Klijn 45:29 Yeah, Rob, from the investment industry, we look at risk from two sides. Of course, it's risk that can wipe out your capital, but also, you can't make money without taking on risk. That's where the returns, to a degree, come from. Why is more money not flowing into this area in terms of prevention and dealing with environmental risks? Rob Prugue 45:51 I've always said, if we could patent air, water, and a clean environment, we would invest in it, but we disregard it because it's free, or we underestimate its value because it's free. The thing to consider, I guess, is that for many of us, we are accustomed to market cycles, and those market cycles were met with enthusiasm, and then eventually mean reversion. As Martina mentioned, this is much more structural. This is itself a very structural event, and how we build a resilient model around it isn't just a portfolio issue. It's a policy issue. On top of that, Martina's point was very valid. Imagine, being Dutch yourself, building only a wall around your small house, but there's no wall around it, or New Orleans, or southwest England, or southeast England. Excuse me. It would serve no purpose. This is a societal problem. Our challenge right now is that we're trying to look at it through lenses that aren't necessarily built for that, and because those lenses aren't disclosing what we need to see, we either disregard it or put it aside as too complicated. I'll deal with it tomorrow. But the more we go down that path, the more, pardon the pun, the wave builds, and therefore the longer it takes to unwind from that. As for portfolios, as I mentioned before, how we address that, the numbers are there. Whether we agree on the validity of whether it's one degree or two degrees, talk to any actuary, talk to an insurance company, they have the numbers to show you of the claims, they have the numbers to show you. We can debate all we like about the science of the environment, but when we equate it back to the actual economy, at least as expressed through insurance, the numbers are already showing a huge uptake. Whether you see it directly through the insurance books, or through the premiums that we've been paying, it's getting increasingly harder to ignore. Wouter Klijn 48:16 Yep, and what do you think of Martina's comment that, to a degree, what you're trying to achieve with addressing these risks is for things not to occur. So, if you're trying to put capital to work, you often want an outcome. In this case, you often work to prevent things and hope that stuff doesn't happen. Rob Prugue 48:33 We don't have a DCF for opportunity cost. Wouter Klijn 48:36 Yeah. Rob Prugue 48:37 It was that simple. What is the growth rate that I would use for environmental issues? Martina said it well, that environmental science was on its own. We, as investors, we're the generalists, particularly pension fund investors. We're paid to take long-term views, and we have a portfolio that has large exposure to long-duration assets. So there perhaps is a gap between our due diligence and how we manage the portfolio, and what the inputs are that we assess versus what we're investing in. Wouter Klijn 49:19 Perhaps we can draw the conversation a bit closer to home. Look at Australia, obviously we have a very unique economy in the sense that it's heavily reliant on resources, heavily reliant on energy, and also agriculture to an extent. These are all sectors that are in the crosshairs of environmental risk. What is your sense, and maybe Kristy, I can come to you. What's your sense of how stakeholders deal with this issue, that any action that we take will be felt in the economy, and then an extension of that, especially in regional Australia. And sometimes these communities are not always brought along in the discussion, they just get rules imposed on them. What's your sense around that? Is it harder to implement here, and what can be done? Kristy Graham 50:11 I'd like to reframe the question, which is all about when you mentioned crosshairs of change happening to communities. There are many communities that are driving this transition and see huge economic opportunity from a green export future economy that Australia is in the box seat to take advantage of. So yes, we have an agriculture industry that is among one of the best performing sustainability-wise in the world. We also have a huge mining and resources sector that can provide things like copper, critical minerals, iron ore that will be absolutely needed for the transition, not just of Australia, but for the world. There are a number of different regions and communities that are seeing and working to develop what that economic development vision for the future looks like, and are bringing in investors and partners and different parts of government around that community-driven vision. So I absolutely agree there is a need for communities to be in that driving seat, and to be actively shaping, driving and bringing others in to support what will be a big transition globally, but particularly in a number of different local communities. But I wouldn't want what we see in mainstream media to be the prevailing narrative of this happening to regional communities, rather than many regional communities absolutely getting in front and driving this transition so that it benefits them and the future prosperity of the businesses and the regions that they live in and have lived in for a long time. Wouter Klijn 51:44 Yeah, Martina, what do you think about this? I mean, risk does tend to hit differently in different areas. Does it make it harder to create policy or frameworks? Martina Linnenluecke 51:54 Yeah, what we're definitely seeing is that there is a very uneven distribution of risk and impact. There are definitely parts of Australia that are much more exposed, but we also see a huge variability in terms of the extremes that communities are exposed to, and certainly also different needs for support and different transition requirements. Not all of that is reflected in policy decisions, especially when they're taken in a very top-down fashion. It's not necessarily giving that diversified policy set on the ground. But I agree with the comments that Kristy made. We're definitely seeing a lot of momentum at the moment. We are seeing that a lot of communities really want to be part of a transition that's happening. We're seeing a lot of momentum, both in rural and remote areas, but I think also in the cities as well. There is a lot of momentum, actually, to see what we can do, and the underlying driver, I think, for a lot of people is to live in an environment that's worthwhile living in. There is so much that we can do, and create a much more liveable environment. Certainly, we see that in Europe, just putting cycling infrastructure in has so many benefits. This is such a small-scale example, but it takes cars off the road, it allows for more physical activity, it makes people feel a lot better about their day if they're not just stuck in traffic, and so on. There are all these small-scale changes that we can implement quite easily that add up to a lot of change as well. But coming back to the more fundamental issues, we definitely see an uneven distribution of climate risk, physical risk, and transition risk as well, and it's deeply tied to the sectors and distributions that we see in Australia around resources, agriculture, energy, energy export issues, and climate-sensitive sectors. There's obviously huge exposure in parts of Australia, but then, as I said, there's also a huge variability in terms of the physical risk, ranging from bushfires to drought. In some parts, we see other types of extreme events, extreme heat, cyclones. So there's also a lot to deal with from the impact side. When we look into the climate projections, none of this is really forecast to get much better, which creates a significant concern. But more to the point, looking into any type of transition, I think it's really important that this is an equitable transition, that this brings people along in being part of it as well. As I mentioned, it's not just about infrastructure investment, it's also a huge part around social and regional resilience, and cultural change within society as well. So, yes, at the end of this, I think there are also huge opportunities involved, because we can really look into building a better future. Wouter Klijn 55:24 So I was speaking a while ago to an economist, and he suggested that perhaps if you look at areas like the Hunter Valley, that is very dependent on coal, perhaps there should be more of a government-driven push to restructure these sectors and potentially build an EV industry in the Hunter Valley. Do you think it needs to be more government driven as well, to force almost this change? Martina Linnenluecke 55:53 In my mind, the most effective change is the change that's occurring across all parts of society. I don't think it's particularly good if policy just steps in and forces an issue. It's not really going to be accepted within local communities, especially if it goes against some of the locally held values. By the same degree, just having this ground-up movement can sometimes also be ineffective if there's no supporting policy trigger. I think, looking across what the evidence tells us, and the research tells us, the most successful transitions in society occur where every part of society can actually benefit from the transition, but can also have input into these types of decisions. So it's not top-down, it's not bottom-up, but I think it really needs to happen at all levels. Certainly, that's hard to achieve. There is no perfect solution to it. But in my mind, it really requires supportive policies that encourage new sectors to evolve, that encourage investment in renewable energies, that certainly support a phase out of fossil fuels, but at the same time it really needs to bring the communities along as well. Simply discontinuing fossil fuels is not going to be a solution for some regions. It really needs to be part of a broader transition, and there needs to be consideration around, how do we best structure this? How do we create other opportunities? And how do we do it in a way that this is an equitable transition and provides opportunities to people as well. Wouter Klijn 57:38 Yeah, Rob, you got some views on this as well, because I think you say policy risk is an investment risk. Rob Prugue 57:43 Absolutely, I would add social consent to that. Wouter Klijn 57:46 Yeah. Rob Prugue 57:47 Before I do, to your point about communities that have ties to carbon energy, be it coal or LNG, let's look back at Wollongong versus Newcastle. Back in the 60s, they were both economically thriving off steel. Steel left. Newcastle had an advantage. It had big black rocks underneath it, or nearby, that opened up a new industry. If we look at the history of Australia, we've had many industries come and go. In the mid-1800s, one of the largest industries and exports was fur, seal fur. In fact, we almost went to war with the US over a land fight over seals. My point is that economic history is full of cycles of what works and what does not. But if we work to create moats that protect certain cycles or certain industries, as opposed to protecting the broader system, those are two different things. We've become more transactional. What's in it for me? And that transactional politics has, I would argue, been a key factor in driving the breakup of the LNP between the city conservative and the rural conservative. The city conservative is more willing to embrace the challenges of environmental issues and has morphed away from the traditional conservative movement towards the teal. The rural community has been more hesitant because, again, their chequebooks depend on it, their salaries depend on it. So some have been gravitating more towards the populist rhetoric of One Nation, Clive Palmer and others. Whether mainstream politics recognises this or not, this is not just a social and structural issue. It is a heavily political issue founded on a level of social consent. And as we all know, there's a hell of a lot of misinformation out there. Case in point, on the South Coast, if you drive or walk along the coastline, you'll see houses with large banners saying no wind farms. Never mind that the wind farms are going to be so far out. I respect that people have a democratic right to vote against it and be against it, but some of the reasoning I saw was not necessarily logical, and that lack of logic was driving a lack of social consent, which was influencing policy out of frustration. Wouter Klijn 1:01:03 So how do you get them to come along on the journey? Rob Prugue 1:01:07 Ironically, these are the same towns that are seeing their insurance premiums rise, and at a substantial amount. So whether we embrace it or not, climate issues cannot just be treated as a political debate. We have to find a way to look at it fundamentally for what it is, strip away the misinformation and politically motivated rhetoric, and look at it for what it is. Is it perfect? No. But this is how the political divide works. If it's not perfect, if it's not yes or no, I'm not interested. No, our world is in the middle. Wouter Klijn 1:01:58 Does it require a big disaster, you think, before we see some real change happening in this space? Rob Prugue 1:02:05 Define big disaster. My friends in Kiribati will tell you we're there, so big disaster depends on who "us" is, perhaps. But it's interesting to the point I think Kristy made, that some rural communities are embracing this. I'm going to take a punt, and I'm going to assume that those communities are not necessarily tied towards carbon energy, such as the South Coast and the bushfires that we see in the South Coast. I know they've been very proactive on these environmental issues and building resilience because they suffered so severely during the bushfires, whereas that same level of interest towards a more resilient outcome is less visible in carbon energy rural areas. Then you have the areas that are more exposed to tourism that probably have more of a stake in mitigating climate change, but even the city people as well, the city conservatives in the eastern suburbs, few would be negating the issue around environmental challenges, and I think that was one of the big drivers of why they were frustrated with mainstream politics, and they went towards the independents. Wouter Klijn 1:03:20 Yeah, so Rob, you suggested to end up with a thought experiment to a degree, where let's assume it's tomorrow, Monday, you come back into the company floor, the boardroom floor. If you're a CIO or a trustee or a policy maker, what different questions should you ask on this Monday morning than before we started this conversation? Do you want to have a crack at this? Rob Prugue 1:03:48 Sure. I guess at the end of the day, it's the same question we should always be asking. Where are the risks? Where do they lie? And where does the portfolio still assume that the old hedge is holding? I would fathom to guess it's going to be more exposed in the long-duration real assets that are illiquid, where they're having a 20% exposure. Sizable. That doesn't mean that if the proverbial hits the fan for those assets, it's not going to hit the other assets. Of course it is. It's going to hit government bonds, it's going to hit spreads, it's going to hit equity markets. But with an illiquid asset, you hold it. You cannot unwind. And where are we assuming some linear adjustment to this nonlinear risk? If we look at it that way, perhaps that will flag, and super funds and pension funds have been very proactive in attempting to quantify this, but again, I would just put it more simply. What parts of our portfolio are assuming that the old hedge will hold? Wouter Klijn 1:05:04 Martina, can I ask you the same question? What questions should we ask on a Monday morning? Martina Linnenluecke 1:05:09 Yeah, absolutely. I'm not sure if that's just the question for Monday morning, probably more a fundamental one, but I think one of the important questions is, what do we value? I think that's very important. Do we want to be part of the problem? Do we want to be part of the solution? In my mind, that is a very fundamental question, because it really comes down to what's driving the change, and whether or not people want to change and do things differently. More fundamentally, it would also be around the assumptions on which the business model, or any type of risk modelling or financial modelling, is built. I think there's a set of really important questions around what assumptions we are making, and are they still holding? Are they still the same assumptions? Historical data points have always been very important around insurance pricing, infrastructure design, planning and capital allocation. But are these assumptions still holding, or are there a different set of assumptions that might have to be made because climate change is obviously complicating a few things? Historical baselines are now becoming less applicable and less reliable. Tail risks are becoming more important, extremes are becoming more important, but also on shorter time horizons. There are sometimes these, it's a one-in-50-year event, or one-in-100-year event. This is no longer as applicable in this day and age. So, questioning those types of assumptions is, in my mind, very important. Perhaps as a thought experiment as well, go with a different set of assumptions and see where they take you. Is that still what you're doing? Is it still viable if you are using a fundamentally different set of assumptions? You might not want to keep them, you might not want to implement them, but as part of the scenario planning that I mentioned, having different assumptions can be a really important starting point just to challenge some of the thinking. It might be something people want to adopt, it might be something they don't want to adopt, but at least having that awareness of the assumptions being made is already, in my mind, a really important point to start the conversation. Wouter Klijn 1:07:38 And Kristy, maybe not on Monday morning then, but what are the fundamental questions? Kristy Graham 1:07:42 Mine is building on Martina's, so they can tackle her question first, and then come to mine, which is also based on this idea of scenarios. If you were to think of what the world, Australia, our industry looks like in 10 years' time, what is the range of possibilities? What is the range of best case, worst case scenarios? And then if we as a company or an organisation were to lean in to give the best chance of success at the best case scenario, what would we do differently to what we're doing today? How can we use all of the things that we have at our disposal to get us closer to what that best case possibility looks like? Rob Prugue 1:08:27 It's not a lack of investability. I mean, we've shown it. The world investment world has invested billions and billions and billions towards AI, where none of us really know how that's going to end. We have invested in a story without certainty of some terminal value. So therefore, if we're willing to do it with AI from an investment point of view, perhaps we should look at the same approach from a positioning point of view. Wouter Klijn 1:09:01 Yeah. Rob Prugue 1:09:01 With regard to the challenges, and to Kristy's point, the best, worst-case scenarios, we do that in most assets already, and to extend this into this matter is challenging, but it's challenging in every asset that we do it under. Wouter Klijn 1:09:17 Yeah. Rob Prugue 1:09:18 Other than cash. Wouter Klijn 1:09:20 So we started the conversation with looking at whether the assumptions on climate and climate risks have changed, and whether this will filter through more and more into the financial system. I think, for my audience in the investor world, it raises a lot of questions around whether the portfolio is running on assumptions that no longer hold true. Are you assuming a level of insurability that might have already moved on? And as you said as well, is there an expectation of a gradual change that might turn out to be much more jumpy and much more volatile going forward? Now, I'm not sure if we answered any of these questions, but hopefully we certainly have given people something to think about. I would like to thank you for participating in this discussion. So, thank you, Kristy, Rob, and Martina.
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  135: Funds SA's Con Michalakis – TPA Lite, The Comic Con of Asset Allocation and my Best & Worst Investment 13.05.2026 58min

  In this episode of the [i3] Podcast, Conversations with Institutional Investors, we speak with Con Michalakis, Chief Investment Officer of Funds SA, which is a $50 billion investment manager for South Australian public sector superannuation funds and other approved state authorities. Con is well-known in the Australian investment industry, not in the least, for his outspoken views on a variety of investment topics, including gold, crypto and asset allocation, much of which has historically been disseminated through his notorious Twitter or X feed. We trace back to Con's roots as a quant and value investor, and discuss how this continues to shape his current investment philosophy, despite the fact that he calls himself now an ex-quant. We discuss the changes in governance and the implementation of a TPA lite framework at Funds SA, while we also touch upon the turmoil in private credit. Finally, Con admits that he was wrong about innovation and disruption being the most dangerous words in investing, while he stands firm on his dislike for crypto and dynamic asset allocation. Enjoy the show! Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights Overview of Podcast with Con Michalakis, CIO of Funds SA 03:00 I'm more of an ex-quant these days 05:00 In my heart, I'm still a value person and a contrarian; I like to invest in areas that are unloved or where capital is scarce 09:30 When I joined Statewide, the GFC hit. It was the worst I'd ever seen and Statewide was in trouble 12:00 By the time we merged with Hostplus, we were one of the top performing funds in the country, but that first six to nine month period was hell 13:30 Covid was short in terms of the market bounce back. What was hard was early access to super 14:30 Governance changes at Funds SA; "There were a lot of meetings here at Funds SA" 16:00 Having a risk management lens and no more siloes is a key part (of the new governance structure) 16:30 You used to have a photo of Trump on your desk to remind you of risk. Do you still have that? "No, I see enough of him!" 18:30 Making changes to the investment committee 21:30 We cut our tracking error budgets for Australian and global shares down by half to almost two-thirds. We've introduced passive, we've introduced quant systematic, and we have an active sleeve. You can't be full one or the other. 23:30 The world has changed: there is faster money, there is pod shops (fund managers that distribute capital across numerous semi-autonomous teams (pods) led by individual PMs) and there is instant reaction 24:00 You have to embrace dispersion across styles and managers 27:00 Implementing "TPA Lite". 27:30 "The idea that you are going to do dynamic tilting, or that you are some sort of macro guru, I call that a Comic Con of Asset Allocation. Everyone dresses up in their favourite character." 30:00 There is a slight survivor bias in the group of TPA proponents that the added value is based on 35:00 You said previously that innovation and disruption are the two most dangerous words in the industry? "I was wrong". 39:00 There was a shoe company in the US that was going bankrupt and pivoted to AI and the stock price went up 5x. Clearly, there is some nonsense going on. 43:00 Crypto; if you want to have it as a digital Ponzi scheme, go for it. 45:00 At Funds SA, we have zero Australian private credit 46:00 Some sort of global small/midcap manager, who has never done private credit in their life, is saying it is going to die. What do they know? 52:30 My worst investment? Probably, single strategy hedge funds. 55:00 Con's Twitter/X presence   Full Transcript of Episode 135 Wouter Klijn  02:56 Con. Welcome to the show.  Con Michalakis  02:57 Good to be here. Thank you for inviting me.  Wouter Klijn  03:00 No worries. So I want to take you back all the way to the beginning to get sort of a sense of your thinking on investments. And I believe you studied mathematical science in Adelaide, then went on to do a Master's in financial economics in London, and ended up at the Oxford Said business school. So there's sort of a combination of, you know, purely mathematical thinking, but also strategic thinking. How has that shaped, sort of, your outlook on investments?  Con Michalakis  03:28 Yeah, sure, so I would say I'm more of an ex quant now. I mean, it's a long time ago since I did option pricing and was a quant So, but still, you know, numbers guy in terms of how I think about it, and to be, to be honest, you know, the younger people that I've worked with, whether it was at Statewide, Hostplus, at Funds SA, to say they're brighter, they're more technical, they're more up to speed, so they've way taken over. So I would, I would call myself ex-quant. I still think in terms of numbers, still, you know, pretty Stemmy. And there's a bias across all three firms that I've worked for for sort of STEM type thinking, you know, science, technology, engineering, maths, the but you can't just all have one I have now believe that you can't just be one grade. I still think you can take stem people and teach them finance. It's hard to take finance people and teach them stem but you need, you need all sorts. And some of the best thinkers are not necessarily the way they think and critical thinking. They're not always just stem types. I've learned to embrace more diversity in that and interesting some of the managers that we've invested in, you know they come from interesting historians. So you got a critical thinking is more important. But, yeah, definitely bit of a buy. As the stem.  Wouter Klijn  05:01 Yeah. So how would you describe your investment style now? Then, because, of course, you mentioned three firms you you worked at Pezna for a while, which is a value shop, a deep value shop. Do you still have some of that thinking as part of your DNA, or are you looking more as sort of a contrarian investor.  Con Michalakis  05:22 I think in my heart, in my heart, I'm still a value person and a contrarian like to invest at the margin in areas that are either unloved or where capital is scarce, because highly likely the risk is that hasn't been priced in, and therefore there's a trade off. But definitely call it the maturity cycle, diversification, the ability to invest long term and make sure you have investments across a broad, strange range of strategies and asset classes, and not being sort of, you know, across the cycle, not having one dominating I think, is very important. I've learned that lesson, and it's a lesson that I know, but in my heart of hearts, if it's contrarian in value, it's probably my kryptonite.  Wouter Klijn  06:19 Yeah. So, so you learned those lessons. Can you give an example of some of the things, some of the trades? Maybe that taught you those lessons?  Con Michalakis  06:28 Yeah, probably bond allocation, fixed income, you know, like, if you look at the Japanese bond market, you know, it was the widow maker, you know, you didn't like it at four. Didn't like it at 3,2,1,or 0, it's come back now. So, you know, maybe the mean reversion took 30 years, but it's coming back. You could just got to be a bit you got to be a bit more smarter than naive mean reversion. Value Investing. There's been a value, statistical value, risk premium over 100 years, but you know, arguably, it's been very chopping. Hasn't worked since the GFC or prior to the GFC. If your portfolio, if you're running a diversified, multi strategy, strategy, multi asset portfolio, and you've let one style dominate your over a cycle, you're going to outperform or underperform because you're too biassed to that at the margin, though, you know, at the margins, I remember you're running a world diversified fund. Occasionally you get thrown these strategies and ideas where either the market has unloved it or there's an opportunity to extract return. That's pretty good. So, you know, we were a bit late to that at state. Well, I definitely noticed. Plus, when we did the sort of insurance link strategies with quota shares, we did that last year here too, at funds SA, and that's that's done really well, you know, in the small and mid cap, you know, where managers can probably do a little bit better. Venture capital, when that was unloved 15 years ago, we were late to that at Statewide, but Hostplus was very good. So you want to, you want to be diversified, but you want to go to early areas and adopt that if you can.  Wouter Klijn  08:11 So looking back on that, what does that mean for portfolio? This, is there still a place for value, or are you more style neutral guy?  Con Michalakis  08:20 There's a place for value and be conscious. If you're going to use a combination of passive, quant, systematic and traditional fundamental, you want to be conscious of what your and how your managers managing that. Some are core. Some identify as value. Some are kind of fighters, quality or growth. You want to be conscious of what you're carrying into that portfolio, except particularly in this incredible market movements that we've had, probably since Covid, for lack of a better word, that you're going to have dispersion. And that gets down to beliefs. Can you ride the cycle. Do you have the ability to, if you have good relationships and you trust your managers to reinvest when there's…, their style or, you know, there's always a style that they've had an issue with a couple of stocks, do you have the backbone to just stay in the game with them and reinvest?  Wouter Klijn  09:18 Yeah, you just mentioned that Covid period. Do you have any sort of lessons from that? Did you change anything in the portfolio to deal with sort of that volatility?  Con Michalakis  09:28 You know, when I joined statewide, it was a GFC, so, so I left Pzena, it was, you know, a couple of weeks off, and joined Statewide the first week, my first week that weekend, Fannie and Freddie was nationalised at the end of the week,  Wouter Klijn  09:44 yeah.  Con Michalakis  09:45 The week later, Lehman went under. Now we're in the GFC,  Wouter Klijn  09:48 yeah.  Con Michalakis  09:48 And that was painful. So really, from September until April, September 2008 April 2009 this was one of the most acute periods of investing I've seen. I. All when, famously, Westpac, had a failed rights issue early on my career, and I think it was Kerry Packer heard to bail it out. We've had Asian crisis, 9/11 but this was, this was up there with one of the worst I've ever seen, and Statewide was in trouble. It really didn't have a diversified portfolio. Didn't have a lot of cash or a lot of bonds. It had to pay hedges by selling equities. Luckily, Chris Williams had joined me, I think October, November that year. Jimmy Vernon Payne is now a consultant at Jana. Bill Watson, I think he's at first super, or is he moving to, you know, I think something like that. And all of that was happening live, and we had to manage that. And that was a really difficult period. We had to write off assets, we had to rebalance the portfolio, but to put in governance structure. We can talk a bit about that later. That was a doozy.  Wouter Klijn  11:02 So that was heavily equity focused portfolio,  Con Michalakis  11:05 that was a heavily illiquid portfolio, but more importantly, didn't have cash or bonds,  Wouter Klijn  11:10 yeah, yeah.  Con Michalakis  11:11 We  didn't have any fixed income. Fixed income was a bit of a saviour. The Aussie dollar collapsed, the international allowed you to international fell by more. So that was a difficult time, and that taught us the importance of the diversification, liquidity, managing portfolio shape, not for currently, but looking out forward, and having a risk management system in that you could understand and also live by. I would say, though, by the time we merged with Hostplus, we were one of the top five or six performing balance funds in the country in terms of peer surveys, your future, your super we're the best Aussie equity numbers over most time periods, the most fixed the best fixed income numbers. Pretty proud that by the time we had merged with Hostplus, we were one of the best performing funds in the country, but that initial six to nine month period was hell  Wouter Klijn  12:06 yeah, I can imagine. I mean, I had in there that, like you must have done something right, because you survived for 14 years after joining state.  Con Michalakis  12:13 Well, ultimately, the central banks and the unbelievable amount of QE and reinvestments and bailing out the financial system. You know, one of the first responders was the Aussie dollar rallying, and we kept the hedge, and we used those hedge gains to rebuild asset allocation. And then, frankly, equity started recovering. I think by May, it bottomed out and it was on the rallying. But yeah, for that period, it felt it was uncomfortable. Now, covid, so, so, so the time we got the covid, we were so well diversified. We had risk management planning, we had liquidity ratios, we had stress testing in in play. And I was only for a week. I remember it was pretty late nights, early mornings, late nights. Chris was then the deputy CI, Chris Williams, who's now Hostplus, was the deputy CI. And I remember was one morning, Chris goes, Okay, now I'm worried this. There's no market. There's no market in bonds. The market was unruly. And I remember being on the couch one night. I was sort of had Bloomberg on, and I saw this big headline, unlimited QE and I remember saying, Okay, this is done. It's over. The markets will respond. So covid was short in terms of the bounce back. What was then hard for most super funds was early access. How would people tap into super How would you manage that? We were moving then to weekly Investment Committee meetings. We had a risk scorecard checklist. We were going through valuation scorecard stress testing. I actually thought we played that well. What surprised us was how quickly the markets bounced,  Wouter Klijn  13:58 yes,  Con Michalakis  13:59 and we had underperformed just, you know, in that immediate period. And then there was a vaccine that was announced. We had quite a few value strategies. They did really well. And then we came through. Yeah, the time we merged, performance was pretty good.  Wouter Klijn  14:14 So it sounds like that in a number of these like tricky situations, liquidity was a central theme in sort of trying to manage the risks in the portfolio, has that sort of changed your ideas on how to manage liquidity, and also in the current environment, where it's quite volatile, very concentrated markets, what is your philosophy towards liquidity?  Con Michalakis  14:38 So front and centre, you know the changes, the big changes we've made at Funds SA, they say was governance. We've set up, we've we've, there was a lot of meetings here. So there was a lot of meetings. There were a lot of people in meetings. We've tightened the meeting schedule. There's less people than meetings. We've broken down silos, and we've introduced concepts like, okay, we've got a proper investment strategy that embraces diversification. We've got liquidity ratio and stress testing. We've got fee budgets. We've got active fee risk budgets that we're implementing. And so we spend, really the first four or five months of every year updating our investment strategy policy, making sure it's fit for purpose, and then basically the rest of the year, reviewing the asset classes that are sympathetic to the overall investment strategy, and in that risk portfolio shape, managing the portfolio, not for today, but over the next 12 months, we have an unlisted forum that goes further and making sure we've got a enough liquidity. What's our effects? Hedging policy, terming out hedges, making sure if markets move, we can take advantage of what's happening. And that's that's that served us really well at statewide. I know it's served Hostplus really well, and we're off to a good start here, ending March. Financial year to date, I would say our balance fund's in the top quartile. Early days, nine months and one year I've been here 14 months. But having a risk management lens and the and shaping the portfolio is and no more silos is a key part.  Wouter Klijn  16:21  Talking about risk management. I've heard that you used to have a photo of Trump on your desk to remind you of risk did you bring that to Funds SA?  Con Michalakis  16:29 No, I see enough of him. I see enough of him everywhere, whether it's news or media. I don't need a photo. It was a joke. I think the team went to some charity and they got a maga hat, and I had a photo of him and Putin, I think, on my desk, which was good, because 2016 election was unusual. If you remember how markets traded, they priced a Clinton win and then a Trump win in the reverse was like, bit like Brexit, actually. And so no, I see enough of him, and I see enough of his policies and and I see enough of the reactions to the markets to tweet, so I, I he's a constant reminder. I don't need him.  Wouter Klijn  17:06 You don't need to be reminded of that. So you mentioned that setting down a proper governance framework was important in sort of reshaping the portfolio Statewide. Can you tell me a little bit about what you think are the essential ingredients of that governance framework?  Con Michalakis  17:22 Yeah, sure, and I starts here with Funds SA so, you know, 14 months in, what did we do? Start with the basics. We actually wrote a plan. I wrote a plan for the board, and what we said was governance strategy, team, structure and within government, Jana coming on as a full of service asset consultant. I've worked for Jana for a number of years, and they've been a great partner, and I consider them not a service provider. They're a partner to us, and we, we, we, we, basically, we rest on their shoulders. We don't have to make things we we can get a lot of their IP and thinking and basically build on that in terms of governance. It was recasting the Investment Committee. There's now a smaller Investment Committee. We have an independent chair, David Holston, who was my asset consultant, then retired, then joined Statewide as the chair of the Investment Committee and board member. He's here as an independent but making sure that's in that's in play, doing things like Investment Beliefs, having detailed asset class reviews, bringing the team together. We have a weekly portfolio construction forum where there's the investment strategy team and the asset class heads. Once a month, we invite Jana as well to that, having papers prepared, going through the shape of the portfolios, what's happening in the markets, trying not to be short term, and managing this for the medium to long term, that's been the, probably the biggest changes here, plus the usual, introducing liquidity ratios, thinking of risk, thinking of how you're going to diversify the portfolio, and being small enough to take advantage of strategies and ideas, should they present themselves? They don't often, and we don't think we can trade our way through it, and we can talk about DAA coming up, but just being aware and being able to execute quickly  Wouter Klijn  19:29 Before we jump into DAA, I want to talk a little bit about Funds SA in sort of the broader investment industry here in Australia, because it's relatively unique. You have worked at a super fund as well. At Hostplus, obviously, they are subject to a whole set of regulations where they need to pass a performance test on the Your Future, Your Super that has influenced how they allocate, especially on the passive, active side of things. At funds, I say you don't. Really have those restrictions. Does that give you an edge or an advantage in finding opportunities that super fund?  Con Michalakis  20:07 Oh, yeah. So we're about 50 billion in assets, and over 90 per cent is the local state pension scheme, Super SA that we run money for it's regulated by the state. So we're like a state, sovereign, if you want to, in that sense, and it has constitutional protection, which is a unique feature. I do think, not being having different being regulated by the state, we have unique and we have some unique tax advantages. Gives us a bit of an edge. We can think about how to invest the portfolio. We still shadow, for lack of a better word, we still shadow Your Future, Your Super we think about the risk we're taking from that lens, but we can free ourselves from the day to day regulatory of an official APRA burden, for lack of a better word, and that gives us, I believe, some unique advantages that we can we can exploit.  Wouter Klijn  21:17 Yeah,  Con Michalakis  21:18 That doesn't necessarily mean that some advantages can be also a balast, because it's active management is difficult. Can't just blindly do it, and hasn't worked for a long time, and it's particularly in recently, it's been a very difficult area. And you know, one of the one of the things we did in the previous review is we had pretty large active tracking error budgets that was purely active in Aussie and global shares. We've basically cut that down by a half to almost two thirds and and one of the reasons is we've introduced passive we've introduced quant systematic, and we have an active sleeve, and we want to let it go, just, just so we, you know, again, diversification, even within Aussie or global equities, it can't be for one or the other.  Wouter Klijn  22:09 Yeah. So is that active component more of a satellite allocation, is it a relatively small?  Con Michalakis  22:15 It's more sort of, yeah, core satellite approach to the active might be a bit more satellite. You can have some style neutral managers. You might have some small to mids value or quality growth. But we, you know, we manage that within a mix, and our tracking error, you know, is moving, you know, maybe in the past it was in the threes. It's now in this of the one, one and a half at both Aussie and global equities,  Wouter Klijn  22:40 that active, passive element is quite interesting in the light of the current environment, because we've seen, you know, equity markets more or less rally for quite a number of years now, concentration in markets, which makes active management quite difficult. But if we would were to see a flip or some sort of recession, that's often where active management shines as well, where they can reduce sort of the downturn. Are we setting ourselves up for failure in that sense, because we're moving away from that active element, and then when a crisis happens, we might not have enough of that.  Con Michalakis  23:16 I mean, we were pretty active at Statewide. We had quite working very well in Aussie and global. And as I said, global, by the time we had finished that net a fee Alpha was pretty good. Aussie was unbelievable. Closer to 2 per cent I would say to you, the world's changed. There's faster money, there's pod shops, there's instant reaction. We've seen it even. I mean, look at between March and April. You basically had equities, you know, fall anywhere between five and 8 per cent and in the first two weeks of April, they basically come back. And in coming into the third week, we're now setting new all time highs,  Wouter Klijn  23:56 yeah,  Con Michalakis  23:56 so the Fast Money response, and what I've I believe, is that you have to embrace dispersion, dispersion across styles, strategies and managers, and in this world of faster money, moving money, you probably want a bit of everything. And the idea that you can be totally active sounds romantic, but I think the path dependency will kill you. The idea of being totally passive, we have some tax advantages that doesn't totally make sense to be totally passive, and the idea of being totally systematic, well, fine, but there was a thing called a quant winter in 2007 and these things will happen. So why not have a bit of everything if you can, but be careful, you know, set your tracking error budget, set your allocations, and try not to one of the things I think that could be happening in industries. If something's not working, they're closing it down, and then they're just going straight to this that's working. Well, okay, that's creating flows and opportunities. When that sort of stops, that's going to create some opportunities on the other side. And I think the other side of that could be an environment where active managers who are targeted and doing well will do better.  Wouter Klijn  25:26 Yeah, yeah. So as part of that, move to towards more passive, basically reducing tracking error, but then we see funds doing a little bit more on the dynamic asset allocation side, where partly is sort of trying to implement some total portfolio thinking, putting trades on top of the portfolio that are almost a little bit hedge fund, like relative value trade, global macro trades. What's your view on that? Is that something  Con Michalakis  25:56 This is going to be fun. So one of the things I one of the things when I came at Funds SA is that there was, there was a lot of siloed behaviour. So there was the asset class, people were doing their own things. Then there was sort of an overlay, doing their own things. What I brought is, everyone's in the room once a week, and we're thinking of what's the long-term strategic asset allocation. Now markets move so you move away from that, what's the commitment to if you've got private capital investments, whether it's equity infrastructure, what's being drawn down, what's being distributed? There's foreign exchange movements, how you should think about the foreign exchange. There's also demographics. There are flows in that. Are flows out they're switching as well. And so I come across from a, I'm going to call it TPA Lite,  Wouter Klijn  26:47 yeah.  Con Michalakis  26:48 So I come across from a total portfolio. What are our exposures? Where, where would you want to be? And if we don't really have strong ideas, run them very close to the strategic assets. After all, it gets reviewed every year, right? We've spent a lot of time spending that as what a research, time looking at that with our asset consultant. The board adopts it early in the year. And if we don't have an idea, stay close to that, then markets drift. And it's all about the rebalance, the idea that you're going to do dynamic tilting, or that you're going to do overlays on top, or you're some sort of macro guru. I call that the Comic Con, right, of asset allocation. Everyone dresses up in their famous in their favourite character. One's a dynamic tilter, one's a post Keynesian, one's a Keynesian. One's a value guy, one's a trend. Great. You can have it. It's all yours. I just think it's noise. And good luck trading that in the last three or four months. In fact, good luck trading that since Liberation Day, and good luck trading that since covid. Because how many people would have told me bonds went from zero to four or 5 per cent and equity market set new time, all time highs? So I think we take a broader portfolio lens, manage that from a portfolio construction level, figure out where the opportunity sets are. Allow a little bit of flex, but you're not going to see us trading frozen concentrated orange juice and pork bellies.  Wouter Klijn  28:22 So do you see DAA as a form of market timing? Yeah,  Con Michalakis  28:25 They can have it. You know, I've heard about other funds. You know, they do SAA, TAA, DAA, macro thematic. Yeah, all yours. It's up to negative. Good luck to them.  Wouter Klijn  28:37 So I had taken you as a little bit of a TPA cynic. But obviously you're  Con Michalakis  28:43 Not totally a TPA cynic. I just, you know, I read the study, and I did start at Watts and Wyatt, and there's Thinking Ahead Group. I think the ideas of TPA are good. The complete adoption, am I going to be the purest TPA, and I know there's been some great funds out there that have done it, that's theirs. I live in a world where we have different clients who have different needs. We have one client who has a sort of an absolute hurdle cash flow for 30 years before it goes negative. I have super clients who, you know, they want us to manage a CPI target. They want to manage against peers. They're switching in between funds. There's demographics. I look at everything, not just through a pure TPA. Call it TPA Lite,  Wouter Klijn  29:30 yeah.  Con Michalakis  29:30 And you know that study that showed all the TPA funds outperforming before I had a good look at it, it felt a little bit like, nothing against my old colleagues, but that looked a little bit like consultant swab.  Wouter Klijn  29:42 Yeah, I looked at that report as well, and I think they came up with 180 basis points or something, but it seemed to be just an aggregate of the funds that were included in that group,  Con Michalakis  29:53 Slight survivor bias, right?  Wouter Klijn  29:54 Survivor bias, but also not necessarily relating it back to TPA. It's just, you know, here's a group of TPA. People. And I think there was even a Swedish fund in AP7. I think it is, which is, to my knowledge, highly geared equity fund. It's not quite comparable  Con Michalakis  30:09 yeah, comparable we, we look at portfolio construction across the thing, we think about what, what, you know, what are we doing to diversify? What are we doing to beat objectives? You know, sometimes your illiquidity mismatches on what's what's a good proxy, where's the actuals? You know, like you maybe want to have some more linkers than nominals in your bonds at the moment, because it's working with better within your overall fixed income allocation. That's how we think about it. We want to term out our hedges. But the idea of being pure TPA Lite, or pure What's your equity equivalent ratio? Yeah, you can have it. Whoever does that. Good luck to them.  Wouter Klijn  30:45 Yeah. Do you think that is to a degree related as well to how large investment team is? Is it easier to do TPA and sit around the table in a relatively small and mid-sized team?  Con Michalakis  30:57 So I've been very lucky that within Statewide, Hostplus and Funds SA, we have relatively small teams, and I think that means there are no silos. That means that we can be far more sort of linked up, to use the term in terms of how we're building portfolios, and have the key people, the discussions in the room. I think that's an advantage that we enjoy wherever you use external managers. We do the implementations internally, of course, but we It allows us to just think a bit and build portfolios, as opposed to trying to manage a lot of people.  Wouter Klijn  31:39 Yeah. I think in a past interview, you sort of stated the importance of stating your opinion and letting the board know what your thinking is. Is that you know possible in every organisation? Or does that need to be created like a culture created around speaking your mind?  Con Michalakis  31:57 Oh, again, maybe luck, all three funds I've worked for boards wanted trust and transparency. There's the Funds SA. It's seven individuals. It's incredible board. And one thing I enjoy, you know, from the chairman, John the CEO, and our board members, is, obviously, I'm not a shrinking violet. So they enjoy the two-way communication, and I think they they want transparency, and with transparency, you can build trust. And so they like the fact that we can have these discussions. Same at the IC. I do think smaller committees allows to have better conversations. That's so the board is, you know myself, the deputy CIO, whoever's presenting, if there's an asset class, the IC, there's there's John, myself and David Holston, the deputy, Kelly, who is sort of like our she makes the trains and run on time in the implementation group, and it just jells at these meetings. It just allows good discussions ample time to have that. And you build trust because they know what you're thinking, you know what they're thinking, and you get, I believe, a better outcome,  Wouter Klijn  33:14 Now Funds SA has gone to quite evolution in recent times, apart from the organisation growing quite rapidly over the last couple of years, you also had a new chair in. Guy DeBell, had a new CEO with John Although John Piteo has been there since 1995 I believe.  Con Michalakis  33:35 Yeah. So I think it's two years so relatively new, yeah. So John, Guy, there's a couple of new board members. Been a few new executives, obviously, new CIO, new deputy CIO, we've added to our implementation team, where Kelly's almost like she's like our COO within the within the investment team. I do think it's a sense of renewal, but I'm probably not the right person, because I've only it's 14 months, but I gather that over the last two years, the Funds SA has changed. It's in a sense that it's more focused on investment returns. Clients are important, and the people who are responsible for managing this business wrapped around making sure we've got appropriate it's really good data and tech that we have here. So yes, I'm part of that change. I think investments has changed a lot, and the team has done a good job, really. I mean, there was a lot of changes, changing governance, beliefs, strategy, no more silos that they've had to go through a lot of change in that responded world to all of that, plus having me  Wouter Klijn  34:55 Fair enough, there's also a lot of change happening in the industry itself, and one of the things that a lot of people talk about these days is AI, artificial intelligence. And I sort of, when I was preparing for this interview, I found an old interview with the AFR, and you said that innovation and disruption were the two most abused words in the industry. Do they? Does it apply to AI, what's your view there?  Con Michalakis  35:22 Okay, I read that article, and I reckon that's aged like a bucket of prawns in the sun. I reckon I was wrong. Okay, so, so this is, let's this is, this is where, you know, you sort of read that went, Oh, I think we are in the age of innovation and disruption. And I severely underestimated, I think that was 2012 Yeah, maybe not. Yeah. A bit later, I think there's been a lot of disruption and innovation, whether it's the digital whether it's obviously now with AI, I think AI is a, is a, there'll be new versions of energy, there's there's ways of living. There's also some bad disruption in terms of, we're in a multipolar world. You know, the cost of warfare has gone down, so the marginal propensity to war goes up. You know, we grew in a pretty balanced world post the war, that we knew we had one world, and now it's, it's bifurcating into various regions and so, so I think I was wrong, having said that, you know, is it as innovative as we've got the round will and introduce fire? Probably not. But the world is changing, and I think we should embrace that, particularly if I think about Australia. And as an allocator, you know, the world has changed since GFC, in some ways, not for the better. We have to deal with energy resilience and climate. We have to deal with critical minerals. What does ai do to the workforce? What does it do for people who gain from the expected productivity gains? Does it go to capital or labour? If it goes all one way to capital, not labour, there will be riots. There will be a greater disparity in terms of wealth and income. People will be unhappy. There will be volatile elections, social media and the rise of that. So I think there's a lot going on in the world, and we just got to make sure whatever as innovation happens, that the gains are shared.  Wouter Klijn  37:47 Do you think it changes as well the asset management game, especially on sort of the active management side, where access to data is easier, it's harder to gain an edge.  Con Michalakis  37:59 So I think the biggest winners in that have been the quant funds and the systematic funds, who are naturally very data enriched and aren't afraid to embrace large language processing models, systems. Much more sort of, might be a bit of P-hacking to use the stats term, but there's, there's a lot more sort of mining and using of alternative data, they were much better than the fundamental types. Probably the systematic quantum are much better job in risk management, more than anything else, the risk management's kept them in the in the game, more than, say, the fundamental types. They're learning those lessons. But you know, when we see, we look at it here, internally, at Funds SA, and then when we see with our managers, it doesn't matter if it's a credit manager, an equity manager, a passive manager, voting of shares. People are using AI in their business. They're using it initially as a tool. We use it here across there's a lot of people, vibe, coding, building macros, building things. It's it's changing. Do I think there's a bubble in parts of AI sector? Absolutely. Do I understand the valuations of some of these large language models that are burning cash and on record valuations? I do not. There was a shoe company the other day on the New York Stock Exchange that was going fail, going bankrupt, pivoted to AI stock went up 5x right? Clearly, there's some nonsense going on. But whenever there's an innovation cycle, or whenever there's disruption, you do get, you know, the old Manic Panic and crashes Kindleberger, you know, one of the bubble things is there's an innovation cycle, and that's part of the game.  Wouter Klijn  39:51 Yeah, yeah. In some parts of the industry, there's a bit of a reminiscence of the dotcom bubble where, you know, you just had to come to your company name and the share price went up at the same time. You know, you see chips are still TSMC came out today, and I think they still had a record profit on selling the chips to the AI sector. So there is a real story there as well.  Con Michalakis  40:19 It's a real story. So Nvidia, the foundries in Taiwan, like TSMC, these are these companies are printing real profits, right? They and Google's another one. So, you know, it's not bubbles can sometimes be overused. But there's, you know, there's some interesting valuations away from them that, you know, it's hard to get your head across,  Wouter Klijn  40:40 yeah. But do you think that that shifts the structures in the equity market as well? There seems to be, you know, the size factor comes back, but almost in the opposite way, where, you know, large caps are dominating, outperforming,  Con Michalakis  40:53 I think when it gets priced in, and we've had a well priced in, I think there will be again, when you get so much, maybe the value person in me, the valuation dispersion, the opportunity sense, will come in. And lately we've seen that with the EM bounce back pretty hard. We're starting to see a little bit of, we're certainly seeing a lot of good alpha, but also some good returns out of the small to mids. So, you know, we had the rise of the Magnificent Seven. The first version of that look a bit bubbly. It's sort of corrected, and now we're getting the sort of the AI type plays. It's it's part of cycles. You can't pick them. You can't pick them on the way up. Good luck picking them on the way down. You just have to be conscious of what positions you take and make sure that at the margin you can sort of lean against it. And, you know, I have opportunity on the right tail in terms of VC or some of these companies, and then on the left tail be diversified and managing your active exposures. I do think the business that we're in of managing capital, whether you're an asset owner or a fund manager, will be changing over the next five years.  Wouter Klijn  42:09 In what way?  Con Michalakis  42:09 Hard to say how it morphs. But you know, if the agentic AI and the models and the and you can develop personas, and they have memories in those models, you know, do you need as many analysts? Do you need to see? I mean, it starts giving you that. So while that rises, you will need the correspondent rise and people almost acting as human whisperers of AI and that output to boards and individuals explaining what that means. So, you know, there's, there's going to be a coincidental rise of those two,  Wouter Klijn  42:43 yeah.  Con Michalakis  42:43 But you know, the first one has more of an employment impact than the second one,  Wouter Klijn  42:47 Yeah, yeah, for sure. So we're not at a stage yet where you should just hold passively the top 20 or top 50 stocks and just let them get on with it?  Con Michalakis  42:55 I don't think I mean passive is a valid part of of any portfolio. But again, I'm not a person you know full TPA or full passive or full active, you know, like I you can have it all right, don't? You don't have to vote against it, but in a default setting where you don't know what you're doing, you don't know where the world's going. Sure, passive and systematic will give you that that beta exposure, but you know, you probably at the margin, can do with a bit of active.  Wouter Klijn  43:31 Yeah, yeah, sure. Okay, so you said you were wrong on the innovation and disruption. You've also been quite critical on crypto. Were you wrong on that as well?  Con Michalakis  43:41 No, that's a load of nonsense. And the thing look, crypto, if you want to have it as a digital Ponzi scheme, go for it. Shoot your lights out. Congratulations. But it's not money. That's the thing that bugs me. When people turn around and say, crypto, or even the gold bugs, gold is not money, and crypto is not money. And we saw that when we went through and with oil in the crisis. The first thing people wanted was cash. And basically, and I would sell all the other nonsense because they wanted cash. I You don't do gold back that. You don't do crypto back there. I'm not, you know, stable, this whole sort of stable area, interesting, the way, sort of FinTech, and that's processing interesting, but, you know, there's been a lot of nonsense in that you can have it that's that's happy to provide the chips and the shovels and the data that they need. But, you know, sustainable crypto, give me a break. You're burning. Energy is already scarce, and what's that used for?  Wouter Klijn  44:41 I think you called sustainable crypto a vegan tomahawk steak.  Con Michalakis  44:45 And once it was, apologies to vegan Tomahawk steaks, which probably, you know, tastes a lot better than the rubbish that's built out by some of those crypto types.  Wouter Klijn  44:54 Fair enough. Another sort of point of discussion in the industry at the moment is private credit. It, and we've seen some liquidity issues with some of the funds. But what's your view on that? Is that a problem with private credit, or just the wrapper that?  Con Michalakis  45:09 So I should say at Funds SA we have zero Aussie private credit.  Wouter Klijn  45:14 Okay,  Con Michalakis  45:15 I feel pretty good about that, actually. So zero, we have about 60 basis points of global private credit. So we're in an interesting situation, but we've put on some really well established global private credit. We've just put on some clo equity, both secondary and primary. I actually think the opportunity space looks good for us because we're underwriting into that. We don't have any existing ones. I think some of the commentary written about private credit has come from it's interesting. You've had all the big, large players in private credit saying, yeah, there are problems, but it's not systematic. Who's on the other side is some sort of global, small, mid cap manager who's never done credit, and they love saying it's a bubble, it's going to die, right? And so what do they know, right? I mean, I mean, the reason they're upset is probably because private credits up there are higher up the cap structure getting their returns. Don't believe private credit, per se, is the SPV of real non-recourse real estate debt of 2007 that's going to cause some sort of crisis. Banks, private credit managers, long term sort of locked up capital that does this is it will, will look will make sure that the system does what it has to do. Are there problems? Yeah. Then one of the big problems is that there was a lot of these BDCs. And when you have a listed entity with unlisted assets, and you offer a liquidity redemption window, it's always the same thing. In any crisis, in any dislocation, it's either leveraged money or money that's not there for strategic reasons, that wants to depart, that creates the opportunity for others to come in and take advantage if they have to sell out of discount. Now are there private credit loans or issues, whether it's been in SaaS software disrupted by AI, or, frankly, bad lending. Course, there are, are there in 5000 equity stocks in the global capital market? Are there 50 or 60 that are in big trouble, or at 70 or 80 that could be in fraud? Course, they are. So you know, you're always going to have problems right in loans. But is it a big systematic issue other than the retail, you know, illiquidity, BDC type, or occasionally bad loans, sure, but I don't think it's a systematic issue.  Wouter Klijn  47:52 Do you see it potentially as throwing up some opportunities for a fund like you?  Con Michalakis  47:56 Oh, yeah, we're taking it as we speak. You know, we're allocating to special sits managers or people who can provide capital and solving for the opportunity. And we're, you know, again, we've come in underweight, so I should be saying private credit is really bad, but I just don't believe it and we're gonna, we'll take advantage of the opportunity across our manager set. We're pretty excited by it.  Wouter Klijn  48:21 Yeah, yeah. Fair enough. So going forward, what's on your agenda for Funds SA? Is there still a lot to do in the portfolio?  Con Michalakis  48:29 So I'm pleasantly surprised how well the performance has been. We're off to a really good start again. Strategy, governance, team. Jana non silo, I really would love to have the third fund I've worked for to continue to have very lucky at stay white, first quartile. Hostplus is a machine, right? It's, I still speak to some of my old colleagues, that is one of the, one of the great funds, and will continue to do all because it knows what it's doing. Yeah, we've turned it around here at Funds SA and my focus is to keep that turn around really happy where we are. But this is like a cricket game, right? It only takes one bad ball and you think you slug and you're bold and you look like an idiot. So happy where, where we've where we are in the process. Early days, very early days, but we got to maintain that focus. Managing portfolios for our clients and members is a privilege, and we can't take, we just can't stop. We got to be on the game and making sure we're aware of what's happening.  Wouter Klijn  49:37 So you mentioned Hostplus, when you look at Hostplus, it does really well, but it also has a very clear sort of target client base. They're young people. They have a long runway, so they can take a lot of risk, which has led to the asset allocation that they have. I think at Funds SA, it's probably much more of a mixed bag in terms of. The demographic of their member base. Does that make it more difficult to set a strategy?  Con Michalakis  50:06 Yeah, so Statewide also didn't have a lot of cash flow, right? So being a smaller team, the unique tax advantages and obviously they're not being regulated by APRA and the setting up the governance structure, I think gives us, and being 50 billion and not 500 billion, and not trying to manage really large cash flows, it allows us to be a bit more nimble and take advantage of the opportunity. Should we get it? And so, like, last year, I was that all of funds. So whether it was the investment team, the finance and ops team, the legal and odd, you know, we've had a couple of opportunities, and we turned them around, going through the process, you know, Investment Committee negotiating commercials, operational due diligence, commercials, and we can turn around within there's one we turned around in eight weeks,  Wouter Klijn  51:06 yeah,  Con Michalakis  51:07 and the the manager said, We've never seen this before. And they manage some sovereign wealth, money, some large pension. Funny. So having the ability to invest, sticking to your beliefs, I think is a Core Advantage. One of the questions I get asked a lot, and I think you were going to ask me, is, you know, what's the best investment you've made in your career? It's the people.  Wouter Klijn  51:34 Yeah,  Con Michalakis  51:34 It's the people. So having being surrounded by really core bunch of people that you can trust. I had that at Statewide. I had that at Hostplus, and we building this at Funds SA as a core, bunch of people, close to your consultant, close to your investment committee and board, and being on this and being committed and not stopping, like being at it, just focused on doing this. That doesn't worry me, because I think we know what we're doing, and it's starting to show on the results.  Wouter Klijn  52:08 Yeah, yeah, for sure.  Con Michalakis  52:09 And you can be niche, you know, we can do a 20 or 30 million VC and 20 or 30 million co invest at our size, and we can do a couple of these, but if you're 300 billion or 150 to get access, and to do that, it's much harder, and just sizing that and taking advantage of that opportunity set, it's I find it easier to run less money than more money.  Wouter Klijn  52:34 Yeah, yeah, for sure. Now, usually I don't let people get away with just talking about the best investment. Can you tell us what was your worst investment and what did you learn from it?  Con Michalakis  52:43 My worst investment, and what did I learn from it? So throughout all the career, probably single strategy hedge Funds was the worst investment. I'm not going to name names, but at Statewide, we had single strategy and you know these, they're all great, big names, big personalities. They promise you diamonds and they give you rocks, right? And we moved away from that at Hostplus. And this is, again, this taught the importance of working with great people. There's Greg, Sam and myself. It was Chris at when I was at statewide, and Dan who it continued lessons just wasn't working. We moved with John to a sort of an allocator model where they were closer they could implement, they could do overlays that was Blackstone here at Funds SA and say Peter, who runs the alts team, has moved from those single strategies to MAN and Blackstone, they're highly specialists. They know what they're doing, and it's worked very well, as opposed to trying to manage these on your own, which are really difficult,  Wouter Klijn  53:53 yeah, yeah, I can imagine.  Con Michalakis  53:55 So I gave you an investment, and the asset class so far, it's turned around. I feel good about that. The other one was, I remember going down the rabbit hole on tail risk.  Wouter Klijn  54:08 Was this the crisis mitigation stuff?  Con Michalakis  54:13 Yeah, yeah. And, you know, you put it on, it works until it doesn't, and then doesn't work. Your people lose going, and then you take it off and, you know, we never got to invest, thankfully, at statewide and Hostplus, and we had a tail risk here at Funds SA, we took it off and we put, put it to productive capital that can make money. Because, remember, you are diversified. You know, the one thing we spend with members is take that, take a traditional balance fund. Equities are down eight, 9 per cent you're about half in equities. You've got fixed income cash now, when bonds move away in a stagflation that could, that could hurt. You've got a bunch of infrastructure and property real assets tend to do okay, so you don't feel the full effect of that. That's the beauty of diversification. And you know, you have to remind people, so the idea that I'm gonna and I'm. Sorry to tell him, and I hope he doesn't call me, you know, idiot, moron, imbecile, than he does, but it's just too hard,  Wouter Klijn  55:08 yeah,  Con Michalakis  55:09 To be fair, and to be fair to him, he does say you should be invested in equities and have this, yeah? Well, we just do balance funds. We've got high growth funds, balance funds, conservative funds. You have the journey for a member. We've got different tailored solutions for clients, so sticking to your strategy and being diversified works.  Wouter Klijn  55:28 Yeah. Now we might finish up with a bit of a personal note. I think a lot of people, apart from, of course, knowing you as CIO, also know you from your Twitter feed?  Con Michalakis  55:39 I've locked that now, are you probably on there, so you still see it?  Wouter Klijn  55:42 Yeah, I actually do. But you know, you got a lot of opinions on there. What do you see of the role of that? And do you use Twitter as well for, you know, getting some market insights?  Con Michalakis  55:55 Well, you get a lot of information very quickly. You also get unfortunate, a lot of fake information.  Con Michalakis  56:01 But I remember many years ago, I did an interview with the Advertiser on this. It started off for football and music. It just morphed into fin Twitter back in the glory days, which was pretty bare knuckles and fun. I've actually met a lot of people through that. Met them around the world. You've met interesting people. You then go to private sort of messaging. So just gotta it's like anything in life, you can use it for good and use it for bad. Use it for noise. Mine's more selective.  Wouter Klijn  56:34 You say it started with music. And I saw some of your comments are around Joy Division, punk music. And I was looking at that, I'm like, That's not just standard business school playlist,  Con Michalakis  56:47 But you'd be amazed. Our chairman famously was interviewed, and he's a big punk rocker, really, Guy, Guy, you know, he will wax lyric on Husker Du or,  Wouter Klijn  56:58 Really?  Con Michalakis  56:58 Pixies, my old co-deputy, CIO, Greg, at Hostplus, we could lose three years just talking about Nick Cave or Joy Division. So, no, no, you'd be amazed. You'd be amazed. How many people come out of their shell when you start doing the music. You'd be, it's more diverse than you think.  Wouter Klijn  57:21 Oh, good, good.  Con Michalakis  57:23 Including the metal types, you'd be amazed how many metal types. I'm not going to out them, but there's some crazy ones out there.  Wouter Klijn  57:30 Fair enough. Fair enough. Now I looked at it and I'm like, Oh, I can now safely bring up my vinyl record collection at some stage, which features a lot of punk, but we'll leave it for another time. Thank you very much for this conversation.  Con Michalakis Was a lot of fun.
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  134: JANA's Jo Leaper – Risk as a Source of Alpha 03.05.2026 31min

  In this episode of the [i3] Podcast, I'm speaking with Jo Leaper, who is the Head of Operational Consulting at asset consultant JANA. We talk about the next evolution of risk management, where risk doesn't reside just with a dedicated team, but is addressed by all functions, including the investment team. When implemented well this form of holistic risk management is not simply a cost, but can lead to operational efficiencies and even alpha. Afterall, investors need risk to produce returns, but how you manage that risk is the key. __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights  __________ Overview of Podcast with Jo Leaper, JANA 01:30 Why is operational due diligence important? 06:00 What I'm seeing is investment governance getting more involved and almost acting like a bridge between the investment team and the risk team. 13:30 Hopefully, we will get to a world where risk is not a cost of business, but it is an enabler of outcomes 17:00 New regulation will always cause a little bit of friction and in all honesty it should 19:30 There is already a strong focus on valuations and risk in unlisted assets, but it will get more intense 23:00 We talk about 'risk sensible' a lot; funds still need alpha 23:30 Is there such a thing as operational alpha in risk? Absolutely. 25:30 Managing risk in a $2tn organisation. Employing multiple custodians and services providers Full Transcript of Episode 134 Wouter Klijn Jo, welcome to the podcast. Jo Leaper Thank you for having me. Wouter Klijn So today we're going to talk about operational risk and operational due diligence. Why is that so important?  Jo Leaper  01:36 Operational due diligence, it's always important for investors to know what they're investing in, and if you're not doing operational due diligence, you're not necessarily understanding what that actually understanding what that actually is, because the risk is important to the portfolio. You need the risk to generate alpha. But if you don't know what those risks are, if they're hidden, then that's where you fall into a trap.  Wouter Klijn  01:52 Yeah. So what are some of the main challenges in managing this? Jo Leaper  01:57 Really the complexity and a lot of the investments that clients have, and the market has, are investments that have come up over time, and in those spaces, historically, you had a pretty good idea about what you were investing in. But assets are getting more complex. Structures of operating funds are getting more and more complex, and so none of them can know everything. So really for us, getting them to look at the operational risk is getting them to say, I can work with that, or I can mitigate that, or I can accept it. It's when you don't know what those risks are that the complexities really come into play. And I think particularly if you look at the current world, with geopolitical issues at the moment, even managing some of the structural issues and challenges in the industry, there are unintended consequences to those actions. So understanding what your managers are doing a it's a really good learning place, because they're doing this, and a lot of our clients are starting to invest internally as well. But it's just, it's a good way to say, You know what, that's commensurate with what our members and our beneficiaries are looking for. And we do want risk in the portfolio. We need risk in the portfolio. But if you don't know what it is, that's a problem.  Wouter Klijn  03:02 So yeah, it's right. The world is increasingly becoming more complex. I mean, you mentioned geopolitics, but you know, we also see AI and machine learning and so many different things.   Jo Leaper  03:10 It's a really challenging time from a risk perspective at the moment, because you've got a lot of participants in the market, not just investors, but a lot of market participants with legacy instruments, legacy technology, and the market is moving at a faster pace. The regulator is expecting more. Members are expecting more. And we've got a lot of data, but sometimes, unless you've got the right guardrails around how you're looking at it, how you're using it, are you going to get the right outcomes. It's the right intention. But you know, the end of the day, it's members best financial interests, not ours, not anyone else's, it's the member.  Wouter Klijn  03:44 Yeah. So you took recently a look at CPS 230 operational risk management approach guideline, and you, you sort of indicated that it signified a little bit of a shift in thinking about risk management. Can you? Can you walk us through that  Jo Leaper  04:00 Of course. So APRA has always been Prudential, like that's literally in their name, and they try not to be prescriptive in the way that they do this. When CPS 230 came across the desk, it really was to bring back a larger view of resilience and resiliency. And I think a lot in the industry are still wanting APRA to be a lot more prescriptive. And that's not going to happen. That's not what they do. It's not their nature. And so when you look at it, and you will look at what APRA is trying to achieve, their ultimate goal is really the same as the industry's members, best outcomes. That's what we want. And if you can do that by shoring up the system and the structure, APRA can't enforce particular investment styles, but they can try to make sure that the system has the right controls and the right mechanisms to manage turbulence when it happens.  Wouter Klijn  04:46 So I mean, clarity is always, you know, a key issue around regulations. I was recently at a conference where I think the word clarity and taxonomy were the two most used words, yeah, during the conference. But. But, yeah, in this complex environment, it can, cannot always be, you know, that straightforward. You can't describe it. So, so how sort of do you deal with that? And I think part of the shift in the risk management is also around integrating risk management so that you don't have separate silos with just investment risk or just operational risk. So you're working towards more of a holistic risk. To what degree do you think that investment team should take this on board in terms of the non investment risk? So Not, not, you know, the investments, the business side of things,  Jo Leaper  05:38 I think they have to be part of the conversation. It doesn't matter. And I've always said in public, it doesn't matter what investment strategy you come up with. If you can't implement it, if your operational teams, your custodians, your administrators, can't manage it, there's no alpha there. It's dead money. And so they do have to be part of the conversation. What I'm seeing, and what I'm liking seeing in the market, is this rise of investment governance being more involved and almost being as the bridge between the investment team and, say, the risk team, so that it's a much more holistic conversation members best financial outcomes is always the bottom line. If that's your guiding principle, you're doing well in the industry. But if you had two managers side by side that looked very equal, would you take the one with the lesser risk on I would Yeah. And so I think they really do have to be in there, but it's also about improving the communication and the decision making processes, and that they're part of the broader discussion. So if we go back to your previous question in terms of APRA and what they're looking for, they still want the same goal, same as what the investment teams want, which is members best financial interest. And so I think with CPS 230 and then, as you say, going into the businesses, by looking across the risk spectrum, they're going to end up with an overall better outcome, because the cost to member isn't just the risk in the portfolio or the fees. It's legal, it's admin, it's it, it's audit, all of those costs come in too. And so if you can find a way to structure or manage your investments to ensure that you're looking at those things as well, that's your true cost of investment. So the more you can find, I'm going to say strategic alliances, a synergy, whatever you want to call it, but the more you can get some cohesion there in the decision making and some understanding of each other's process, I think the better it will come together.  Wouter Klijn  07:20 So is it more a degree to a degree about communication, or do you think should it be a new function within the investment team?  Jo Leaper  07:32 A risk function that is one person responsible for line one risk has always been part of it. So I don't think that's any change really. In particular, I think the main change is actually coming through the FAR legislation, the financial accountability regime, because that's designating individuals as being specifically responsible for particular parts. And when you think about it, the board is absolutely responsible at the top, but they have to delegate. The board can't do everything. They can't know everything. The IC can't. The audit and risk committee can't, and each of those C suite executives or others who are designated accountable can't know everything about everyone else's role if they're not communicating, if they're not exchanging knowledge between teams, if they're not talking in advance of an investment, they're letting themselves down. The better ones will have their operational and risk teams separate to investments, but we'll talk to them regularly in terms of we've got this coming up. This is what we're thinking. Is that doable? Is that not doable? What? How long will that take the custodian? What will it cost me? And it becomes part of the process, not an add on at the end.  Wouter Klijn  08:29 Yeah. So do you think that this will change, then structures within organisations? Because I sort of had the idea around, okay, well, if we make this everybody's responsibility, then it ends up that nobody's responsible. Nothing gets done, right? So with FAR coming into place, and basically, I think it requires organisations to pinpoint people and say, okay, they're responsible. In practice, that might not necessarily work out that way. But do you think that structures might have to change to make this more smooth process, or  Jo Leaper  09:00 They already are. I think in a lot of cases, APRA has definitely given indications to funds with regards to where their operational function sits, where their risk function sits, where their finance function sits, and what should be within investments and outside. The main thing with SPS 530 was segregation of duties, and so a lot of funds have taken that to heart and done some really good steps to get going. And now we're seeing this move. And if you look on SQL LinkedIn, there are so many investment governance and investment risk roles coming up for advertisement now, because there's a recognition that there has to be a bridge between the two and a dotted line is okay, but it can't necessarily be sero to CIO, necessarily, because day to day, they're not going to be across the challenges. Whereas an investment governance person or investment risk person as line one working into line two, risk, that's a much better conversation. And there is also that the way the information bubbles up, the language that you would use with an investment committee about risk may be slightly different to what you would use with a risk committee about risk, and this allows us. To look at the operational outcomes and say, Well, hang on, what should be going to the IC and what is actually an ongoing risk that may need to be managed by audit and risk and funds are just getting there in terms of giving that some thought now too. Because really, if we're going to make the audit and risk committee delegated from the board responsible for the risk, they need to understand the investment side. But equally, the investment committee needs to understand the audit and risk side as well.  Wouter Klijn  10:25 So these sort of new roles that are created or that are out there, do they function as sort of a translator between the different teams? I sort of make the analogy where, you know, insurance companies often what we found that the investment team didn't really talk to the actuarial team, even though they worked off same assumptions. And, you know, there was obviously a liability question around there, but, but there wasn't really a lot of communication, and the language was quite different. That could potentially be a problem here, too.   Jo Leaper  10:55 Yeah, it definitely can be. And I think they've always talked, but they're not always talking the same language, or they're using a word, and it's not necessarily the same on both sides. And someone who's got a good understanding of operations and investment or risk investment and governance can be that conduit. But it's also when they're looking at new investors or new investments rather, that they can then say, Hang on a second. What's going into the mandate? CPS, 230 if we go back to that, or 530 has quite a bit of onus on the asset owners of what they need to understand. There's been a big move and a much bigger shift towards including some of those requirements in the mandates or inside letters, and having the investment team do that. They're looking for a practical outcome. That's their job. That's what they're very, very good at. But an investment governance or investment risk person will look at it from the broader enterprise perspective, and so having someone in the middle that marries the two concepts and says, what's easy for the manager to facilitate to us in terms of information and what can we easily digest and use? Because it would be nothing worse than getting something back from the manager and nothing happens with the information. Yeah, that's really quite challenging.  Wouter Klijn  11:58 Yeah. So what is your sense of how much organisations are on top of this? The FAR regime is relatively new. It comes well this month into force in 2026 what is your sense there?  Jo Leaper  12:13 They started work on it quite a while ago. Yeah. And it sort of started around the same time as CPS 230 was just getting moving. And so I think they're reasonably well along in terms of the journey and designating what, who's accountable, who's accountable for what, etc. But if we go back to the premise of APRA and members best financial outcomes, and what we want to see with clients, it's that we want to see them utilise that legislation and structure to improve things, not to make it harder. Historically, I would have said that regulation was really additive. It's like, what's the next thing we can do that? What? How do we plug that hole? How do we make more sense of it? And you end up with boards with ginormous information packs that not sure they're totally understanding. And it's not because they don't have the intent to, and it's not because they don't have the capability. It's just that the volume of information is so much, and I think same with FAR, by stepping back and having those executives understand what their responsibilities are and utilise that in a, in their decision making and B, in how the information comes up to the ICS and the boards, we should see it evolve. And I think we've seen a little bit of evolution. But imagine the next two or three years, as far gets locked in, and as CPS 230 gets more settled, we start to see up as reviews of asset owners around that as well. Fingers crossed. We'll start to see that cohesion come, and then hopefully we can get to the world, which is what I'd really love, where risk is not a cost of business, it's actually an enabler of outcomes, whether that's investment or otherwise.  Wouter Klijn  13:39 Yeah, yeah. So when this all comes together, what are some of the main areas that you really want to take an extra look at? I think in the past, you have mentioned, like systems and security, costs, things like that, what are sort of the main areas?   Jo Leaper  13:53 Well, at the moment, the hot ones, ai, ai, has got the potential to do amazing things for our industry, but it's also got a lot of challenges, and where the industry is going at a very fast pace, so that that is a question, the integration of the broader operational costs back into that risk discussion is another large part of it, really strong alignment of roles and responsibilities. And I think what we're seeing across not just not just asset owners, I think it's actually across, whether it's investments or broader companies that the roles and responsibilities aren't always aligning with where the current role is and with historically, I think the world globally had a view that if you're the CRO, your job is this. If you're the COO, your job is that. But companies merge and morph and their roles change slightly. Now we've got new legislative requirements coming in. It's going to force some Dillon force some delineation, which is probably necessary. But at the same time, I think if you look at it from the positive perspective, it gives organisations a chance to go back and say, Hang on a second. If we did this now, starting from scratch, how would we set that up? Now? What would our structure look like? Who would be doing what? And so I think I. That's probably the biggest potential driver of immediate change, is making sure that your roles and responsibilities are aligned. Tech is still a huge one. It's never going to go away. Legacy technology in the industry, like I said earlier, is, it's quite challenging, yeah, and so yeah, there's a lot. But at the same time, if you've got the right premise in front of you of how do we get the best outcome? We should be okay.  Wouter Klijn  15:23 So do you think that the regulator, to a degree, want to go back to basics, and basically, as you said, not add something on, but to rethink the entire approach to risk management?  Jo Leaper  15:33 I think so. I was involved in the Appra and ask for discussions on CPS 230 and as you know, I'm leading the ask for working group for operational due diligence as well. And all the way through the comments from APRA was we didn't want this to be additive. They really do want us to look at removing something. But if I'm a board trustee, how do I get comfort that taking away that piece of information isn't going to cause me drama later? And that's where there really is a lot of work going on in the industry. There's a heck of a lot of work going on in the industry looking at what's going up to boards and what's actually being presented internally, because you've got this push pull between board and management, management that are doing the work want to present it. They need the feedback, they need the support and to know that they're doing a good job, which means lengthy papers, however, for the trustees to do their best job, a more efficient approach would be, let's just raise the anomalies. And it's finding that balance between the two, and some funds are making a lot more progress than others. Others are looking at what goes to the IC versus audit and risk or other committees as well. And so again, that evolution will continue. It'll be  interesting to see where it goes.   Wouter Klijn  16:39 Yeah. Now this is an Australian regulation. It's not sort of a coordinated global effort, I think. And sometimes that can be quite tricky, because we require more information from a whole lot of external services providers, often. And I sort of remember when they were talking about valuation methods in unlisted assets that it's sometimes very hard to get it out of the managers that you employ. To what degree do you think that might, you know, cause some trouble in implementing this?    Jo Leaper  17:08 It will always cause a little bit of friction. But in all honesty, it should. It really should, no no. Because if you look at, say, you've got the ipef standards, you've got other industry groups that are designating what they believe is best practice. The ask for guidance note is looking to do that as well. But I think different markets are at different stages. Some of the alts in the US are incredibly developed in terms of the way they do the valuation committees, the way they do their independent valuations, how they validate and verify the information they provide. And others are in a much more, I'm going to say more infancy sort of state. They've absolutely got the right idea. If we want alpha in portfolios, sometimes we've got to accept a little bit of that risk, and that's where the individual risk appetites and risk frameworks make a difference. But it's certainly not a blank check to accept everything. And I think what we've learned, particularly since the original guidance note came out is that talking to those managers, having that conversation, starts to change the dialogue. You know, we've had managers where we've done DD reviews for years, and then five years later, they come back and go, Oh, we're actually about to uplift that is all that stuff you said still valid? And sure enough, that's what they take, which is great, but we're one voice. Some of these big managers could have 50 consultants asking for things, and unless we're collectively asking for the same we don't talk to each other. It's not necessarily going to align, but I do think there is a lot of focus on the unlisted market at the moment, particularly private credit, private debt and otherwise. And there should be, but it's an evolution as well.  Wouter Klijn  18:37 So is this going to affect the private asset space more or do we actually suppose more?  Jo Leaper  18:41 I think the valuation governance frameworks that are in 530 already are having that impact, but I think it will get more intense, because APA really wants to understand and so does ASIC. And unfortunately, as we all know, there have been some challenges in the industry around shield and first guardian and others in terms of look through and understanding what you're actually investing in, and at the end of the day, good governance will get you so far. The valuation processes can be as robust as possible, but there is always risk. And that's, like I said, it's that balance of is that risk in line with what we're trying to achieve for our members? Yeah, sometimes it will, and sometimes it really won't be.  Wouter Klijn  19:17 Yeah. So these new rules are basically they intended to uplift governance, make people responsible, personally responsible, for some of these areas. What is your sense on how much impact this new legislation will have? If I compare it, for instance, to your future super that had quite a massive impact on the industry? Is this similar?  Jo Leaper  19:40 I'm actually not sure on that one. I think with your future, your super the regulator was looking for very specific outcomes and trying to correct specific behaviours. But APRA, in the recent prudential standards, the cross industries and the super standards, they're saying Prudential. They're saying that it's they're not going to be prescriptive. And so. Don't know that it will be quite as much of an impact. But what I do think is that 230 in particular is allowing for the right sizing of risk, and that's not being prevalent in the past. So in the past it was you need to look at your manager. You need to look at it every year. You need to have covered this, this and this, and this is how they categorised and and there you go. Whereas now it's a much more sensible approach, from an mdfi perspective, to say, Hang on a second. My riskier managers deserve more attention. I need to work on them if I'm going to stay invested my less risky managers, okay, I still need to look at them. But where's the best place for me to spend members money and our resources that members are paying for to get the best kind of outcome? And so that right sizing is really critical. At the same time as we've been talking about, the alpha has to come from somewhere. And if you can find the right way to use 230 to look at those risks, you can really start to drive the uplift that you were talking about. And I think in our previous discussions, I've talked about giving Alpha its wings. Risk has to be part of the discussion to enable an investment it's not just a detractor. And I think historically, the world's been a risk cost, cost of compliance, cost of doing business, as opposed to hang on a sec. Are there things I can do here in my business to make it safer, potentially attract more money into the investment manager we're looking at and start to generate some real outcomes. The flip side, though, is the potential for contagion risk, because if we have manager concentration, which is where 230 comes into play, but we've also got those geopolitical risks, I think, as we were talking about before, there is so much more general risk across the market that April's right, there is the potential for a systemic event at some point, but there always has been, and there always will be. So the more prepared we are for it, the more we understand what our managers are doing, the better look we've got on the data, and the better way for us to try and look at correlation and causation as two different factors in there, there's a much better chance that we'll be prepared, and that's what they were wanting with 230 it's operational resilience. It's the readiness, yeah, and you can see at the moment.  Wouter Klijn  22:11 I think you mentioned before the sort of what is playing out in the private credit space as well, and in the US. Do you think that this will help prevent sort of, especially the super funds, investing in funds that might have over promised on liquidity or have too high of a retail base? Jo Leaper  22:30 Yeah, and I think so yes, and I do think it is, if it's not already, it already is starting to prompt those discussions. And when we say that risk is necessary. It's understanding the risk that is necessary. And if this prompts those discussions, then I'm really happy, because that way they can look at it and go, does this work for us, or does it not? It might have fit in the portfolio. It doesn't now, or that opportunity we said no to that actually fits now because we don't have a better understanding. So I think it is that evolutionary discussion that private credit, private debt, feel like the hot topic at the moment, but really it's just about trying to get any funds, need to get extra alpha in there, and finding the best way to do that, logically and sensibly. We talk about risk sensible a lot. Wouter Klijn  23:16 So you mentioned the alpha and talked about the concept of giving Alpha its wings. I think in the US, they talk a lot about operational Alpha. Do you think there is alpha in this sort of holistic risk management framework? I genuinely  Jo Leaper  23:29  I genuinely do we, particularly from our side, we get a lot of the operational alpha out of the operations side. Risk is definitely part of it. But unless you're understanding that whole of risk construct, you can't necessarily seek out the operational alpha, but the operational alpha can also extend into how my FX is being done. How am I actually implementing my trading What am I doing with my idle cash that sits at custodian if it's not getting a lot of cash return on it? And so if I was to say, take that operation sorry to the custodians in the world, take that operational cash and invest it that comes with operational risk, which means I need to be talking to my IT team, my risk team, my audit team. How am I going to be investing that? Am I in sourcing? Am I outsourcing? There is genuinely a possibility to generate more alpha from what you have already within the portfolio. It comes with risk with every change that you make. That holistic approach absolutely is a way to try to generate that alpha in a sensible way. Yeah, just understand it.  Wouter Klijn  24:30 So it's not just about avoiding disasters. Jo Leaper  24:34 No, no, definitely, not definitely avoid disasters. Please, avoid disasters. It's about trying to find a way to do what the job is. Yeah, our job is to manage someone else's money. We have to do that in a really sensible way. And I'd hate to see alpha being left on the table, because someone could make the operations work. That's not a sensible approach to me. Wouter Klijn  24:57 Yeah, so we started off saying that this is. Is becoming more important because the world is complex. Investments are more complex. Do you think there's also a element here where it's going to be harder for the more funds get larger and larger? I mean, we see some of them hitting, you know, close to $500 billion. How do you how do you manage risk in an organisation that's like one or $2 trillion? Jo Leaper  25:25 I think that is a very interesting question that we don't necessarily have the answer to yet. Fair enough, I think we need to learn from what overseas peers are doing. There are definitely pros and cons to internal management at Every Size and every fund needs to make their own decision. In that sense, if we look at the US funds that are already that size, they've got 234, custodians, right? I'm not sure in this market that we're prepared for that, but we probably should be looking at multiple custodians at some point. They also have multiple securities lending providers. They also have much larger teams, but then their regulatory environment is different to ours, and so we can't say, Let's do what the Canadians do, let's do what the US do, or what the Koreans do, or Netherlands. It's what do they do. And what can we learn from Yeah, because other people have done this before us. So we'd be very naive to come in and go, right, we can build a model from scratch, but I do think a lot of a lot of investors would benefit from going back to the drawing board and saying, if I started this fund today at this size, how would I set it up? And that's quite challenging.  Wouter Klijn  26:30 Yeah, so you mentioned you're part of as far Working Group on it as well, and I believe you're coming up with a guidance note on investment management, operational due diligence at sort of a high level. What will this focus on a roadmap for funds to implement? Jo Leaper  26:46 It's not a roadmap. It is more it is a guidance note. So it's more like a practice summary. What what we want to do is continue on the previous work. The genuine benefit that we want is to bring a benchmark to the market for what they should be expecting. Because when the guidance note was written, which was seven, eight years ago, to where general market practices are, has changed. There's no point leaving guidance as it was 10 years ago. There are really good innovations in there. And so with the guidance note, we've kept the same categorizations like trading and back office risk valuations, HR, etc, but what we have looked to do is bring together, and in the Working Group, we've brought together, got Jana as an ops DD consultant to asset owners, Mercer as an ops DD consultant to asset managers. And then we've brought in superannuation funds, obviously, as far and asset managers that are part of Asfa, as well as a legal component as well, to try and ensure that the guidance note reflects all of the different parts of the industry and how they work together. And so it's very different format. You know, we'll see a very different format there is the sort of documentation you should be asking for to try and validate, because we really are leaning into apras document and understand what you're doing. And so we're leaning into that a lot. It has an extra section on CPS 230 it is less prescriptive in terms of how often you should do the review, and it's trying to be more reflective of 230 in terms of risk adjusted approach. Let's use the resources sensibly and try and make sense of it. What is different about this model in Australia, though, we're the only market in the world where the manager pays for that review, right? Okay, and a lot, a lot of the feedback we got from overseas counterparts was that that's they're just not okay with that. And when it first started way back in the day, I wasn't okay with it either. But working with that model for so long and seeing that the reviewers are putting into the reports that go to the clients and prospects, exactly what the manager has said, typos and all. It gives me a lot more comfort that it's in there as it should be, because it's not an audit. This is where I really get into someone say, get on my high horse a little bit. I really want risk to not be seen as a cost. And yes, this is a cost. Yes, it costs the manager. Ultimately it's going to cost all clients. This is a pretty economical way, because it's a smaller fee paid for there. But what the feedback from the managers that I'm really enjoying, including overseas managers, which is great, is they are able to distribute it to any of their clients globally, to any of their prospects globally. That's really good, and because it gives us a standardised benchmark of good practice, as opposed to you had x many tests in this GSW seven that didn't pass, it's actually really good, genuine feedback for the managers, because a risk or a compliance review that they get done is often based against legislation as opposed to market practice. And so I think our clients and the as well as the asset managers that are using the reports are getting a lot more back and a lot more relevant information they can use to lift the quality of the market. And if the rest of the world wants to follow suit, great if they don't. This is where we're going at the moment, it's not for everybody. And as you said, as super funds grow more and more. Maybe this is useless, maybe it's not. But could it be useful, perhaps, in the retail space, in the platform space, when you're dealing with very high volumes of investments coming in and investors that may not be as savvy as some of our wholesale investors. Wouter Klijn  30:14 Well, Jo, thank you very much for your time and for coming to the office. Jo Leaper Thank you very much for having me. It's been great. 
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  133: From the Archives – Gus Sauter and the Early Days of ETFs 13.04.2026 44min

  In this episode of the From the Archive series, we look at a 2019 interview with Gus Sauter, the former Chief Investment Officer of Vanguard, who worked for more than 25 years at the company. Sauter is also an adviser to the Australian Retirement Trust, then Sunsuper. Index and passive investing have gained momentum in recent years and it is estimated that about 60 per cent of investments follow passive strategies today. Considering this sheer weight of money and the move of more Australian superannuation funds to passive investing in recent years, it is easy to forget that index tracking and the popular investment vehicle for doing so, Exchange Traded Funds, were once controversial. In fact, Jack Bogle, the founder of Vanguard, was not a fan when Sauter launched the ETF business for the company. In this interview, Gus takes us back to those early days and revisits the active/passive debate, a discussion he never tires of. __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights __________ Podcast overview Gus Sauter 1:00 You started a bank at age 8, is that true? 3:00 Then a goldmine in your 20s? 4:20 Gold is an Armageddon type of investment; if the world collapses, gold is probably going to be fine 5:50 My first stock 6:30 I've had the active vs passive debate literally thousands of times and 'no' I'm not tired of it. 7:00 Passive is a good investment strategy, but it is never going to be top performing in any given year 9:00 I'm not totally on board with the efficient market hypothesis 10:00 Why indexing works 12:00 But does the market capitalisation method work in fixed income, where you skew to the most in debt entity? 14:00 Over time, markets have become more efficient, compared to the 1980s. 15:00 Did Jack Bogle cut his holiday short to find out why you were adopting ETFs? 16:00 Jack disagreed on ETFs 17:00 The crisis of 1987, and the subsequent redemptions from mutual funds, shaped my thinking on ETFs 19:30 Is there more institutional takeup of ETFs in the US, than there is in Australia? 20:00 ETFs are not a product; they are a way to distribute index funds. 21:00 Not a fan of smart beta 27:00 You don't think there is necessarily a correlation between GDP growth and stock market returns? 28:30 You can take a great firm and make it a lousy investment by overpaying for it and visa versa 31:30 Working with Sunsuper 33:00 Do you see a lot of similarities or differences between the issues that investors in the US and Australia grapple with? 35:00 Should pension funds in Australia be more dynamic in their asset allocation? 37:30 What have you learned from past crises? 42:00 Jack said: "One day indexing is going to be really big and we'll have US$ 10bn in assets" We now have US$ 4 trillion. Full Transcript of Episode 133 Wouter Klijn  01:00 Gus. Welcome to the show. Gus Sauter Well, thank you. I'm glad to be here. Wouter Klijn  01:52 Let's start a bit with the start. I'm going to take you right back to age eight. There is a website that is called Buggle heads, and it has your buyer up there, and said that at age eight, you started taking deposits and making loans to neighbours, effectively starting your own bank. Is that true? And what is wrong with playing with Lego? Gus Sauter  02:16 It is true. I'm hesitant to admit I think I probably broke several 100 banking laws. But yes, I didn't think my neighbours were going to turn me in. They would give me $1 or two, and I would turn around and deposit it in the bank and earn interest on it, and then turn around and give them the interest that they would have earned. So yeah, I was a little enterprising at eight and not too much into Legos. Wouter Klijn  02:40 So where did you get the idea from? Gus Sauter  02:43 You know, just from my parents and going to the bank with them. And I guess I was just curious about how money could make money for you and and really, that was the genesis. Wouter Klijn  02:53 And then it also says that around in your 20s, you formed your own gold mine, but what inspired you to make that investment? Gus Sauter  03:04 Probably naivety. I was working as a commercial real estate developer in Denver, and we were building, really about 11 story office buildings, and I was working on the financial side of putting these deals together, and this opportunity came along to develop a gold mine, and I figured, well, I'm the financial side raising capital to build buildings. Why can't I raise some capital to build a gold mine and and so I put a venture capital deal together. Took me about three years to run it under. Turned out to be a little bit of a frustrating point in my life. Wouter Klijn  03:35 I can imagine. So looking back, what is your view on gold today? Because a lot of investors think that gold is a bit speculative. It doesn't have any inherent value. How do you look back on that? Gus Sauter  03:47 Yeah, so I started that in 1982 and that was really kind of the height of the gold mania, the gold rush, and I was looking at a little bit more like a mining company, as opposed to the lustre of gold itself, although I must admit, if we were mining for salt, I probably wouldn't have created the firm. So my view then was to hopefully make money mining gold and selling it immediately, not holding on to it. My view is that gold is kind of a Armageddon type of investment. If you if the world collapses, probably gold is, is fine. My view is the world is not going to collapse. And so I, you know, gold doesn't give you any sort of rate of return. It is, you know, as you indicate speculative. You buy it with the idea you can sell it later to somebody at a higher price. There's no dividend on it, no interest. So I think if people do have it in their portfolio, it should be a small, small part of the portfolio. Wouter Klijn  04:47 Yeah, well, I'm glad the world is not coming to an end. So we had banks, we had a gold mine. You mentioned real estate. How did you get started in the asset management industry when my gold mining venture went on? Gus Sauter  04:59 I had a good friend from business school who had kept in contact with me, and he went to work for Pimco, who is now the famous bond management firm, and he kept after me, and kept telling me that I belonged in the investment management industry. And actually, quite honestly, I felt that as well. I bought my first stock when I was 11 or 12 years old after after the banking experience and and I loved investing, so I followed his advice. And interestingly, I had some opportunities, perhaps, to go with PIMCO out on the West Coast, in California, but I grew up in Ohio, in more the centre of the United States, and I wanted to go back home. Unfortunately, there just aren't many investment management firms in Ohio. So I worked for a bank in Ohio in their trust investment area, and got experience. Wouter Klijn  05:47 And I think that that first stock was that a basketball team. Gus Sauter  05:51 The basketball team was actually my second stock. Yes, my first stock was a snowmobile company, and my second one was the Cleveland Cavaliers. I'm proud to say I was one of the original owners of the Cleveland Cavaliers. I grew up 90 miles south of Cleveland, so, yeah, Wouter Klijn  06:07 So taking it to Vanguard, not looking at individual stocks, but we're looking at indexes, and even to deal this day, we still have this discussion about active, passive. You know, what is better? Do you get tired of this conversation? Gus Sauter  06:27 You know, I've had the debate 1000s of times, literally 1000s of times, as we were trying to build indexing back in the 80s and 90s, it was not well received at all. And it was really a brick by brick business building venture, and I was invited to many, many conferences, and interestingly, they would have me on a panel, and I'd be in a debate with somebody else, and it would always be a top performing, active manager. So you know, you're always kind of with with your back in the corner. Indexing is a very good strategy and appropriate for most investors, but it's never going to be top performing in any given year, it's going to be a good performing investment that really compounds over time into top performance. So I actually, I do love the debate, because I think it shows the advantages of indexing and also allows for the advantages of active management to complement indexing. Wouter Klijn  07:18 And it seems that we have moved on a little bit from one against the other two, where I think we see more especially amongst the larger funds that don't always have a choice to go 100% active, that they say, well, we'll do both. We will have a core allocation to passive, and we'll do some things around it in the active space. Do you feel that the this debate has become more sophisticated around this issue. Gus Sauter  07:42 I do. I think a lot of investors have realised that there are significant advantages to indexing, and it should be a core portion of their portfolio. It's a great foundation, because it's going to provide you with very competitive returns that will outperform a majority of investors in the marketplace. So it's a great place to start, and you have a good deal of confidence that it will provide that rate of return for you in the future, at the same time the satellite portion. So a core satellite approach, you can use the satellite portion to invest in actively managed funds to enhance your returns that you get from an index fund. So if you if the index fund is your your ballast, or your foundation, hopefully you can add some incremental return above and beyond that, without too much risk, by investing in active as well thinking about indexing. What is indexing? Wouter Klijn  08:28 And I think in the past, you have made a strong point around an index is a market capitalization weighted construction. Why do you feel strongly that it has to be only that type of model? Gus Sauter  08:45 So it turns out that there are two rationales for why indexing should be an attractive investment number. The first one is based on the modern Efficient Market Hypothesis. I personally believe the markets are quite efficient, but not perfectly so. So I'm not totally on board with the efficient market hypothesis. If you if you believed in the efficient market hypothesis, then clearly the only thing to do is index. I mean, that states that everything's fairly priced and you shouldn't spend any money trying to outperform because you're not going to be able to do it. The other argument is what is called sharp math, or Bill sharp was the inventor of this simple concept that in aggregate, investors get the rate, the market rate of return. I mean, in aggregate, investors own the market. They own it by market capitalization. In other words, they own more stock in in, let's say, Facebook or or Microsoft or bhp, than they would in a small company. So that, by definition, is telling you that investors, in aggregate, own by market capitalization, some will outperform, but others will underperform by the same amount. I mean, to the extent everybody on average gets the market you can't all be above average when you introduce. Costs into the equation, and costs are really significant. I think people really dramatically underestimate the impact of costs. Then all of a sudden, the marginal outperformance before costs become underperformance after costs. And that's really why indexing works, because it's extremely low cost. It's a handful of basis points, or a fraction of a percentage point that you pay in costs, and you get largely the market rate of return, and you'll outperform a majority of investors because of that, but that argument is based on market capitalization weighting. There are, as you're implying, other ways that people are coming up with indexes equal weighting, or things called fundamental indexing. Those really give you something very similar to what you get with capitalization weighting, with tilts to it. So in other words, there are segments of the market, there are large cap stocks, there are small cap stock, there are value oriented stocks, and there are growth-oriented stocks. So all of these different segments of the market will perform a little bit differently from the market as a whole. And when you weight things differently from a market cap weighting, you're actually inadvertently tilting towards one of those investment styles. So when you equal weight an index, you're getting a tilt towards smaller cap stocks. And it turns out that you can just invest in a small cap, a small cap index fund that is capitalization weighted, and get a very similar return. Same thing when people tilt towards value, when these fundamental indexes, they're basically a tilt towards value. You can get the same return if you use a capitalization weighted index that is tilted towards value, so the capitalization weighting is less expensive. You don't have to rebalance as much. It's lower cost than fee wise that most of these other types of indexes charge. And it's it's more tax efficient because you basically buy and hold so I think you can accomplish if you want a small cap tilt or a value tilt, you can do it with capitalization weighted indexes. Wouter Klijn  11:59 I think part of the debate around market capitalization model is around. Is this the best way to construct an index? And I think where this debate becomes most clear is within the fixed income space, where there are issues with having the largest exposure to the most indebted entity in the index, even though that represents the market. Do you think that's a fair comment? And can we still call them indices? Gus Sauter  12:26 So you know, going back to the sharp math, the bill sharp math, which is a mathematical tautology, again, you know, in aggregate, investors are going to get the market rate of return when we start to think of other asset classes other than stocks, like bonds, fixed income. The concept still applies. If you want to be a top performer, outperforming the average capitalization weighting still makes sense. It's true that you put more weight in in companies that have or countries, for that matter, that have greater debt. And people have said, well, so you're taking more risk because you're investing in the most heavily debt laden companies or countries, but at the same time, that's already implicit in the pricing. So in other words, if there's additional risk associated with investing in either that company or that country, it's going to be reflected in a higher yield, a higher rate of return. So so you're really being compensated for that. And the people who say, Well, you know, you're just taking on greater risk, you're being compensated for taking on greater risk. And again, the only way to ensure that you're going to be a top performer over the long term mathematically is by relying on that sharp math and owning the entire market capitalization, weight weight market. Wouter Klijn  13:42 So this is where the efficiency of the markets come back in, where it says, Okay, this is greater risk, but it's priced accordingly. Gus Sauter  13:51 Yeah. So you know, as I said earlier, I don't believe in perfectly efficient markets, but I don't think there are grossly inefficient markets either. And actually, over time, I think the markets have become more and more efficient. I mean, I think back to the 1980s when I started in this business, and quite honestly, active management was a lot easier back then than it is today, and that's because there were greater inefficiencies. So there were greater opportunities to take advantage of mispricings. Today, those mispricings are very small, and even if they're not precise, they're not grossly wrong. And so, you know, it's very, very seldom that you would find a company or a country that is much riskier than its yield would indicate. Wouter Klijn  14:33 I would like to take you back a little bit to innovation in the index space, and especially the exchange traded funds. I understand that you were one of the earlier believers at Vanguard within this vehicle, but I also heard that when Jack Bogle, the founder, found out that you were going into ETFs, that he cut short his holiday and came back to grill you on why you're going down this route, even though he was supposed to have retired already by that stage. What happened there? Gus Sauter  15:01 Yes, Jack was retired at that point, and Jack always went on vacation for the whole month of August. He had a house up in the mountains, and he went away for the month of August. We happened to announce that we were going to launch ETFs while he was away. I mean, that was just pure coincidence. And since he wasn't working with the company anymore. He wasn't aware that we had been working on this for, actually a couple of years. It took a long time for us to to launch because of our unique structure and getting it through the regulators. But so Jack did find out when he was on vacation. I don't know that he actually came back early from the vacation, but, but the day he got back it at Vanguard, and so he still had an office at Vanguard where he did his research. And we have a building that has the the dining area, the dining hall, that most of the employees congregate for lunch, and it has an upper level and a lower level. And I entered it the lower level to go grab some lunch, and Jack happened to be standing in at the upper level, at the top of the stairs, and he saw me at the bottom. And this this foyer is typically filled with lots of people around lunchtime, and Jack has had a booming voice, and he held out, gosh, what the heck is going on around here? So you know, Jack was vocally not in favour. Or, you know, I'll say it's that Jack was against ETFs. Jack and I agreed on an awful lot of things, but we disagreed on that one. Wouter Klijn  16:33 Did he ever turn around on this topic? Gus Sauter  16:35 No, he was very vocal, you know, till his final days that he did not like ETFs. Wouter Klijn  16:42 So what attracted you in ETFs as a vehicle? Gus Sauter  16:45 I started with Vanguard in 1987 to be precise, October 5, 1987 some of your listeners will recall that October 19 was the crash of 87 two weeks after I started. And I think we're all shaped by our experiences, and that was a scary one for me. I was actually managing the very small equity group at that point in time, but it put a lot of pressure on us. And, you know, we had some withdrawals, and I was trying to sell stocks to meet those withdrawals that day. And that really kind of shaped my thinking. When I started thinking about ETFs, I started thinking that we were we had just come out of the late 1997 period, which was known as the Asian contagion, and the markets became very volatile. Then we went into the summer of 98 which was the Russian debt crisis, again, volatility in the markets, and I was worried that we might experience another crash of 87 type of event. So I started thinking about, how could we enable investors that wanted to get out of our funds, enable them to get out of the funds without impacting the fund itself. When an investor gets out of a fund, you have to sell off some of the investments in order to fund their redemption. So I started thinking that if we had a share class of ETFs in the same fund. In other words, you could invest in the Fund two different ways, either directly with the fund, like you typically would, or through the ETF share class. It turns out, because of the mechanics of the ETF share class, if an investor happened to own that share class, they could sell that on the stock exchange, which is where you trade ETFs, and it would have zero impact to the fund. And so I reasoned that if investors were so inclined to sell, they would be attracted to the ETF share class and not to the conventional share class, and that would enable them to have all the flexibility they want without disrupting the investors that were long term oriented and leaving the fund with additional costs. So they really complemented each other. Wouter Klijn  18:46 Yeah, and is that impact mainly in terms of taxation? Gus Sauter  18:50 It's, it's both taxation and transaction costs. Yes. So the taxation piece would be, if you have to sell off an investment that is appreciated in price, you have a capital gain you have to pay tax on. But at the same time, if you have to sell off, you have transaction costs of selling the investments as well. And so we would avoid all of that by if people were in the ETF share class. Wouter Klijn  19:11 I think to a degree, the initial take-up here in Australia was mainly retail, and we don't see a lot of institutional investors using ETFs other than temporary parking money or tilting how's the situation in the US? Is there more institutional take up? Gus Sauter  19:29 There is a little bit more institutional take up in the US. So we see institutions using them for any number of reasons. Sometimes they use them for long term investments. Sometimes, as you indicate, just short terms, they might be migrating from one type of investment to another, or from one manager to another. You can imagine a large institution that has a manager, and they might fire the manager, but they need market exposure while they're looking for a new manager, and so they might move, for short term, into ETFs. So I'd say ETFs. Are used considerably by institutions and tremendously by the advisor community in the US. Wouter Klijn  20:07 So what do you think is going to be the next innovation in indexing or in ETFs? Is that around active ETFs, or perhaps the Smart beta ETFs? What is your view on that? Yeah. Gus Sauter  20:18 So the interesting thing a lot of people talk about ETFs as being a product, and I've been pretty vocal saying they're they're not a product. They're a way to distribute a well known product. In other words, it's a it's really just a different way to distribute an index fund. If you look at all the ETFs they can be done in a traditional mutual fund, ETFs in the United States are legally organised as mutual funds with certain exemptive relief. So they come out of the same part of the tax code. To me, ETFs are really just another way to distribute. I do think they will grow into a way to distribute active funds as well the Smart beta concept I'm not a big fan of. In fact, we had what's become smart beta in the early 90s. We started, I mentioned earlier about the different segments of the market, and that's a little bit of what smart beta is all about, is targeting different segments of the market. You know, talked about fundamental indexing. That's fundamental indexing turned out to be difficult to market, so you rename it smart beta and like, why would anybody get dumb beta if you could get smart beta, but it's really just getting different exposure to different segments of the market, and you can do that through capitalization weighted indexes, which we have offered since the early 90s. But I think my objection is they're being marketed as something that will provide you long term outperformance, and I just don't think that's going to hold up. And I think investors are expecting more than what these products can deliver. Wouter Klijn  21:52 You talked a little bit earlier about the market structure as well, and that you said that in the past, it was probably a little bit easier to be active, and today, markets are a little bit more efficient. There has been a lot of discussion as well about the impact that the large technology firms have on the structure of the market with capital light models, and potentially has changed the structure of the market as well in the sense that there's less ability to participate in the growth. Do you worry about these types of developments? Gus Sauter  22:27 I don't. I think that technology has been an advantage for investing and has reduced costs significantly. So I think on the transaction cost side, it used to be that humans were involved in all trading. And if you wanted to buy something, you had to buy it from a market maker, and or conversely, sell it to a market maker. Now it's done electronically. Almost all trading is electronic nowadays, and it cuts out a layer of profit that that middleman would would earn. And so transaction costs have plummeted. I mean, literally, from what would have been 1% or more if you, if you bought a stock, to now maybe a quarter of a percent. So that is a huge amount of savings to investors. That's a benefit. I think your question is also about investing in technology companies, they are light in capital. As you point out there, it's more human capital than physical capital. That's I don't think that distorts the market. It's just a different way of creating a business. And ultimately, you're investing in businesses for the profit they earn. And it doesn't really matter if the profit is generated by human capital or machinery, like a manufacturing company. So from an investment standpoint, you just have to analyse it differently. I think you were also asking a little bit about, do you get to participate in the early stages of, say, it being kind of venture capital, a lot of firms, Lyft just went IPO last week in the United States. Lyft is like Uber, if Lyft isn't here in Australia, and the people that created Lyft, it went for $22 billion IPO. So these are called unicorns, anything that IPO is for more than a billion dollars, and the venture capital investors do extremely well and and then ultimately, investors, public investors, get to participate after the initial public offering. You know, I think that's just the risk one takes in venture capital for every unicorn we hear about, there are 1000s of dead unicorns along the road. So you should be compensated for risk. And even when these companies do go public, they still generate good profits for investors. I mean, look at companies like Facebook or. Amazon or Google investors, public investors, have made a lot of money investing in those, those companies. Wouter Klijn  25:07 Now, you did work with the Securities and Exchange Commission in the US on equity market structure issues. What did they focus on? Gus Sauter  25:17 It was a number of things. So I worked for help four different commissioners, four consecutive commissioners of the SEC over a decade or more, and they were working on a lot of structural changes to the marketplace, you know, going from that old structure that I mentioned, where everything was driven by humans, and prices were priced in eighth so it was $10 point 125, cents, 12 and a half cents. They created decimalization, so things started being priced in pennies. They brought in electronic trading. They tried to make sure that electronic trading was fair across different platforms. So there are, there used to be three exchanges in the United States. There are probably 50 now, or maybe even more than 50 at this point in time, and it's not fair if you trade on one exchange when there's a better price on another exchange. So they were trying to link the exchanges together to ensure that investors would always get the best price they could. So I sat on a number of panels for the SEC and gave my thoughts and opinions as to how I thought things should be done, and had the opportunity to speak directly with all of the commissioners during that time period. So it was a lot of fun for me to as a practitioner, to help out with the regulators as they were, I think making great improvements in our marketplace. Wouter Klijn  26:36 Yeah, expanding a little bit on this idea of markets and exchanges as a vehicle to participate in profit. A lot of the discussion around emerging markets is about the economic growth and GDP growth and how you can participate in that as an investor, but I think you are a little bit more cynical about the direct relationship between economic growth and GDP and how that translates into markets. Can you expand a bit on that? Gus Sauter  27:06 Yeah, I can give you two examples that explain that GDP growth, economic growth and stock market returns really aren't correlated. So think back to the global financial crisis 10 or 12 years ago, as you recall, Everybody I talked to around the world felt we were going into a very slow growth economic environment, and I agreed with that view. And it turns out we were all right. We've been globally. We've been in a very slow growth economic environment. And then, if you'll recall, at the same time, because of that, people felt that we would have very low equity returns going forward because of this low growth. I was arguing that, no, it would actually be the exact opposite, that you would have high returns going forward because of the perceived risk in the marketplace. We'd had the crash of the tech bubble in 2000 to 2002 and then we had the financial crisis. And I think investors perception of risk was extraordinary. And you know, if you think, Well, if you were expecting a low return in equities, let's say equities have returned historically about 10% and if you expected, say, 5% would you invest in equities when you could get a 4% return on bonds, which, have, you know, a fraction of the volatility. Nobody would invest in equities. They'd put all their money in bonds for, you know, you wouldn't take all that volatility risk for an extra 1% so I was arguing that the stock market had repriced itself so that it could provide great returns going forward. It's all about pricing. That's what determines future returns. You can take a great firm and make it a lousy investment by overpaying for it. Conversely, you can take a lousy firm and make it a great investment by underpaying for it. So it's all about where you price things initially, and the markets had pulled back dramatically, pricing things very low to provide great returns going forward, which we've had over the last decade, extraordinary returns. Another simple example that I give is the period of the 20th century, the 1900s the UK economy grew 1.8% per year. Their GDP growth was 1.8% per year, and the US economy grew 3.2% per year, much faster growing economy, if you compound that out over the 100 year time period, the UK economy grew about seven fold. The US economy grew about 17 fold during that same period of time. During that period of time, the UK equity market returned about 10.1% per year on average, obviously, with volatility. During that same period of time, the US equity market returned 10.1% per year with volatility. So there really has been no correlation between economic growth and equity returns. Wouter Klijn  29:53 You mentioned there as well that the important element in there is risk. Is it a case where. Perhaps people focus too much on on volatility as a measure of risk, rather than taking into account all the other elements, including valuation. Gus Sauter  30:08 Yeah, I think people do do focus on volatility. And if you've got a long time horizon, you don't really need to focus on it. If you've got a short time horizon, I think volatility probably is important to you. If you need your money a year from now, volatility is definitely your enemy. If you you happen to get a bad return over the next year and take your money out, you've got less money to take out. So. So volatility is important, depending on your time horizon, if you're 25 years old, saving for retirement 40 years from now. It doesn't really matter if the market goes down dramatically in the crash of 87 or the the crash of the tech bubble or the global financial crisis. All that matters is where the market is 40 years later, when you you're retired. And actually, if you look at a the stock market itself. Look at the price levels of the stock market over the last 50 years, all of those market crashes look like a blip in the in a heartbeat. When you look at them, they're really nothing when put in a long term perspective. But so people probably do focus on volatility a little bit too much, but people tend to be too short term oriented, too they don't think long term. Wouter Klijn  31:24 You are here in Australia, partly because you're an advisor to the Investment Committee of Sun super. How did you get in contact with them? Gus Sauter  31:32 I retired six years ago from from Vanguard, and Sun super was a client of Vanguard. I had not actually had I spent a lot of time in Australia during my working career, because I did have an investment team in Melbourne. So I got here a couple of times a year, and did meet a number of clients at Vanguard's. But I don't believe I had actually ever met Sun super. Turns out, when I retired, Scott Hartley, who was the CEO of Sun super, was, I think, looking for somebody to lend advice to the Investment Committee of Sun super somebody who had perhaps a slightly different point of view. He was looking for somebody who could, I think, play a slight devil's advocate role, maybe offer a slightly different point of view. And while you know, investing is investing, and we've all had the same theory of investing, you do have a little bit of a different experience depending on your environment. So, you know, my work experience is probably different from what you might experience in Australia. And so I think Scott felt I might be able to add something at the margin to Sun super as either a devil's advocate or something that they just hadn't thought about. Wouter Klijn  32:39 So did you have to play devil's advocate a lot so far. Gus Sauter  32:41 Oh, you know, I I chip in every meeting, and you know, I wouldn't say anything earth shattering, just something that a lot of times there's perceived wisdom. And sometimes I question it. Sometimes I might even believe in the perceived wisdom. But, you know, I just want to be a hair shirt and challenge the thought, so see if people can justify the thought. So I, you know, I try to play a meaningful role without being obnoxious. Wouter Klijn  33:13 So do you see a lot of similarities or differences between the issues that the Australian pension funds and perhaps us institutional investors grapple with… Gus Sauter  33:25 I think the nature of superannuation is a little bit different from institutional investors in the US. So ultimately, Superannuation is about members, whereas institutions in the US frequently might be an endowment, a foundation, a defined benefit plan, a pension plan, and of course, you have those here as well. But Superannuation is not like that. Superannuation would be more similar to our 401, K plan structure, and where you're dealing directly with individuals and members. And so I'd say it's very similar to that, which is, in our view, it's a little bit more retail than institutional. But I'd say it's applied a little bit differently. Here in the US, it's typically stocks, bonds and cash, and here, through most superannuation firms that I'm familiar with, in addition to those big building blocks that everybody's familiar with, they also invest in private investments as well, and alternatives also. Wouter Klijn  34:30 Yeah, I think in the past, you also have put a lot of emphasis on the importance of asset allocation within an investment strategy. And I think in Australia, there's still a lot of funds that have a static asset allocation, high percentage of equities, little bit of bonds. Do you think that makes sense, or should there be a more dynamic form of asset allocation to play into the different circumstances in the market? Gus Sauter  34:56 Investing is a social science and not a hard science, if it were. A hard science, I would say, you know, you should be dynamically adjusting your portfolio given the circumstances. Unfortunately, if you ask 10 economists, what's going to happen in the economy over the next year, you'll get 11 answers and and that's the problem with with investing, we just don't know what's going to happen. I mean, everybody's got an opinion, but frequently the consensus is wrong. So if you were correct and knew that the market was going to go down, and if you're correct in that assumption, then yes, it would make sense to dynamically adjust your portfolio and lighten up on equities. Unfortunately, people overestimate their you know, their knowledge is, there's a it's called in behavioural finance. It's called overconfidence. People suffer dramatically from overconfidence, and they typically do the wrong thing at the wrong time. And so, you know, think to yourself, how many people do you know you've heard of that sold out in 2009 got out of the stock market in 2008 or nine after the market had crashed. And then, I mean, people were asking me, in 2012 When do I get back into the market? Well, the market was already up 100% by 2012 and they've been sitting on the sidelines. So that's the danger of trying to dynamically adjust your portfolio. It's just that we just don't know what's going to happen. Wouter Klijn  36:25 Yeah, I think there's an interesting illustration of that in the annual report of one of the largest Australian super funds. And this is a super fund that has what I call a direct investment option, where they allow the members to manage or pick some of the investments directly. And you could see that over the course of the financial crisis, it's exactly what they did. They sold out at the lowest point and sold back in when already stocks had gone up for most of its recovery, and so destroyed quite a bit of value there, which I think everybody's prone to but it's an interesting question around these direct investment options as well. Gus Sauter  37:05 Yeah, that's, that's, that's a tragic story. I mean, you know, that impacts people's lives and their, ultimately, their retirement. And it's, it's really unfortunate. There's been a whole study in finance called behavioural finance that looks at these issues, and hopefully in the future, we'll learn and be able to counteract them. Wouter Klijn  37:24 Yeah, now throughout your career, you've seen a few crises. Is there anything that we can learn from them? Every crisis is different, but are there some shared elements that people can guard against, or is it more a question of sensible asset allocation? Gus Sauter  37:42 You know, I think it does boil down to sensible asset allocation. At Vanguard, we always talked about stay the course. And the only reason for that is, as I mentioned earlier, because we just don't know what's going to happen. I think the crash of 87 I going into that, you know, I didn't think we were going to get the returns that we had gotten previously. I didn't see a crash coming, and it happened all in one day. And so, you know, it was too late to respond after the fact the tech bubble, actually, we at Vanguard were concerned about that. I mean, that's, to me, that's one of the most visible things that you could observe. I mean, valuations were just ridiculous, and we did. We didn't know how it was going to play out. I mean, we knew that returns were going to be less going forward than historical returns. We didn't know if it would just be you'd get 3% for the next 10 years, or whether you'd see a 43% decline in the market. Well, we got the ladder. Unfortunately, we didn't know that. The other, the other situation I saw that really, you could see, I think pretty plainly, was one I mentioned earlier at the bottom of the market in the global financial crisis, that equity returns were going to be good going forward. But usually, you know, in my career, the only two that really seemed probable to me was the decline of the bubble or the imminent decline of the tech bubble, just returns were just going to be less, and in financial crisis being an opportunity to invest at the bottom. But I didn't see the financial crisis coming. I mean, we knew there was a lot of turmoil, but I didn't see the destruction that we had. So, you know, you didn't have cash sitting on sidelines to bottom, anyways, if you didn't get it out of the market beforehand. So, you know, our view is, really, unfortunately, investors typically are best off if they stay the course. I mean, that's just what we observe historically. Wouter Klijn  39:38 Yeah, and doing a bit of crystal ball gazing. Are there any sort of risks that you think people should look out for today? Gus Sauter  39:45 You know, it's interesting. The markets have been, actually pretty, pretty reasonable, not, not too volatile. You know, we've had a few spikes here and there. But actually, if you're the last five years, historically, that's we've experienced low. Volatility. I think it's more of the same for the foreseeable future. I don't see what upsets the apple cart from an economic standpoint. You know, typically economic expansion ends when either the central banks are trying to fight inflation, which they're not. I mean, they're hoping we get a little bit more inflation, in fact, and the other would be when consumers are so stretched from borrowing that they just can't spend anymore. And while I am a little bit worried that debt levels have increased, I don't think they're at crisis levels, and hopefully we don't get to crisis levels. I mean that that's what happened in the financial crisis, but so I think it's a little bit more of the same kind of muddling along, probably okay returns in the stock market and slow growth for the next year or year and a half. Wouter Klijn  40:50 And summing it all up, I thought I might ask you as well, looking back over the long career that you have, could you share some of the moments that you find most memorable of them as well, and perhaps some points where you said that was a hard period, but I learned a lot from it. Gus Sauter  41:10 Yeah, well, there are so many things that I remember. I mean, you know, obviously the crash of 87 was really scary, and I was two weeks into my job, and I wasn't even thinking about, could I be fired or laid off, because all of a sudden we've got a lot less assets. But fortunately, we stuck with it. So that's certainly my mind. You know, reflecting back on my career, I think the most fun was actually the people relationships, the people I worked with, a great bunch of people still have very strong friendships. Going back, I also enjoyed talking with investors. For the most part. I was, you know, back at the office, overseeing the investment team, but but I would get out and talk with institutional and retail investors from time to time, and I really enjoyed that. And I guess a few particular instances, I remember one day Jack Bogle, early on in my career, coming into my office and standing in the doorway. We had just crossed $2 billion in our s, p5, 100 index fund, the only index fund at that point, and and he said, Gus, you wait some day. Indexing is going to be really big. We'll have $10 billion someday. Jack boogle was not really prone to understatement, but he missed that by by a bit, because he's now Vanguard has $4 trillion worth of indexed assets. But I'll always remember that one, and I guess that you mentioned something that I really learned from that might have even been a scary experience. The financial crisis was extremely, extremely scary, and I had the opportunity with our CEO, Jack Brennan, to speak with the Treasury and various regulators during that period of time trying to figure out what was going to go on. I remember driving in to work at about four in the morning, because that's when our opportunity was to talk with the Treasury. They were working all night long, and I was sleeping for a couple of hours, but it was pitch black out, and I was thinking to myself, you know, the world may have changed going forward, and that was scary. And, you know, I learned I don't want to repeat that one. Wouter Klijn  43:19 No, I can imagine that. Well. Gus, thank you so much for this conversation, and it was a pleasure to talk to you. Gus Sauter 43:28 Well. Thank you very much. It's been very fun to be with you.
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  132: Michael Kollo – New Book, Building an AI Equity Analyst and AI as a Review Agent 29.03.2026 47min

  In this episode, I speak with Michael Kollo, a return guest to the [i3] Podcast. Michael has recently published a book on artificial intelligence, called: Future-ready with Generative AI Skills, Mindsets, and Stories in the Age of AI We speak with Michael about how he build an equity analyst AI agent in a weekend, how AI helps review your work and how you can get it to find solutions that are tailored to your style of working. We also delve into deeper philosophical questions around the nature of language, how AI changes people's interaction with language and whether AI changes our perception of what is artificial and what is not. Enjoy the show! __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights __________ Overview of Podcast with Michael Kollo 03:00 We, collectively, still struggle to have the right framing for what this kind of AI is 04:00 I wanted to write a book on AI from a white-collar perspective that was neither hype nor alarmist 10:30 You build an equity analyst in a weekend, using AI agents, which produces broker reports? 14:00 What good looks like is still very much an individual judgment 14:30 AI is a mirror to yourself 18:00 Students are very strong users of AI across many different disciplines. And they are symbiotically learning with the AI and are becoming natural users of it 18:30 One of the more powerful usages of AI is not to do a job, but to review a job 21:00 AI helps you to think on a meta level: what is it that you find interesting, useful and powerful? 23:30 Can you get an AI system to explain to you in plain English why a non-linear system works, test it in 10 different ways and write a research report about it? Yes, you can. 31:00 "I'm expressing myself in my adult language (English), but (AI) is taking it and swirling it into patterns of Hungarian (my childhood language) that are hitting me back at a whole different angle that I'm not sure if I could have done myself". 32:30 "Language was supposed to be this thing that was supremely human. It encapsulates all this weirdness and contradictions that is to be a human being. 34:00 An AI system is not an individual or a single entity that has a will or a desire. It is a field that you can land on and move from one place to another, as you will.  37:30 There is a danger that power users of AI might experience burnout, because they are constantly given things to review. 43:00 AI experts should not be asked about workforce impact, because they don't know enough about it Full Podcast Transcript Wouter Klijn  01:17 Welcome to the [i3] Podcast. I'm here today with a return guest, Michael Kollo. Mike, welcome to the show. Michael Kollo Hi. How's it going? Wouter Klijn Pretty good. Pretty good. So we're here to talk about a book that you wrote on generative AI. It's called Future Ready with Generative AI: Skills, Mindsets and Stories in the Age of AI. Michael Kollo  01:39 Well, thanks very much for that. That's a bit of a mouthful. We kind of continue to expand the title. It feels it's coming out in the middle of March, so I think the 14th, 15th. It's being published by a publisher called Rutledge, which is a UK based publisher. So it'll be available here in the US, in the UK, all around the place. Wouter Klijn  01:58 So what prompted you to write this book? Michael Kollo  02:01 So look over the last three years and for years before that, but certainly the last three years, the topic of AI has obviously become very, very popular. Everybody's been thinking about it and talking about it. But one of the things I found through lots of presentations about 40 keynotes per year from all kinds of different audiences, from boards of directors all the way down to, you know, the average person kind of presentations is that we, we collectively, still struggle to have the right framing for what AI, this kind of AI is, and what it might mean for us. I don't think anybody has answers as to where it's all going, what will happen to the workforce or jobs or personal relationships and so on, but I think we have a pretty good inkling as to its capabilities and how fast it's moving. We have a pretty good inkling as to the different areas it might impact, but we don't have the right framing or the right thinking about it. So I was very keen to write a book that I could capture the imagination of a white collar worker in across any industry, just about to help them just understand what this thing could be and what it means, and get them to form their own view, but to form it in the middle ground, not to be hype and not to be alarmist. I wasn't keen on creating a book about how it could all go wrong and how it could be all terrible. And I wasn't also keen to create a book about, you know, the utopia that it could foreshadow in the future, but I was just interested in informing the average person how the middle ground could look. Wouter Klijn  03:29 Yeah, so not hype, but you do call it a civilisation altering technology. What do you mean by that? Michael Kollo  03:37 Yeah, so that's, um, so okay, there's a story behind that. Okay, so the story is the following. I, I was asked to give a brief testimony to the Senate, Senate hearing in Australia, and it was for the education use of AI within education. And so a lot of the speakers before me had come and talked about the dangers and the problems and so on. So I was really keen to try to counterbalance that with the significance, but in a positive light as well. And what I was trying to say with to that audience is that if we get this right in terms of how we teach the next generation, how we enable the next generation to reason and to think better, then we could bring about a whole golden age, a whole kind of new renaissance, I suppose, of reasoning and thinking, and this could be civilization altering. And so really, the context of it was, how do we use this technology to enable people to be their better selves, or to reason or to think better? It was a bit idealistic, absolutely, because we all know that not every technology, in fact, most technologies, arguably, and not always used for the betterment of people. There's a whole bunch of other negative things that we've had recently, especially with social media and the way that it impacts people. But I was kind of, I suppose, making a case for if we can use this properly, in a good way, that there's enormous an abundance of positivity that we could have for our civilization. So. I really was looking for a term that would say, actually, civilization materially changed with the printing press. It materially changed with a few other critical things we've done in the past, nuclear power, or electricity, or so on. And each one of these changes just brought about change. That's all it is. And this is one of those moments, Wouter Klijn  05:17 And you explore that concept further by actually saying it's not just the technology. I think you describe it as: it's a system that helps you navigate uncertainty. Can you explain a little bit what you mean by that? Michael Kollo  05:31 So this was one of the big challenges I had in the book, is I was trying to get across to people that they should not think about this as just technology, as data, as statistics, because for a lot of people, that alienates them immediately from the topic. They go, Well, I'm not about technology, I'm about people. I'm about conversation. I'm about artistic things. I'm about something else. And so for them, it pushes it away somewhere in the corner for someone else to deal with, and it's more comfortable that way as well. And so I was trying to find the right words or the right framing in this book by positioning it in as a companion, positioning it as a co worker, positioning it as a whole bunch of different kinds of things in the fiction and the non fiction stories. And I think in this particular case, it was somewhat of an abstract way of saying that if you think about this as a reasoning engine, as a thinking intelligence of some kind without will and without desire. So we take those off the table and we say it's just about that. Then it really is about how to help the average working person understand information, distil it, or expand it or manipulate it in different ways, and then ultimately, to deal with the core part of most jobs, which is dealing with uncertainty. Decision making under uncertainty certainly is really prevalent in finance and in financial services, but it's prevalent in many other industries as well. You have to make decisions. Do you write two two paragraphs or one paragraphs to your boss to explain what happened? Do you do you put in a big report or a small report? Do you go with one stock manager versus another stock manager? Whatever the decision might be, there's a constant set of understanding, evaluation, analysis that happens in our world. And this is a capability. I wouldn't even call it a tool. I'd call it almost like a companion to help with that. Wouter Klijn  07:13 I think a lot of people are a bit concerned whether it's going to replace them or not. You say it's more of an analytical tool that helps you make better decisions. And I thought it was an interesting example that you gave in a book where you talk about a friend who is a programmer, and he basically recognised where his own input was when he asked it questions. And some of it was really relevant, but some of it led him down, you know, a deep rabbit hole that absolutely was not worth pursuing, but he recognised which one was, you know, the right path to follow. And that's when he realised, this is where I contribute to it. It will help me. But left on its own, it could easily descend into, you know, just time wasting, resource wasting. Do you think that that translates to other professions, and in particular our industry. Michael Kollo  08:04 Yeah, look absolutely so white collar work Financial Services is about navigating uncertainty. So as we just said, it's about creating analysis, thoughtful analysis. Some of the analysis is pretty scripted, cash flow modelling and things like that. It's almost like a task based thing. But then there's a lot of choices to make along that pathway. So if you're, let's say, doing manager selection, you might look at the track record, you might look at the data, you might look at the portfolios, but then you might also look at the character of the manager. You might look at the way they talk about the markets, and you try and anticipate how they will respond to certain market conditions, and you try to essentially understand their partner. So I think it's, it's, there's a lot of judgement that goes into these things. There's a lot of personal judgement that happens as well. And so when you're using these AI systems to analyse something, because you don't have a set path, you're discovering the path as you go, and you're using judgement as your compass. In a way, you're using these systems more or less as a transportation vehicle to get to where you want to go, but your compass is in your hands, which is your judgement and so but the speed at which you can get to those places is much, much quicker. So it puts some pressure on your judgement to be a lot quicker. Your Compass has to figure out where you are much quicker, because these systems can, at speed of light, create analysis in different directions. So I think, I think the first part is understanding the fact that you're in charge with that judgement, with that compass, with the where should you go? What does good look like, is entirely up to you. There's only a very few jobs where what good looks like is already scripted, that is already is written down in hard ways, and you're just executing that, in which case your judgement is anyway not in the picture. And so you would assume that for those kinds of things, that you'd almost happily hand it over to an AI system. But anytime it's up to you, and you understand the why something happens and why that your judgement works like that, you should think about these as just very rapid, iterative companions. Wouter Klijn  09:59 It's. Yeah, but having said that, I do understand that you build an equity analyst in a weekend which can produce its own broker reports, and quite hard to distinguish from the human produced ones. Michael Kollo  10:12 So this was a kind of experiment I did recently. We were just chatting about it before, but Okay, so let me describe what it does, and then let me describe why it still fits into my model, so I can defend my model, my mental model here. Okay, so in the first instance, what it does is it's a forensic accounting type system. So it takes financial statements over a number of years for a company, it then looks through them, looks for unusual attributes of the accounting that's been presented, the cash flow statements, the earnings, the accrual accounting, the way that various other things. It then creates hypotheses as to try to explain those particular anomalies, and goes out there and test those hypotheses. And it does so by looking at competitor data, by looking at product market fit, by reading the news, by looking at other contractual, other statements, and so on. So it covers a wide variety of different data sources from trusted places. But importantly, the way that it thinks, the mechanism of its reasoning is a very kind of stoic, kind of philosophical kind of reasoning. So observation, empirical, observation, hypothesis, test, confirm or deny. And it does that. And so it typically takes about 17 page, 17 minutes, excuse me to do something, and as an output, it gives me back exactly the investigation path. What is what is found, is unusual, where it looked and so on. When I was calibrating it, after a couple of iterations, I started noticing that I was guiding it more as to what is significant. So what is material? You found a bunch of things over there. It's actually, don't worry about that. That's it's interesting, but it's not material for what I'm trying to do. Or what does a hypothesis actually look like? Well, I want you to actually create very striking hypothesis. Don't want you to create an average hypothesis that says that the reason that that particular ratio is out of whack is because, on average, you know, cash flows are easy to do with something. I want you to create a punchy one that says it's that way because the manager is trying to do something bad. It's a governance outliers. Yeah, I'm looking for I don't want average explanations to average things. I want extraordinary explanations or extraordinary things, a combination of both. So what good looks like lay in my hands and my compass lay in my hands. And so from the outside, it looks like it produces five, six pages of beautifully written material, and soon enough, you'll have one, and I'll have one, and the person down the street and person listening to this will have one. But I want to distinguish what what makes it tick and what actually makes it good or not, will no longer be just the advent of that. There is five pages, because today, you know, there's lots of people that provide equity research, but not infinite amount, just a lot. Tomorrow, there'll be a lot more, but it'll be even harder to tell inside those systems what is the reasoning pattern being followed and why that's good, why your system of reasoning is better than mine. And so therefore, if I'm trying to evaluate which Equity Research AI I should listen to, I'm probably going to need my own AI that that, you know, I've calibrated that tells me this is actually a better way of thinking about it, and it will go and evaluate other systems so you can see kind of escalating. But the problem is, what does good look like? Is still a bait, at the moment, very much a source of individual judgement, yeah. Wouter Klijn  13:20 And going into that a bit further, I thought one thing that was fascinating in your book is where you describe, sort of the the impact that expertise and training and just experience has on how you interact with an AI system. So I think there's a couple of stories that you tell in the book where people quite quickly recognise, okay, this is the path to go through, but to a degree, it also relies on how well they understand where their advantage lies. That can be sometimes a very tricky thing to analyse and to recognise. Michael Kollo  13:56 I often, over the last years of working with AI, I found that it's most often a reflection on me, in other words, like it makes me question why I do that thing, or why I'm asking it that way. And so it's a mirror point to yourself, really, which is, again, a very unusual thing, this idea of meta Meta reasoning, or meta thinking. So thinking about thinking, when I asked that question of doing it that way for the equity research for example. Let's take that example. Why is the forensic accounting the right approach? Why is this kind of a hypothesis testing the right way of doing things? Are there other ways of thinking about value? Is there other ways of solving for this kind of problem? And I think knowing the why and owning it then becomes a very empowering thing. To go back to the AI system and go, Okay, I want you to look at these three other ways of doing forensic accounting. But ultimately, the aim is to do whatever the objective is, and you can rotate your lens around the problem, if you're comfortable enough to rotate your lens. Around the problem. I think for a lot of us, we become accustomed to doing things a certain way, and we haven't exercised those muscles of, why am I doing it this way? There's just a there's a process, there's a structure. I'm going to look at these five things, or these six things. I'm going to fill out the boxes. You know, I'm going to talk a little bit about it, but I didn't set up this system. I'm just executing it. I I'm just a custodian of it. I think for those kinds of jobs, companies are going to look at that and go, Well, if you don't, if you're just a custodian of this system, either you quickly start to own it and go, Why? And that becomes you, becomes yours and your manifestation of your will, or it becomes a process that's executed, in which case, why not bring an intelligent system to do it? Wouter Klijn  15:47 Yeah, yeah. So often people think, Well, young people that are growing up in this age of, you know, a lot of technology, the internet, that they might be better equipped to work with AI. But it seems, from sort of this reasoning, that potentially more senior, more seasoned people could work better with AI because they know better questions to ask it or better give them better instructions. Michael Kollo  16:12 I think so. I think I think there's, out of any problems that I can see, this is one of the biggest ones I can see, which is that we have many of our industries are set up in ways where younger people come in, they learn by doing or by osmosis, and then over time, they develop knowledge and they develop judgement, and then they manage others to do the same. And if AI comes in, hollows out that beginning part and basically says, well, we can kind of execute based upon your commands, dear senior person, and you're quickly going to get to a point where, which is what you're seeing today, which is that graduates are having a lot of difficulty finding work. They are possibly the cheapest resource, yes, but they also the ones that are most unproven in terms of their ability to add value. So for the average organisation, look at an AI system, and they go right, if we can basically scale the expertise we have in the senior people, maybe we can do that. I think that's one point of view. I think the other point of view is that younger resources are often more flexible in their cognitive capabilities. So they may not yet have worked out what they believe to be the best way of doing things, but that often means that they are open to different ways of doing things, and they're open to learning and so on. So normally, a lot of the younger generation that come across in universities are very strong users of AI across multiple different disciplines, and they're symbiotically learning with the AI system to use it better and become natural users of it, which means that they're able to question and iterate to better solutions much more rapidly than a domain expert who's just trying to manifest their own way of doing things into an AI system. Wouter Klijn  17:51 It seems like an ideal tool to do like pre and post mortems of certain business cases. Michael Kollo  17:57 It's so good. I mean, the one of the use cases that so often people start with AI going, why? I'd like you just to do something for me. Okay, write my report, or, you know, write a transcript of this podcast, or whatever it is, and therefore it'll just do it for me. Probably one of the even more powerful use cases is the reviewer. Is the review this for me. Review this report and tell me where the inconsistencies are, where the mistakes are. What's better way to frame this? When I wrote this book, I gave it to a number of times to be reviewed, and while it was complimentary to begin with, it was very sharp and very critical very quickly, about, you know, loss of tone, about consistency across chapters, about consistency of messaging. And it helped me to pretty high level, which I'm not sure I rose to, but, but it's, it was a, it was a really interesting thing where you put something that you feel like it's a part of you, like when you write a book, you inevitably put a lot of yourself in it, and it acknowledges that goes, thanks, Mike, yep, I can see this is you. That's lovely. Anyway, now you need to do these things. You almost like, Oh, it's right. I don't like it, but it is right. Wouter Klijn  19:02 Yeah. So it's polite, but also, to the point, to a degree, it seems that what you get out of it depends a lot on how specific you are in what you put into it. And I think you gave this example in your book, where there was somebody in a financial services company who said, Write me a market update, and then that led to rubbish. But then, when you specified, okay, write a market update about volatility in emerging markets with, you know, an eye on the US dollar, then it came up with something much more interesting and much more to the point. To what degree is it like a matter of, like, you know, garbage in, garbage out, and just being specific about what you want, Michael Kollo  19:46 it's all about that. So, I mean, there's a bunch of different ways I can say this, but let's say, for example, in this example, you said, right? Write me an interesting market update. Okay, so what does interesting mean? So this goes back to our meta conversation, right? So what makes interesting for you? Well, interest. For me, means sharp market movements with contradictory news or mysteries. Okay, great, so is a mystery. Is a sharp market move 5% or 10% Well, at least 10% okay, great, etc, etc. You follow this path and suddenly you get half a page of write for me, articles that relate to at least 10% market moves, accompanied by interesting news articles that point to x, y, z, etc, and you start to really define very carefully what it means. So you can't just look at something and goes, I'll know what it when I see it. And this meta thinking actually makes you again question, what is it that you do? What is it that you find useful, valuable, powerful, and so on. And these systems can take you anywhere. So one of the kind of visual metaphors in this book, which I quite like, is the is the kind of the Ranger metaphor. So imagine like an infinite woods in front of you with many, many clearings. And your guide arranger is going to take you to one of those clearings. And depending upon how you instruct it in terms of what kind of clearing you'd like to get to, you can get to beautiful oak trees and sunny whatever, rainbows and butterflies. Or you can get to dark, terrible things, or you can get to pretty average looking, or you can get to plasticky ones, or any proportion permutation of woods that are available to you. And the only thing that will take you to one place to another is what you whisper into that, into that Ranger, AKA your prompt. So if you just say to it, take me to a wood clearing, please. You're literally looking at any number of those that you could land in. Wouter Klijn  21:34 Where are some of the best benefits you think can be had in our industry? And you know, we sort of discussed the analytical part of it, the decision making process. But you also describe in your book, where you make the comment, financial markets are not linear, and one of the things that we often hear about AI systems is that they can help find trends in nonlinear processes. Is that sort of another area where you find a lot of benefits in? Michael Kollo  22:01 It's a good question. So people often confuse these terms. So with generative AI, and specifically with language models that this book deals with, it is very much the patterns and trends within language and expression and information. And so really, what you're doing here is you're intermediating your and another person reading of information. So if you're doing a report or analysis and so on, you're putting a system in the middle of that which is very good at reasoning, cognitive capabilities, but also speculative writing, creative writing, and so on, so on. Can you get it to explain a non linear system for you linguistically? Yes. Can you get it to recommend for you methodologies to tackle that loneliness, yes, can you get it to write the code and execute that nonlinear system to test it for that yes, you can. Can you actually ask it to test 10 different ways of modelling that weird nonlinear system, write the code, evaluate it on certain grounds, come back to you, write a research paper for you and explain it to you without the technical logit. Yes, you can. And so where we are today is this really interesting moment where, at the beginning of it, had we been having this conversation three years ago, I would have said to you, well, it's good for doing, I don't know, emails and reporting, but after that, you're on your own. Today. We're at this point where the systems can pick up skills, can pick up what this is a methodology from Claude. Can pick up, in this particular case, Knowledge Base. Can execute code, can test, can revise their hypotheses, can re execute again, iteratively learning and updating their hypothesis, all through the medium of language models. So language models become the controlling layer, and underneath that are these systems that are working not just to write code, but to execute and then learn from it. So again, two years ago, yeah, I would have said to you, yeah, just use it to write some code, and then good luck to you, Python or whatever else you want to do today, the system will write it and execute it and look at the results and to see whether it's actually what you want, and then go back and write it again, if it isn't all in a loop. And I think it's, it's a it's easy to lose track of how fast this progress is going. If you haven't looked at it for six months or nine months, you might go back and say, I tried that. It just didn't work. But I, and this is something I find often in LinkedIn, because I'm quite active there is that people don't understand that this is a very much a thing in motion. So whatever has you kind of characterise it as it's like that, or it's like this in six months time is no longer probably not true anymore, except, so this is one of the challenges of writing a book like this. I had to write in such a way that I try to pick out those eternal characteristics of the system. But I wouldn't be too much pointing fingers, going, haha, I can't do this, because by the time the book come out, it can do it just fine. Wouter Klijn  24:47 But is there sort of a confusion, maybe sometimes, about what it does, because you take a clear approach that you look at, sort of the language, the large language models, but the language aspect of it, while, if you're. Looking from an investment side, you're probably looking more at mathematical trends rather than just language. Do people confuse that you think where… Michael Kollo  25:08 Massively so right? Let's take a step back for a second so you've got basic statistics, econometrics, statistics that used to measure back test so on. Most of quantitative finance, if not all of it presently, is based upon econometrics and linear models. So standard linear models, little bit of exponentials, maybe a little bit of logit here and there, and that's about it. And so therefore those systems are input output equation go hypothesis testing, kind of methodology, then neural networks came along to finance, probably 2014, 2015, and people went, Oh, can I use this to do stuff, trading, liquidity management, high frequency, because it eats up data at higher rates. Can't use it for monthly data. So it's a very specific area. Finances started to think about using it, which is the higher frequency trading elements of it. Can't use it for macroeconomic research, because the data is to 60 observations, monthly observations to work with, or you got 600 it's just not enough. You don't have hundreds of 1000s. So the methodology fell by the wayside as a primary methodology to model financial systems at anything else but a high frequency range when language models came along, and this is a very specific area of AI or kind of neural networks. It said, Look, maybe we can model how language, or how words and tokens, in this case, come together. And it turns out it was quite good at that system, again, through the transformer mechanism, but that that mechanism didn't transfer. I can't put a stock price in there and go by the way, can you also tell me what's going to happen to happen to that? So it's much more along the lines of modelling language, and over time, it obviously got bigger and better to the point where now we can do 24 languages, but we can do number of programming languages, and we can do mathematical proofs, which was an unusual thing up until now because we thought, well, how can language models do maths that's kind of dumb. Maths is a whole other part of your brain and whole different ways of adding numbers together. And still today, if you ask a system to do math for you, it's more likely to write code and then execute the code and give you back the response than it is to figure it out directly. So when you're thinking about the difference between language models or generative AI versus modelling or forecasting the world, forecasting methodologies are often much more simple in their applications, with more limited data, with more speculative outcomes, but the difference now is that language models become so powerful that they themselves can do the testing for you. So it's not the case that the language model itself has a neural network that's specifically about stock prices, but the fact that the language model understands the fact that it can run a regression for you, test the results, understand what the results are, gives you back the results, or iterates over and over again. So it's a layer that sits on top of empirical testing, and does that testing with you, for you so on. Wouter Klijn  28:09 Yeah. Because I think when you wrote this book, you can sort of get a sense that you get almost at a more philosophical level, where you start to ask what language actually is. And I think there's a passage in your book where you talk about beneath the surface of language, words and concepts in communication, there are deep patterns that represent common ideas, thoughts, impressions, emotions and experiences in life, where you basically talk that there's a lot of abstract commonality among different languages. And I think you gave an example where from your childhood, where you go back to Hungary, and it's a very different language. It's, I think you say it's more complex, but you realise that there is these commonalities underlying that. Can you tell me a little bit about how it has changed your concept of language. Doing this, doing this exercise, Michael Kollo  29:04 It's a big topic. I think it's one of those things that is very personal to most of us. When I first looked at this, I thought that maybe language itself was a weak expression of an inner world. So you have this big inner world. Both of us have first language is non English, and so our we grew up as children speaking another language, and so maybe there's like this big inner world of emotions and so on that we try to squeeze through the keyhole of language into the outer world. And therefore AI is just that keyhole, or language model specifically just represent that keyhole, but they can't represent the entire inner world. I think as I got to know language models more, and as they kind of got bigger and better, I felt like there was more power and more things that linked us than not through languages, through the expression of language alone. Yeah, and that made me question about my inner world, whether my inner world was also a lot more linked to both language and maybe to each other and to other people and but I think just falling deeply into this idea of what can language represent about the mind, how much of your mind is imprinted into the words they use, and how you express yourself and so on. I think for me, has been an interesting journey. Again, being dual language, expressing my ideas through English, getting the system to translate into Hungarian writing music with that, writing poetry, with that, seeing the way that the words form around my ideal, of my thoughts in a different language, has been really humbling. There's this moment where you're like, I'm expressing myself in my today's adult language, but it's taking it and swirling it into patterns of Hungarian which then hit me back on a whole other angle that I'm not sure I could have done myself and and again, these are moments where you have these wow moments about this is more than a or, if it is a mirror, it's a mirror into humanity, as much as it's a mirror to yourself. Wouter Klijn  31:07 Yeah, and you delve also into the concept, then what does it actually mean artificiality? And I think, you know, for me, it's very relevant, because as I starting to use it more, I'm starting to think, should I give chat GPT a byline or not? Michael Kollo  31:24 Oh, interesting. I like it. I like it. Wouter Klijn  31:27 But, you know, it becomes concluded where the system didn't generate it by itself. I didn't generate it necessarily by myself, but it was an interaction. So tell me a little bit about how you now think about the concept of artificial. Michael Kollo  31:43 It's so that I never liked the word artificial, because it there's always a tribalism attached to it. For me, like a separation. Artificial means not of Me, of over there, and that separation means that it's over there, and it's becomes adversarial eventually. And so I feel like we have lots of adversarial pictures of AI in our history, right? So everything from terminators to whatever, and they're normally just versions of ourselves to humans with more power, bigger muscles, you know, etc. It's always very amusing for me now to watch Terminator two back, which is an awesome movie, and go, these systems have figured out how they work time travel, but they don't quite understand language, you know, this kind of I think because, you know, language was meant to be supremely human. It was meant to be the thing that really encapsulates the weirdness that is and contradictions that is to be a human being. So I think, I think we're just in a very different world than we were back when those kind of systems were thought about. And I think AI really came from a world where technology and statistics and data were over there, and we with our humanity and our flowing and whatever were over here. And it was a very clean separation, and made us feel comfortable now that separation is not so clean anymore. Now these systems can talk to us, can modulate voices, can understand and reason and help. The number one usage for Claude is personal therapy, like it's it's going to be really so called, coming into this space that we, up until this point, we had thought about as purely human, and that's okay. That's not something to be concerned about that's more about a really interesting kind of self realisation about what it is that you bring to the table, versus what's another AI bring to the table. So to your point about having a when you set up a GPT or any kind of system, you'll say to it, this is what I find interesting, and what I don't find interesting, and you will embed a part of you into it, and then it'll run for a while. And if you allow it to continue to evolve itself, aka, based upon a number of clicks or readerships or your likes, for example, it will try and choose more of that or less of this. Again, it's just a ranger. An AI system is not an individual. It's not a single entity that has a will or a desire. It's a field. It's an S surface area, and it's a vast surface area that you can land on and move from one place to another, as you will, because you bring the will, it brings a surface area. Wouter Klijn  34:16 Yeah. So it comes back to sort of this concept, the better you know yourself, and the better you know your skill set. You seem to get more out of these systems. Do you think that that will translate in how people, the people that will do it better, are a specific type of mindset and thinking, for example, about people whose jobs revolve around delegation. It seems that a lot what you do in interaction with language models is delegating them to do things right, and recognising where you come short, and finding solutions to that. Do you think there will be a certain subset of people that are just better in interacting with these systems? Michael Kollo  34:58 It's a really interesting, very live. Problem, right? So lots of HR professionals are grappling with, what are the skills of the future? I think, being able to explain yourself and what is it that you want to do and why is absolutely a key skill. There's no question. Now. Full stop. Agree with you. Nothing more to add. There is a danger here. And it's a very funny one. So one of the things that you find when you work with AI too much is you get spoiled. You have this intelligent system that is only constantly listening to you, thinking about what you're saying, and trying its damned hardest to do how you want it to be done. As it learns more about you and learns about the background, how you like to do things, updates his memory, or your skills or whatever. Every conversation feels like. It's easier. It's like it's already a step in there. It's already thinking about it like that. You already find yourself nodding as it's finishing the note to you. It's very hard for humans to compete with that. It's very hard for me to walk back into room with four humans that I don't much work with and try to align them, to get them on my page, to get them understanding, to get them understanding. There's all the social cues, the etiquettes, the intentionality, the all of the things I've got to work past, then I've got to understand where you're coming from, then I've got to align you, and so on, so on. The gift for me is that I get to work with people, and that maybe one of you has a better idea than I do, and we make something better than so that's there's absolutely reasons to make that investment. But I think in many cases, people will go, why am I doing this? If I can just go to an AI system and it'll get me quicker, better, faster. This feels so slow, this feels so difficult, by the time I get around to it and so on. And so what I think this will kind of lead us to is a world where individual power users will be incredibly good at using AI systems, and their only danger will be, as I'm finding certainly recently, is burnout. Ai burnout, right? I work six hours, and then I my brain stops. I look at a blank wall. I can't really focus anymore, because the man of will and attention. It's literally like a room full of really smart people constantly giving you things to review, and you're constantly judging reviewing next, judging reviewing next. And as soon as you set another milestone, it's achieved and it's achieved and it's achieved and you're running at full speed, and I tend to be quite strategic. Think I do tend to think a couple of steps ahead, and even I'm like, Okay, so I've thought three steps ahead, and you've already got there, so I need to now think three more steps ahead and so on. Wouter Klijn  37:36 Yeah. So in that context, like so we talked a little bit about this, this equity analyst that you created, and I thought one interesting aspect of that is that it came up with, I think you said, it creates a hypothesis, but then it spawned new agents to look in different elements of all of those hypotheses. So you get this sort of cascading effect and but ultimately it came back and gave you a report. But when you look at that process on itself, it seems like it's something very different than, I think, where people started out maybe two years ago, where everybody was expecting that AI would automate a lot of stuff. This doesn't feel like automation. What is your sense there that these language models end up more, as you say, reasoning agents for individual people, rather than straight through automation? Michael Kollo  38:36 It's a good question. So I think we need to understand the category of use cases much better in organisations. So an organisation is a rich set of use cases, and then sub use cases tasks underneath them, and some of those tasks are about the movement of information. Reporting. For example, you're moving information from one system to another. Maybe you're combining it with few things. Maybe you're making a calculation. But then ultimately, so everything from your custodian to your fund, reporting to other things are simply linear movements, and what you're doing, in most cases is your search, retrieve problems. Where is my data? Where can I get it? Is it accurate? And then moving it from A to B? So that's fine. I think that's automatable, and it's automation friendly, and maybe up until now, it's been hard to automate because it was the data's been finicky. It's been all over the place. It's been messy. Now with AI, it'll iteratively search and find things for me and things like that. So that's better then you've got this class of discovery type problems, right? So discovery is, I don't know what I'm looking for. I just have a principle of what I'm trying to do. So in this case, the principle is, I think there might be something wrong here, but I don't know what it is, so I have to give the AI system breadth to explore that, and I'm going to lean into its intelligence to do that. So I'm going to lean into the idea that it can creatively create hypotheses, that it has the reasoning systems to test those, or to write code and so on. So I expect it to go widely in a deep research kind of way. So go. Wide and come back in again. Go wide, come back in again, go wide, and so on. And at the end of it all, I wanted to have covered a lot of ground, and ideally, hopefully it's figured out what relevance is, or I've given it good instructions as to what relevance for me looks like. So out of the 180 things are found, only 18 get mentioned to me, and out of the 18, only three are flagged for me to do, and again, for research purposes. This is an incredibly powerful tool. That's what you're seeing now. Physics Research people are talking about, or mathematics research being co done with AI at much faster speeds. I'm not giving you another example, Monash. I was at Monash, I think last year, I was giving a presentation to the faculty and a bunch of other quants in the room, and it was about using AI as a paper reviewer, as an article reviewer, so if you've got a working paper, submit it to a journal. Normally it takes six, seven months for you to come back, and then little bit back and forth, and then the next journal and so on. Give it to an AI system that goes out there, reads the nearest 20 other papers, figures out what your unique contribution is. Then reads the next 20, the next 20, the next he's read 150 papers and said based upon what you've done. And these 150 papers, I think these are the elements that are unique, or not unique, or these are the suggestions I would have, and so on. It can now do that within the space of 15 minutes or 20 minutes, and that's a tool that allows us to create much sharper research. But then you ask the obvious, the question, and you go, Well, why don't we just get the AI to do that the beginning of my research project, rather than the end? Before I even pick up the pen to go, what should I be doing? Let's go that way. So, a lot of different applications. But the bottom line is, the is, we're all discovering this idea of what it is useful for, because, at the moment, this thing called generative AI, and where it's put into agentics, or whether it's a chat bot, is is a raw material. It's like the genie flask with the genie coming out of it. Wouter Klijn  41:52 Yeah. So in a lot of ways, AI helps to accelerate processes, rather than really replace entire functions. What do you think is, sort of, if we may do a little bit of crystal ball gazing, what is sort of the natural progression of that? I mean, as you said, there's only so many hours you can review, you know, all the things that come back at you and the information overload. Do you want to take a stab of where AI might take us in the next two or three years? Michael Kollo  42:23 I don't actually, I'm going to plead ignorance, but you should definitely just read the book. No, it's, um, yeah, I have a bug bear about people that have expertise in one field being asked about a different field. I sort of often think that, you know, AI experts shouldn't be asked about workforce impact or things like that, because they just don't know enough about it. I don't think it's as Armageddon as everybody believes it is to be. I get the sense that, like with anything else, people will do very creative and interesting things certain Emperor's close moments might happen, things that you know, we kind of do currently, just because we think we should suddenly become not that relevant. I think there is reason to think that there'll be moments of disillusionment, perhaps in a sense of society will and unions and governments will suddenly go, Hey, this is happening way too fast for me. We need to slow this down, not necessarily for safety, but more for like protection, society, workers, those kinds of things. But ultimately, the there's a very small percentage of people in the entire world that will take this and will do incredible things with it. Will advanced sciences, biochemistry and physics, mathematics, hopefully economics, although I don't hold my breath much, much further, and I think everybody else will be struggling or a little bit trying to balance between the human rate of change that's possible, which is typically three, 4% per year versus the AI possibilities that will keep opening new doors every time that you're just about told your staff about what you think AI is another door gets opened, and in three, four months time, you need to tell them what else it is, unless we adopt it and use it, it won't have any impact on our society. So AI is not a weather pattern where you just sit here and it rains on you, and then it doesn't rather it is only comes about because somebody has picked it up and done something with it. And so innately, the rate of change from AI in the world is only manifested through the adoption of people, at the rate of adoption of people. And so that gives us a lot more time, I think, that more people believe when they just look at the capability and go, Oh, look, you can do this. So therefore tomorrow, it's only going to be done this way. Wouter Klijn  44:46 Yeah. Now that's a fair comment. Well, Mike, thank you very much for this conversation, and thanks for coming to the office. It's fascinating. Michael Kollo  44:54 My pleasure. Thank you. I look forward to the GPT, by the way, the [i3] AI column, I look forward to reading that. Wouter Klijn  45:03 Yeah, I should have a few AIs writing for me that would be helpful. All right, thank you.
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  131: From the Archives – Greg Cooper 15.03.2026 30min

  Greg Cooper is Chair of financial services giants Perpetual and Colonial First State, but is perhaps best known for his role as the Chief Executive Officer for Schroder Investment Management in Australia. In this interview from late 2019, only weeks before COVID-19 broke out, we spoke with Greg about whether public markets are broken, the state of active management and his interest in the venture capital space, topics that are still very much alive today. Enjoy the show!  __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights  __________ Greg Cooper podcast overview: 1:00 Starting out in actuarial studies 3:00 Focussing on Japanese equities 4:00 Compared to 1986, Japanese equities are still at the same level 5:00 What were some of the highlights of your career at Schroders? 6:50 We've moved on from strategic asset allocation 7:55 As a CEO, don't be afraid of what others think and try to draw out ideas 9:35 Are public markets broken? 11:00 Not having a well-developed VC industry means that a lot of good ideas get starved of capital and eventually go offshore 11:30 Will that change when the effect of QE goes away? 15:00 No investor is entirely passive. 16:30 Passive rose, because active had too large a share, but you can't have a 100 per cent passive investment market 17:30 Will value-style investing come back? 21:30 You have an interest in fintech and hold a board position at OpenInvest? 25:00 Joining the TCorp board and chairing the investment committee Full Transcription of Episode 131: Wouter Klijn  01:12 I'm here today with Greg Cooper. Greg, welcome to the podcast.  Greg Cooper Thanks, Wouter. Wouter Klijn So can you tell me a little bit about how you started in the asset management industry. We had some former guests on there that started with, you know, creating banks at eight. What were you doing at eight?  Greg Cooper   01:26 I certainly wasn't creating banks. Probably more surfing and and that kind of stuff up on the beaches and the Central Coast than anything. I mean, my career in investment really started in the latter stages of high school. I was at one stage looking at becoming an accountant. And then my maths teacher at the time had said, Have you thought about actuarial studies? I didn't even know what one was at that point in time, and, you know, and so I looked it up, and things kind of sort of went from there so that, I suppose that was the real genesis of things year 11 and 12 at high school.  Wouter Klijn  01:59 So how do you transition from an actuary training to an investment career?  Greg Cooper  02:04 So I mean, I started out in the more traditional actuarial fields. I was working for Taos Perrin the time as a defined benefit actuary, and it was at the point in time, I was in the early 90s when the SG was just coming into play defined benefit plans, some were being wound down, but there was a lot of work to do in the DB space, but as SG kind of kicked in. Then there was a whole pile of, you know, actuarial work to do around, you know, justifying minimum contribution levels and so forth. And then, you know, one day, one of the investment guys had come over to in the investment asset consulting area, come over and asked me if I was interested in doing some research. And it was on Managed futures at the time. And, and I kind of said, I said yes. And and started doing and I really enjoyed it. And that was kind of the first foray into investment consulting. And so sort of from starting out in the actuarial field, I was lucky enough to get off at a roll up in Hong Kong with with towers. And I sort of took the view that the traditional actuarial work was, was, was a good mainstay, but was not likely to be a growth engine. And moving into the investment space was, was a lot more interesting, and it also worked from a commercial perspective.Wouter Klijn  03:15 Yeah, did you ended up doing anything with those managed futures research? Greg Cooper  03:19 Well, apart from it was kind of the early stages of hedge funds, I guess. And it was at the point where saying, you know, alternatives kind of had a place in a portfolio that was, that was the primary emphasis of the research. So, you know, it's interesting. And obviously, you know, alternatives nowadays have become a much bigger, much bigger part. But back then, it was really just looking at that small hedge fund, like type diversifying characteristics and see whether they fit it in a portfolio. Wouter Klijn  03:44 Yeah. And then from there, you went to Schroeder's and started doing Japanese equities. Why Japanese equities? Greg Cooper  03:51 Yeah, good question. It was really partly as a function of the role that was there at the time and Schroeder's. I come out of asset consulting, I was much more interested in working in the asset management side of things, the role, while it was in Japanese equities, it was much more about the product side of things. So it was more like being in charge of the business, of running an asset management sort of sub strategy, if you like, rather than specifically worrying about, you know, Japanese equities or European equities. But it was very interesting, because at that point in time, Schroeder's was the biggest manager of Japanese equities. You know, you were just coming out of the 90s, which had been a bit of a lost decade, but, but in the latter part of the 90s, you know, Japan had taken off with the likes of SoftBank and so forth. So, you know, there was this real kind of boom happening, and it was just a really interesting time to be involved in, in in the markets, but particularly Wouter Klijn  04:48 in Japan. Yeah, any views on Japanese equities today? Greg Cooper  04:51 Well, it hasn't been a terribly good investment since that time. I remember one day sitting with one of the team, and he said, he said, Oh, you know, he said. I started in Japanese equities in 1986 and the markets pretty much at the same level it is was then. And I think we're always say the same now, so, but it's, you know, it's a very interesting case study in what happens in a deflationary environment. And, you know, when assets get overvalued, you know, you can have everyone thinks that equities kind of go and, you know, 10 years in equities, you'll make your money, but you'll make money. Wouter Klijn  05:21 I was just about to say, Did I just hear you say that equities don't go up always. That's right, Greg Cooper  05:25 so, you know, and it's a fantastic case study, but also one, I mean, sort of investment aside, it's a good one to think about, that, you know, despite, you know, the economic criteria not looking that good. You know, the social cohesion in Japan, everything else is held together very well. And so, you know, life isn't all about just economics. There's more to it than that. Sorry, all the economists. Wouter Klijn  05:49 So you spent almost 20 years at Reuters, climbed up to be the CEO of the Australian business, and also had a global distribution role. What are some of the highlights you look back on your career. And also, do you have any tips for aspiring CEOs, Greg Cooper  06:06 I suppose, in terms of highlights, you know, it was just, it was fantastic, and still is fantastic being involved in, in in sort of the dynamism that is the whole investment marketplace. I mean, in particular, just look at, I mean, not just Australia, look globally, but certainly in Australia, you know, the rate of change that's taken place with funds. And, you know, back in the late 90s, early 2000s you know, there was obviously a much larger number of very, very small funds. And you look at where we've come to now, I'm having conversations about internalising and, you know, financing specific assets, and you know, the size of the asset pools and so forth. So I would say, you know, over that whole span, it's just been a very exciting time, and I think that will continue. It's no less exciting looking forward than it has been in the past. But just the sheer growth of the industry has been fantastic terms of some particular highlights. I mean, I always quite enjoyed standing back and looking at sort of the way the industry was was developing, and coming up with suggestions for maybe how things could be done better, or where, you know, the industry had adopted certain practices that I didn't think were the right sorts of practices, and it was much more fun kind of standing back and trying to point those out and offer suggestions for better ways forward, rather than just joining the chorus of sales people out there. Wouter Klijn  07:21 Can you give an example of that? Greg Cooper  07:23 I mean, the key one that you know, and I write a lot of research papers around this, is the i concept of around, sort of objective Based Investing, and the idea that benchmarks and the whole strategic asset allocation process, which we've grown up with in the 80s, didn't always work. And you had in Japan is a great case in point, you know, a fixed, strategic asset allocation with a large exposure to equities through the 90s in Japan killed you. And so you know that that, to me is, you know, it's resonated very well in the industry, and I think it's a key part of sort of thinking about how to do things differently. And so, you know, sort of, it's not to say that strategic asset allocation is that that style of investing is bad. It's just to say that I think we've moved on from there, and there and there are better ways to think about this, and there's some consequences that come from that, and that's worth bearing Wouter Klijn  08:07 in mind, the consequences. Yeah, so in your answer, it sort of shows that you, you've always been quite keen on fostering a culture where it's open for discussion, and there's pretty much no topic of debate. Why is that so important to Greg Cooper  08:21 my mind. You know, we work in an industry where there are lots of really intelligent people, and no single person has all the right answers. So the more you can foster debate, and the best way to foster that debate is to have a fairly transparent and open culture, then ultimately you get a better outcome. And it might be sort of painful in the near term to hear, you know, if your particular idea shouted down or what you're doing, you know isn't you know doesn't resonate with everyone, but I think fundamentally, it gives you much better outcomes, and when, when people are, you know, more open, transparent, and in particular, prepared to bear criticism to their ideas. That's how you that's how you drive change and move things forward. So you asked about sort of tips for aspiring sort of CEOs, and that would be, you know, a very clear one to me is, don't be afraid of what others think and try and draw out that. And certainly don't create a culture where you know yours or a small number of views preside. You want to create a culture where you hear right through an organisation, because then, particularly today, like the world's changing so much, sometimes the best ideas come from, you know, some of your really junior people who are right at the coalface. So you want to, you want to make sure those ideas get aired and have as much resonances, you know, some of the more experienced ones. Wouter Klijn  09:36 Yeah. So is that a matter of staying competitive, or is it also more generating sustainability within a business that you can see risks or potential challenges coming that are further ahead. Greg Cooper  09:47 I think it's both. I think, you know, this industry is nothing if not cyclical. We see markets are very cyclical. You know, performance of asset managers is very cyclical. You know, the active industry is probably having a pretty hard time. Of it at the moment, I see that as a very cyclical outcome, and I just think that if you're not open to, you know, sort of change happening, then you know, particularly when times are good, and that's often the time when it's hardest to make changes in an organisation, because everything seems to be going well, but that is often and always the most dangerous time when everything's going really well, because you tend not to see the risk. So just trying to, yeah, it's not to say you get it right all the time, definitely not, and it's difficult, absolutely. But at least, you know, keep your eyes open. Wouter Klijn  10:30 So one of these big topics we've recently spoken about is the functioning of the public markets. And we see that more companies stay longer private. There seems to be a bit of a challenge in raising capital through the public markets. What is your view on that? I think you have a bit of an idea that maybe the public markets aren't where Greg Cooper  10:50 they used. Yeah, look, I think I wouldn't say the public markets are broken, but, but I do think there are some real issues in the way public markets are functioning. And if one goes back and sort of says, Well, what was the point of a public market? It was to allow capital to be held in the hands of a very, very heterogeneous group of individuals, and for new capital formation to happen. The way the broader investment market has changed is you've got a smaller number of very large holders, and almost by definition, those holders end up becoming more passive in their equity holdings. They have to become much more active in a governance sense to compensate, but they become much more passive in terms of their equity holding, just because they have to be so I think that that has changed the way you know public markets function, and will continue to change them. And at the same time, you know whether it's regulation or other things sort of driving, you know how new capital gets formed, people are more prepared to sort of keep their companies private and accept some of these large investors because they just don't need to go to the public markets. And the private markets tend to give them a bit more flexibility. So I think that's changing the whole dynamics of it. Where I see a real danger is in the smaller end of the corporate capital formation process, where how do new ideas get funded? And I think in other jurisdictions, particularly in the US, where they have a really well formed venture capital industry, we don't have that. And I think there's a danger in Australia that not having a well formed, or even a barely call it embryonic VC type industry means that there'll be lots of good ideas that get starved of capital and potentially go offshore, and that's bad in the long term for the economy, and bad certainly for those funds in the long term. Wouter Klijn  12:38 So to what degree is this also the influence of quantitative easing, because you could make the argument that, well, it's easier to raise capital from the private markets when capital is so cheap, but once that goes away, then perhaps the public markets start functioning, and the way they should be, well, there's Greg Cooper  12:54 certainly more capital around. There's no question about just given what's happening in terms of QE. But but whether we have QE or not, you will still have larger asset pools. So in a relative sense, you know, you just have to look at the Australian market. You know, the top 10 asset pools, you know, represent a significant chunk of the Australian equity market. So that feature occurs no matter what, with or without QE. So I think, I think QE has pumped, yes, more capital in the system. But I wouldn't blame QE for where we are. And I don't mean blame in a negative sense. I mean it's just where we are is a function of the rise of large asset pools. And that's that's not a bad thing by any stretch. It probably leads to, you know, better overall capital allocation decisions, because they've been made more professionally, rather than by, you know, a vast number of more amateurs, but, but it does have that consequence of potentially, certainly in Australia, starving the more junior end of the market of capital. The other Wouter Klijn  13:54 consequences is that there's more money flowing into passive and you've did some research around how this could potentially also distort markets, especially the public markets, where they come up with all sorts of different flavours of essentially similar indices, but it also then channels potentially funds to, particularly a couple of companies that occur often in certain indices, and basically get funding on the basis of that, rather than of their fundamentals. Yeah. Greg Cooper  14:21 So I thought, like any, any capital allocation process that's rules based is prone to, prone to some form of danger. So if you just keep following those rules blithely, and the whole, remember, the whole point of passive was about allocating, you know, in a in a certain way, a market cap weighted sense, across the broader economy, almost. And it works when you've got very large and diverse equity markets, but gradually, as the proportion that is passive becomes larger and larger, and indeed, in fact, in certain markets like Australia, where they're sort of more concentrated, that can have a consequence that it starts to distort certain companies in the way that they're weighted. In the indices. And then, I think the rise of passive as a sub. Don't use the word asset class, but, but where you get, like, you know, sort of a passive exposure to a certain thematic that then overweights the companies with no real bearing on their economic impact, and and you just get this weight of money. And then the other passive money comes in and has to allocate more to it, because to it because it's got a higher weight. And so you can end up with a with a disproportionate allocation in certain companies. And you've seen that, I think, in some of the tech names and even some of the dividend payers, whenever a thematic comes through, it gets a lot of money, and then, by definition, those companies get pushed up in price and get overvalued. Wouter Klijn  15:42 Yeah, yeah, yeah. I can remember that at one stage I saw there was a sushi ETF coming out, and I was wondering if that's really a product The world needs. Yeah. Greg Cooper  15:51 I mean, those are, those are marketing concepts. You know, the idea is that passive was meant to be low cost exposure to a broader group of investments. And I think that's been sort of slightly skewed when you start talking about real flavour of the month passive strategies. Wouter Klijn  16:04 So the other argument for passive investing is that it's simple. It simplifies the investment process, and often, when there's too much complexity in a portfolio, it's hard to keep track of it all and also to basically communicate it to stakeholders. How do you look at complexity? Are we giving up too much by just having passive strategies? Greg Cooper  16:24 Look and passive has a very good place in some portfolios. And bear in mind that actually the bigger investors, as we just talked about, have virtually no choice but to hold passive or quasi passive exposures. The point that I would make about passive is that no investor is truly passive. You have money coming in if you're in your accumulation phase. You have money going out if you're in a decumulation phase. So you have to manage the cash flows and where you allocate capital to and take it from. Shouldn't be entirely a passive decision. You should have some view on where you know what price you're paying for assets you know, and particularly when you're allocating amongst equities, bonds, property, cash, whatever you should have some bearing. So you can't be entirely passive, I think, in a total portfolio context, and even where you are, those big passive holders have to take a much more active role in a governance sense. So, you know, to me, passive is just, you know, it's a it's a simple way of implementing a certain part of your investment strategy, but it's not your investment strategy. It's just a way of implementing a piece of the investment strategy, and as long as you bear the total portfolio in mind and your objectives and all that kind of stuff, passive has a has a place to play in that, but it's but it's not the answer to everything. Wouter Klijn  17:40 So you're not concerned about the predictions that I think it is by 2021 we will see more money in passive than in active, Greg Cooper  17:46 Not at all. And I think, again, I would, I would sort of come back to the point about markets being somewhat cyclical. And I think the passive will rise just because active, you know, probably had proportionately too larger share. But there's a point where passive can't, you know, you can't have 100% passive, or the markets don't function. So, you know, and whether that, I don't know whether that numbers, you know, 40, 5060, whatever. And I kind of almost, you know, it's not that relevant, because we'll never get to really high levels, just because something will happen that causes a change and the cyclicality will kick in. Wouter Klijn  18:21 Yeah, you mentioned that cyclicality, looking at investment styles, value hasn't worked for probably the past decade. What are your thoughts around that? Is that something that is structural, or is that cyclical? Greg Cooper  18:33 You can make an argument for both. I mean, I've seen plenty of arguments about it being structural just because of the way value is defined. And I think, you know, if we think about value in a, you know, sort of booked value context, or, you know, or in businesses which, have, you know, high tangible assets and low intangibles, then certainly there's this, you know, that's, you know, there's a change that's taken place in markets where intangibles are now, you know, of extreme importance. And so how you define value, I think, has probably changed over the course of that, but, but, you know, value as an investment philosophy is, you know, a very sensible strategy buy things that are cheap. I mean, like, it kind of makes intuitive sense, and I don't think that will ever go away. I'd be far more concerned about buy things that are expensive, things that are cheap, but values also had, you know, it's had long periods where it doesn't work again. That's the cyclicality of markets, yeah, Wouter Klijn  19:28 but it is within these big technology companies, where there's so much depending on the IP that arguably, it is harder to value what an IP is actually worth and when it's at a discount Greg Cooper  19:38 or not. So I agree. I think that's the issue. Is, is the definition of value, and how do you how do you place a value on certain of these organisations? Is the more difficult thing, but also too. I mean, I think certainly at the moment, markets have gotten a bit carried away. And whether it's QE or, you know, the some of the passive bits that we talked about, or just sort of momentum. Generally encouraging more investors to invest in it's could be a whole combination of things, but it's quite clearly that there are some levels of what I would call exuberance in certain parts of the marketplace. And while that hurts in a value context, you know, value is always going to be or any investment style hurts the most at its peak or at its trough. I should say, you know when the when the alternative is at its peak, that's, that's the point of Wouter Klijn  20:27 maximum pain. So do you think that the process of value can be adjusted to reflect the current market conditions, or do you get very quickly to a point where you basically have style drift? I think I'd Greg Cooper  20:40 be very careful about saying current market conditions, because, because that that I think does infer style drift, I think it's more about, you know, making value work for the nature of markets, and recognising that the term of value, and particularly getting this rise of intangibles on the balance sheet requires maybe a bit of a different way of thinking. But I'm sure there's plenty of value managers have already all over that and captured it, and some of these things probably still look really expensive. So, yeah, I think, I think again, styles are cyclical, and value and quality in particular. You know, if I had to have a bias in my portfolio, would be slight advice to value and quality than I would be to certainly to momentum. Wouter Klijn  21:17 So one of the things that you, you're interested in is more in this private market aspect. Can you tell us a little bit about what you're Greg Cooper  21:24 doing there? Well, it really comes back to the whole sort of VC space, and how do you encourage better capital formation? And particularly, as I said, in Australia, I think you know, you've got a well established VC market in the in the States, potentially, sort of, as the assets have grown in that space, probably, you know, managers charging too much for the for the service, much like, sort of what happened, I think, in private equity. But in Australia, we don't have it. And I just think that there's, there's really something that can be done. And where you've got a small number of large asset pools, you know, we really should be looking for ways to allocate capital to that space and try and generate some sort of venture capital ecosystem, albeit without necessarily, you know, I think this is our chance to kind of invent that space without imposing, you know, a more traditional third party fee model over the top. Wouter Klijn  22:16 Now, one of the activities you do is, you're a director of a FinTech company. One of them is open invest. What is your interest there in this particular space? Greg Cooper  22:26 So that was much more specific in the asset management space, and we talked about some of the issues that active asset managers, or just asset managers generally, were facing, and the rise of large asset pools, particularly in Australia, making the institutional market less of a source of funds for them, but at the same time in the, you know, what I'd call, sort of the retail and wholesale markets, you've seen this, this real explosion in SMSFs and and so forth. And I would say, actually, a large amount of professional or non professionally invested assets. And so the idea behind open invest is to have a simple mechanism through which people can allocate to a diversified portfolio and get a lot of the benefits that come from a more traditional portfolio structure, but build it very cheaply. You know, one of the things that gets me is when I look, sort of, you know, all the regulation, other things that have had gone on in Australia, in the retail marketplace, Royal Commission and so forth. You know, the cost to member hasn't really gone down. And it's like, well, you know, surely we can build things, particularly with technology, that deliver professionally managed portfolios to individuals at a much cheaper cost. And that's, that's the concept behind open investor. Wouter Klijn  23:38 It's an interesting model, because I think it shows what a lot of FinTech companies trying to do, in the sense that you have sort of a traditional model, where you have a distribution platform, you have the asset manager space, but then there's elements incorporated of social media, like features, so you can like things, you can share things. In essence, what is happening there is that you try to create communities around certain products or services. Is that sort of what interests you, or is it more directly coming from?  Greg Cooper  24:09 Yes. So the point to me is really about, you know, simple, well designed portfolios being delivered to the general public in a relatively cheap format. And I think that's, you know, we were great at creating themes, and, you know, charging, you know, probably excessive fees for that as an industry to individual consumers and trying to stir up, you know, momentum around those particular themes or concepts, whereas actually, what I think we really should be doing, particularly with a more fiduciary type of mindset, is simple, you know, typical balance type portfolios that are well diversified and well structured and delivering them at a pretty reasonable fee, and that's the concept. And you know, with that, you need to have things like content layer. That sort of give you all of the right sort of behavioural impact with your customers and so forth, and deliver the messages out there in the right way. But the real premise is you have to do all that sort of stuff to deliver a simple, well diversified, professionally managed portfolio at a cheap cost. Wouter Klijn  25:17 Yeah, absolutely. But I was also thinking about that struggle for getting people's attention, and it can be very powerful to have something that's just sitting on your phone, and you can talk to other people, and you basically can go there without necessarily having to invest in a fund. You just you can just check up on it. That must be a very powerful Greg Cooper  25:36 feature, I think. So, yeah. I mean clearly that, you know social media, more generally, is changing the whole way in which consumers interact with each other, way in which they interact with third parties, and that will continue. People come up with new ways of delivering content to the end customer. You know, things like web 3.0 and things blockchain and so forth, could even mean that, you know, some platforms are no longer the right delivery mechanism for for all sorts of content, because it becomes much more individual to individual. But I but, yeah, I mean, I think what you're seeing is an explosion in the way people want to interact. And definitely have to look at my kids, you know, they spend an awful lot of time looking at their phones and interacting through their phones, and it's just, it's the norm. Yes. Wouter Klijn  26:23 So you just mentioned the fiduciary side as well, and you've joined the asset owner side as well with T Corp. Can you tell me a little bit about how you came to T Corp and what your role is there? Yeah. Greg Cooper  26:35 So I've joined New South Wales Treasury Corporation as a non Executive Director. I was lucky enough to get approached by them in my sort of last few months at Schroeder's, when it was, you know, all very public that I was retiring from executive life, and I think it just turned out to be a good fit. I mean, T Corp is a fantastic organisation that's going through some pretty fundamental changes, particularly in the investment model as a result, you know, of the merger between what was workcovers, now I care state super and the original T Corp portfolios. And now it's, you know, looking at a an asset size in excess of $100 billion and needs to be managed in that form. So it's a really exciting time to be there. The team's been built out. It's, it's, it's a great role. So as well as being a non exec, I'm also chair of the board Investment Committee. Wouter Klijn  27:29 Yeah, the executive team seem to have a real drive to build us out into a global quality asset management firm, coming from sort of that more sleepy government organisation, probably. But yeah, I probably but, yeah, I probably wouldn't Greg Cooper  27:41 describe it necessarily as sleepy, but, but certainly quieter, and the asset size was significantly smaller if you go back five years. And I just think that that, you know, we've seen a pretty fundamental change in their business, or driven by the right sort of economics and and that's a great time to be there and be involved in the transition. There's also, you know, it's a very interesting business, Teik court, because it's also the government's debt issuing authority. So it's got a very large, you know, issuance side to the to the balance sheet as well. So it's a fundamentally different organisation to most asset owners in that you've got, you know, these two fairly large parts to the business. Wouter Klijn  28:22 So it took a while to get your head around all the different moving parts. I would say some of it, Greg Cooper  28:26 you're still getting your head around. You always are. But I think, you know, that's the that's the great thing about, you know, these sorts of roles and the challenges. And, you know, particularly in moving from a third party asset manager to an asset owner, there's, you'll learn new things all the time, yeah. Wouter Klijn  28:40 So what else is on the agenda for you? So you have directorships? Can we see you at any other roles? Greg Cooper  28:49 Well, I think in terms of sort of building out a portfolio, you'll see me pop up, I suspect, in one or two other places, as in a non executive or advisory type capacity, as well as that, I've got some personal business interests with the family, which, which keep us occupied for a little bit of the time. And as I said that, you know, the whole thing we talked about in terms of the venture capital space is something that interests me in terms of helping, you know, build out that ecosystem in Australia. And I think, you know, it's, it's a, it's a really exciting time in my career to be involved in a whole range of different things, rather than, you know, sort of singly in one sort of more commercial type arrangement. Wouter Klijn  29:30 Yeah, yeah. Excellent. Well, Greg, thank you very much for your time. It was good speaking to you.  Greg Cooper  29:36 Thanks, Wouter, that's great.
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  130: RQI Investors' David Walsh – Is A Quant Winter Coming? 01.03.2026 46min

  In this episode, I'm speaking with David Walsh, who is the Head of Investments of RQI Investors, a First Sentier fund manager. And we delve into the concept of a Quant Winter.  Some market participants argue a new Quant Winter is in the making, since growth and momentum factors are compounding with limited breadth, driven partly by the promise of AI. This can lead to distortions in the market and the collapse of quantitative models. David has tackled this topic in a recent paper, called 'Lessons from the Quant Winter' and we discussed what it is, how likely it is another one is coming, the impact of monetary policy and innovations in quantitative strategies through machine learing and AI. For the full paper, please see here: https://www.firstsentierinvestors.com.au/au/en/adviser/insights/latest-insights/lessons-from-the-quant-winter.html __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights  __________ Overview of Podcast with David Walsh, RQI Investors 04:00 From engineering to investing 09:00 What is a Quant Winter? 11:00 Is a Quant Winter a form of mean reversion? 15:00 Do I see another Quant Winter emerging? Probably not. What we are seeing is an anti-value period 18:30 On average value should beat growth, because the market is behaviourally tilted towards growth and overpays for it 20:00 In a high volatility environment, a rotation towards quality is sensible 23:00 A good quant portfolio is not just about established factors, it should be much more about finding idiosyncratic sources of alpha 25:00 You don't want a 100 signals in your portfolio; you want them to be able to breath 26:00 Machine learning let's you build models in ways you couldn't in the past 28:30 How to deal with cost in implementing non-linear signals 31:00 Higher dimensional portfolio optimisation through quantum computing 33:00 Quant Winter versus a recovery 38:00 Is AI in a bubble? "My guess is that the air will come out of the balloon, rather than it popping" 41:30 The extent to which passive or passive-enhanced money has affected the market structure is definitely an issue that has been arising in the past five or 10 years. You can broadly read that the market is becoming less efficient Full Transcript of Episode 130 Wouter Klijn  00:00I Welcome to the [i3] Podcast. I'm here today with David Walsh, who is the Head of Investments for RQI Investors. David, welcome to the show.   David Walsh Thank you very much. Great to be here.   Wouter Klijn  So I understand you studied electronic engineering before you got into the investment industry and specialised in reducing circuits and chips, is that correct? And optical communications? So how do you end up in the investment industry after that?   David Walsh  00:28 Yeah, well, that was the topic du jour when I was studying my electronic engineering, way back a long time ago, the idea of what was called, at the time, very large scale integration, which was the idea of taking a circuit board or a chip design, and shrinking it down as small as possible had a lot to do with the way in which the mapping of the transistors on the chip worked, the material science underneath which materials you're going to use. That was very interesting. Also worked and looked at optical communications quite an early part of that industry. A lot of the talk about the fibre technology and loss rates and speed rates and bandwidth and so on, are quite interesting topics that were quite topical at the time. Emerging industries, the material science and the optical technology side, were very interesting, and clearly emerging technologies that have gone a long way since then. I took that and worked in power and mining engineering for a few years after I graduated, not directly in those topics, but used a lot of the ideas and instrumentation design and the like when I when I was in the industry, it doesn't naturally segue into finance, but it's important to think that a lot of the problem solving techniques that you get from being an engineer or training as engineer, the way you approach problems, the technical issues you use, the things you realise you're missing, apply themselves pretty well to a finance study as well. So when I, some sense, moved careers from engineering to finance, a lot of the skills came with me.   Wouter Klijn  01:49 So when you talk about shrinking circuits and chips, is that related to like Moore's law, where, you know, trying to get more and more things on the chip and making them smaller, and then that would increase the computer power. Or is that totally off?   David Walsh  02:05 Yep, no. Same field, pretty much. The idea there is you can only shrink them down to a certain size, beyond a certain size. It's impossible to to get the chip widths, the better the actual tracks you use for transmitting electrons around the circuit. You can't get them any smaller than a certain size. So there's that sort of limit, physical limit. There's been a lot of work since then. That's a long time ago. A lot of work since then, that's evolved that technology. But the idea was, how far could you get it down before we started to impinge on on issues regarding impurities in the material, in terms of the track sizes, in terms of the transition times, in terms of getting things out of sequence. So the design was really important in that sense, that was kind of the the intuition behind it.   Wouter Klijn  02:44 Do you sort of with that background look at today's, you know, development around machine learning and AI and like this need for chips and the dominance of AMSL, with that background, does that surprise you? Sort of where that has gotten to?   David Walsh  03:02 Not at all. No, I think it was a natural evolution. We would see of the of the the technology was growing back in the day when I was again while studying it a long time ago, the evolution of the technology was, was clearly progressing towards faster chips, greater memory, better software and the like. It's pretty early days, but you can see the trajectory it was moving on. A lot of discussions at the discussions at the time not about where the hardware or software would go, but how the usability of those technologies would move. And really, even then, artificial intelligence was a concept. At some point the industry expected to get to the point where it could replicate some kind of human behaviour, not to the scale we see it today. But certainly there was trajectory. I don't think it's been much deviation from that. The only real direction I think has been interesting, and I don't really understand this properly yet, is the idea of quantum computing, which gets away from the original idea of logic gates being zeros and ones to an issue where to a logic gate or a bit can have both zero and one at the same time based on some probabilistic distribution, which I can I've studied Quantum Physics A long time ago. I kind of understand basically the principles. I still don't get quantum computing the way I'd like to.   Wouter Klijn  04:04 Yeah, no, it's a fascinating topic, but very complex indeed. So that engineering background you now work as a quantitative investor. So you know that engineering background was that sort of a natural progression to become a quant, rather than, say, a fundamental approach?   David Walsh  04:21 Yes. So I transitioned across to finance academia first. So I was doing a higher degree in Finance as part of my studies, further studies. And I liked it, and transitioned across at an academic level, mainly because I liked the idea of research and pushing the ideas of knowledge and challenging myself. And I liked teaching. I like communication side. Did those skills necessarily move them across to quantitative investing? The answer is yes, I think fundamental investing has changed quite a bit since I've been in the industry. There are a lot more quantitative skills being used, but it's still not disciplined in a way that a quantitative investment process is. So having those tools and techniques that I'd learned as an engineer were not. Really directly applicable, but the discipline around problem solving, the idea of numerical optimization, the idea of constructing a problem in a certain way, those things lend themselves very naturally to quantitative investing,   Wouter Klijn  05:11 Yeah, but you're not getting to a stage where you built your own computers and systems for backing up the quant strategies?   David Walsh  05:18 No, no. There are many more, many people in the industry, including people that work with us, who are much better at that than me, my skills, are more around I think thinking about how the evolution of information works in markets, what things get priced in, what don't, what drives volatility, what events are happening that will perhaps override those that sort of quantitative discipline applied to the investment market. So it leads us on, naturally to where I've sort of come from in my come from in my industry, rather than going back to the technological side.   Wouter Klijn  05:46 Yeah. So part of the reason to do this podcast is because you wrote a paper that was talking about the quant winter lessons from the quant winter, which is perhaps not the topic you expect from a quant, because, you know, always works, doesn't it? What is a quant winter?   David Walsh  06:02 So quant winter was a term that was coined by a couple of industry people back in about 2020 also 2021 to reflect a certain period when a lot of quant factors didn't work as expected, both not in terms of factors not working, but in terms of the complementary factors that usually work not working either. So I went to almost a drought. So you could call almost a winter or a drought would be sort of either terminology. I don't like the winter term very much because it tends to mean that there might be seasons in quant behaviour. There's a spring and a summer. Yeah, that's not really how you want to think of the world, but a lack of of drivers of underlying fundamentals that have worked for a very long time, that certainly reflects a more wintry period or more drought period in terms of those factors. So it wasn't coined by me, but it's become a bit of a topic, particularly more recently, with some of the quant factors behaving in, again, peculiar ways, particularly for the last year or so. That suggests that maybe there's been some discussion, maybe there are reflections of that quant winter appearing now. Winter appearing now. Are we still saying the same things? Is it going to happen again? The Quantum winter itself probably can't be defined easily as being a single period, although it does tend to reflect times when certain style factors didn't work as expected, and the other factors, as I said, which were complementary to those didn't work as expected, either, and that period of nothing working was a winter or a drought.   Wouter Klijn  07:25 So what is, sort of the fundamental driver behind that? And as I was reading the paper, I got a sense that it points out that people were paying more for sort of the same earnings growth, that there seemed to be a bit of a mean reversion element to it, where you know that trend of paying more for the same earnings growth is not sustainable, so at some point that will break. Is that just mean reversion, or is there something else going on?   David Walsh  07:51 Yeah. So you don't want to try and bet against the markets when they're doing things which appear to be irrational. We all know that those sort of expressions, but what appeared to be happening was a narrow part of the market became more and more expensive after a long period when value was hadn't worked for about 2011 to 2017 or 18, value had been in a difficult period, low interest rates, low inflation and stimulated growth. Companies had driven a lot of the AI boom. A lot of the technology around that was developed in that period because it had a runway. A lot of investors were buying in to that period, what we saw from about 2017 or 18 onwards was a strong period when value underperformed, because that narrowness of growth continued very strongly and went upward. So in a sense, it's mean reverting. It kind of is a precursor to a mean reversion. I think that's why it's thinking of it. So in other words, markets became more and more expensive during that period, with the inevitable outcome that eventually it's going to be a reversal, which we saw in 2021 so that you get a reversal. And that was, in some sense, the main reversion that you speak of. But what was interesting as part of this was there was no way probably you could really have predicted or changed your position accordingly if you want it to be tilted towards value, you couldn't change that value characteristic. But normally, in an environment we know in quant investing, if value is not working, which is associated with mean reversion, trending signals like growth or price momentum tend to work, they didn't really work either. So it's because the market was so narrow, in the sense of a handful of stocks that were running, you couldn't really pick up a growth story unless it was very much a tech, US tech, expensive US tech story. And that's not usually, that's too narrow a bit for most investors to make. Certainly, for quant investors to make.   Wouter Klijn  09:34 So in this quant winter, a lot of factors are not working. Some factors are, I think, distorted a little bit in how they perform as well, when you look at that, is that mainly a problem from the perspective of a factor neutral investor, because usually, then you sort of don't want to take a bet on one particular factor. You try to have a broad spread that if one doesn't work, hopefully some of the other ones work. So is it mainly a problem from that perspective, or just did nothing work at all?   David Walsh  10:05 So if you were to bet on tech, as I said, I mentioned earlier, so if it was a tech bet, you're willing to buy expensive tech, expensive tech growth in the US, then you didn't have a problem. You were going to be overweight those names, and you'd do fine. But most managers weren't willing to pay up for the excessive earnings multiples, because the earnings had not yet been realised, even though the valuation is reflecting those earnings. So you're getting stocks trading on 30 and 30 plus times forward earnings. Those sort of numbers are pretty big for anybody to own. So that was a difficult thing to swallow, and that was what was driving the market lot of the time. That concentration was driving it. So in a sense that if you have a diversified factor model, like an alpha model, the quant model shop like us would have, you'll find a lot of things wouldn't work. You wouldn't necessarily be penalised by them, per se, on average. But in this case, we would have been, because we've been underweight a lot of those, those tech stocks. But generally, those sort of factor models would be have an alpha drag because of those. In fact, any model would have an alpha drag unless it had those characteristics that we talked about. I'd be, I'd be thinking that it's kind of a binary bet. A lot of ways, you either buy that story or you don't. And if you don't, no matter what your investment style is, you're going to be underperforming, whether diversified quant or a style risk premier capturer or a fundamental investor, the same thing will apply.   Wouter Klijn  11:23 Yeah. Now, you mentioned earlier that there are some people that saying maybe we're facing another quant winter. And to a degree, it does sound familiar, the concentration in the technology stocks, we do see that it impacts how momentum and growth work, because sometimes they seem to get a bit concluded in this narrow market. What is your take? Are we facing another quant winter?   David Walsh  11:47 Yeah, again, I'd push back a little bit on the term quant winter, although it's an easy thing to say, I get it, and it's catchy, isn't it? It's very catchy. And I get the point. I think probably the more the story that we are so uncertain of the direction, there's a lot of volatility in factors. There are periods and pockets when things are working. Things are working more quickly, perhaps, than we might have expected. Things which are in the past have worked aren't working. That sort of lack of product predictability probably isn't quite the same as a quant winter. It's more about an excessive period of volatility and uncertainty in the market, and so you're getting a lot of policy decisions, a lot of directions of the market, which are probably not what you would have taken as your bet being longer term, certainly. So do I think, to answer your question, do I think we're seeing a another winter emerging? Probably not. I think what we're seeing is an extensively value, anti value period in concentration and in expensive stocks and in tech unwinding. We are seeing that at the moment, and that unwind I would expect to continue. I don't think I would see a period where everything goes flat. More likely we'll see value continuing to do well, as we've seen over the last few months, after a period when it didn't do well, momentum will have difficulty. Growth stories, which are very uncertain in a higher inflation, higher interest rate environment, are difficult to pick. So some of those factors that have worked for a little while are not going to work. Would have called a winter No, I'd probably call it more just a high volatility. In fact, there's a lot of factor risk going on. So perhaps in an environment when someone like like us, who's investing a lot of these contractors, needs to be very cognizant of those. Probably would like to take some risk out of them, out of the process, or have it taken out simply because cross sectional deviation has gone up this uncertainty we're seeing. Yeah.   Wouter Klijn  13:34 So how do you prepare for that? I mean, the increase in volatility, does that also provide opportunities?   David Walsh  13:42 So yes, um, if it's cross so usually, quantitative models work better in environment when cross sectional dispersion opportunity set is bigger. Yeah, no question about that. So, so yes, you're exactly right. That's what you'd expect to see. So bigger dispersion, more likely opportunity set, provided it's the right sort of dispersion that you would see. So on average, that's true if it's macro factor risk or thematic risk that you're not normally betting on or is driven by factors you wouldn't normally see. What happens then is those factor opportunities don't appear. Contra sectional risk increases, and the model automatically adjusts itself by shrinking its positions and holding more names. That's part of the rebalancing process. When you use a risk model that we do, you tend to hold more names in period when cross sectional variance is higher. That's kind of what we're seeing at the moment. Volatility has been up a lot more uncertainty, and we tend to see a more of a risk averse process falling through. But we still have great conviction in our ideas. Longer term. You know, we were happy with those things. There's nothing in there we want to throw away. But it does seem to be that a lot of volatility in those factors and a lot of factor risk, which is not part of the normal Alpha factor risk that we need to take into account.   Wouter Klijn  14:51 Yep. So you mentioned the value factor there, and you said, well, that underperformance is sort of unwinding, but you don't necessarily. Expected to outperform going forward. What is your sense there in terms of, you know, the role of the value factor in portfolios? Because we've seen a long period where it pretty much did nothing or underperformed, then it started working a little bit again. But it's, it seems that you saying, well, we don't expect that to continue for a long time?   David Walsh  15:21 No, no, I think what I was saying was the value factor probably should continue to work for a little while, but the growth component of that probably, the growth factor probably would not so Okay, so I'm more of the view that historical evidence associated with value is going to continue to be true. We've gone through some periods when it didn't work. As you noted, 2011 2018 1020 period value was a struggle. It's rebounded strongly, given back some it's come back again. More recently, on average, value should beat growth, because the market is behaviorally tilted towards growth and overpays for it. Yeah. So you tend to get this bedding up of growth and then disappointment. The market sell off, you get glamour stocks, which are sold off, and you get under unloved stocks being sold off too far before that and bouncing again. That value premium has been shown many times through history. I would expect that to continue in the future, but longer term, but with volatility being as high as it is and uncertain drivers that we're seeing, macro drivers, thematic drivers, as well as these sort of factors which are highly volatile. I'm not going to say that we're going to have a period over the next 12 to 24 months when value is going to shoot the lights out, but I'd certainly expect it won't underperform by anywhere near as much as it has done during the period we saw prior to that.   Wouter Klijn  16:31 So it's not time to throw value out of the portfolio just yet, because it seems that when you look at sort of asset owner portfolios, that some of them have migrated from a pure sort of value exposure to more of a quality exposure, and basically, don't have a lot of exposure to it, to a pure value factor.   David Walsh  16:53 That's that's a good point. I think the the idea of a rotation towards quality measured however you can measure it, quality is a bit of a slippery concept, but, but measured however you measure it, that's sensible, because in a higher risk environment, you know, more likely better quality stocks, again, however you measure them, should outperform. But we would make the case pretty strongly that it makes sense to have a style balance for asset owners. They should be having quality in their portfolio, certainly, perhaps a little bit more of that, if that's their view, but you're going to be buying growth, because growth is where a lot of the returns are going to come from, and so you need to buy growth. You generally have to buy good quality, bottom up stock picking growth managers understand those companies, understand where growth is going to come from, not just narrow in tech, but more broadly than that. But that gives you a risk. You get an expensive growth e portfolio, particularly with the quality side that sits out there on its own without a balance now that stops paying off, you can significantly underperform. So we find, not only does value outperform over the long term, we like to think of value as being an insurance policy against those and then in client portfolios, we've had just a few clients have told us this. They like a low turnover, transparent, robust value process to balance out the styles they get from their other managers. So it's almost like a risk management tool in some for some clients, it certainly is. Others buy the value story and will own it longer time as a longer term as their core there's no question about that. But certainly for some larger asset owners we speak to, it's a balancing item. It's almost insurance policy in some ways. Yeah.   Wouter Klijn  18:25 So one debate in the quantity industry is focusing on, you know, how many factors are there, actually? And the answer, I find sometimes, ranges from three to five to like, 1000s. Yeah, sure. Where do you sit?   David Walsh  18:41 So there's a lot of discussion around what the academics called the factor zoo, lots of ideas and many, many different anomalies and factors in there. We tend to break it down, sort of at a high level, in terms of what we call composites or families of signals which follow certain themes. When it comes down to it, there's going to be themes which are, at one end, very risk based. So for example, volatility type signals, which will pay off over time. If you're tilted towards low volatility on average for the long term, it should outperform. Or there are periods, as we know, but it doesn't work. But that's quite a simplistic implementation. You just tend to buy low vol, low beta names and lab perform well, there's not much science in that, a little bit. And if you did build portfolio, build portfolios properly, you'll certainly see that that tends to act more like a risk premium. So you're picking up risk, and you're being rewarded for taking on that risk, risk associated with low volatility. You might do the same thing in taking on risk associated with value. For example, if you believe value is a risk, or if you believe that quality is a risk, you might find those as well. So at one end, you can think of these high level factors as being risk premia. I think any good quantitative portfolio should have a component of those within them, even if it's seeking idiosyncratic alpha, simply because we know that risk premia. Listing works on average, but your portfolio shouldn't be all about that. It should be much more about searching for more idiosyncratic sources of alpha and building those in. And that's when we get into this factor zoo issue that a lot of academic evidence, a lot of practitioner evidence, finds things that work, that perhaps worked thematically at the time, or perhaps based on a certain data set, or perhaps we're not able to be replicated, because this is replica replicability issue in finance academia, as is in every industry built you to do the same thing over again. That chasing of that next big idea probably is not really the way that you'd like to build your your alpha model, right? So I'd like to have, I'd like to think of our model as being a balance between risk premia, not too many of those, a small proportion of those that give you that long term risk premia harvesting issues associated with behavioural in markets, certainly behaviour in terms of the way in which investors work, the way that markets are pricing things in the data complexity issue is one that's really important. So issues around complex data models and how hard it is for individuals, or even invest many investors, to process efficiently and ingest that level of data. And I think those things, and I guess and limit, as well as some things associated with an inability to price in these things simply through mechanical issues, whether it's a short selling constraint or trading issues or institutional things that prevent you all of these things lead to various types of what I'd call idiosyncratic Alpha sources. Now, if you were to build a model that was a range of all of those things, you could end up with hundreds, as you said, of factors in there. The danger with that is you just squeeze out anything, you overfit. You end up with it with it, with a model which is very much data driven, can't be replicated in the future, no individual signal gets any oxygen. So as a balancing act, a little bit of art in building a model that says, I want enough alphas in now, have enough conviction over that are spread across a number of different insights that consistently work. So how many do you have? Well, 10 is too few and 100 is too many. It really depends on the alphas that you actually have, yeah. So really, it depends on the research you do. And that leads a little bit to the nature of, sort of the differentiation between quant managers that comes a lot of the time from the way in which you research and build those models, I think.   Wouter Klijn  22:15 And has that changed with the advent of machine learning in its current form, because you're basically looking with some of these risk premium for trends that are replicable, and machine learning gives that extra element where it can find nonlinear trends, so it potentially opens up a new source of factors. Is that how it works?   David Walsh  22:40 Or, yeah, very close to that. I think the there's a bit of a misnomer with AI, which I don't like the term artificial intelligence very much anyway, or machine learning, then it's going to find the answers for you. It's not really working that way. The insight, the understanding of economics behind it is really much more associated with what drives good returns machine learning tools, and has been a strong advance in many of these machine learning tools over the last three to five years, as we all know, let you explore those ideas in ways you couldn't in the past. It lets you pick up data sets you couldn't in the past. It lets you test things and build models you couldn't in the past. That's where a lot of the innovation comes from, not from finding new ideas, there's a little bit of that, but then taking old ideas and making them implemented, implementing them more efficiently. I think a lot of the ideas associated with machine learning allow you to extract those. I can give you an example. A lot of models that you might have in quantitative investing look at peer relative valuations. So you look at a peer group and you say that company is expensive compared to that company. So I'll go overweight, the cheaper one underweight, the more expensive one in that peer group. The question then is, how do you define the peer group? Do you talk about a sector? Do you talk about common geographic revenue? Do you talk about same customers? How do you do it? Well, in some sense, the machine learning tool in the past, you would have done that. You would have specified it that way, the machine learning tool has the ability to, in some sense, learn what the peer groups are over time within which your relative valuation signals can work. So while in the past, you might not necessarily have been able to pick up what those peer groups look like, now that relative valuation signal can be applied within peer groups that are determined by the machine learning tool. That's a really nice innovation, and much more powerful than a simple sector relative PE, for example, yeah.   Wouter Klijn  24:30 But do you find that that that group, that it then identifies, that that is a stable, permanent sort of group? Because sometimes you think that they find trends, but yeah, it might be a moment in time.   David Walsh  24:44 Yeah, really good point if you tune your model in us. This is part of the use of machine learning. If you tune your model in a certain way, you can find at that point in time the perfect peer group. And then tomorrow it doesn't work anymore, and yesterday didn't work either. Depends on how you tune it. If you. May tune the model too slowly, those peer groups don't evolve quickly enough. Which case you're lagging. So it's a question of how you build your machine learning model, how you understand it, and then the interpretation of what those peer groups might actually mean. So you want some kind of level of stability, but you want to be adaptive as well. And that comes down to the machine learning tool you use, the way in which interpret the evidence, the way you measure the importance of the input factors. All these sort of things matter.   Wouter Klijn  25:22 And the other thing that matters as well, and that is, I think, cost, because, from what I understand, that some of the non linear signals that are found by machine learning that they're real, they're sort of sustainable, but if you don't manage your cost properly, then get eroded away very quickly.   David Walsh  25:41 Yeah, two levels of cost for that. One is the trading of them. You can wear a lot more market impact by turning these things over much more quickly. So it's got to be an integral part of your process for testing and implementation of quant signals. No question about that. But the second thing is the cost involved in processing these things earlier on. When you do the analysis for these you're requiring fairly sophisticated tools that need to run for some time, and conventional computing hardware and systems are quite often not built for it. You need to be able to use much more scalable processes to be able to do a lot of the work that you need to do now. So cost in the sense of fixed and variable, cost of the hardware and software you use, as well as the trading costs associated with implementing them.   Wouter Klijn  26:19 Yeah. So we started off talking about a quantum winter, where you have certain factors not working. You got some distortion with factors. Do you think that machine learning can also help in sort of managing the risk, in the sense that it would pick up these signals earlier from distortions taking place?   David Walsh  26:36 Yes, indeed. So there's two strands. So that's a really good question. There's two strands to that. One would be trying to assess the way in which these signals are being implemented, sorry, being priced in. Now, what we've seen particularly at corners in the market. In Australia, we saw this in October and November. We saw sharp sell off and then rebound. A lot of factors behave very differently around those corners. Now, could you have a machine learning tool that allowed you to adaptively pick up what the factors are being priced in and change your model accordingly. Yes, of course you could whether that generate you get your original question, which is another good one, what about the cost involved in this? If you're turning over your portfolio too quickly, is to chase these things. Does the net reward? Is net reward positive? After costs, you might generate turnover. You burn it all up in transaction costs you earn you nothing. So you need to be able to assess those in history to work out whether it cost you when the time comes. But the answer is definitely yes. Machine learning tools could do that. They can also adaptively weight signals through time. So you need a machine learning tool that tells you what the best trade off between returns and risk and cost might be in terms of the mix of signals you use. That also is something that tells you in the normal run of things, rather than actually in terms of more in more volatile times too. So I'd say definitely, machine learning can help you in terms of portfolio construction, in terms of model selection and in terms of adaptability in the market. One thing I'll get back to a moment. I read an article this morning on quantum computing, again, trying to understand it, which I don't one of the tools that's being used there is for much more higher dimensional or granular portfolio optimization. So it's actually applications of that that apparently are toy examples that are being used at the moment that demonstrate how a much more efficient portfolio potentially can be built, not by changing the machine learning tool, by changing the particular application of a technology, the hardware you might do give much more space to search that space more efficiently than you're otherwise able to. So not just a machine learning tool, it's a hardware solution.   Wouter Klijn  28:25 Yeah, so with your background, then you look at quantum computing, and it's sort of a high level. Do you think that the gain there is mainly in faster computers, or could it also be that the fact that I work differently allows for a different type of software or program to be implemented?   David Walsh  28:44 I think the first one, again, I put the condition on that I'm still learning this stuff slowly, and I couldn't profess to be anything like an expert in what they do or how they might implement it. However, I think it's much more associated with the the selective problems it can address that current technology can't address. It has ability to compute many more computational cycles in a more complicated way than current computer. Computer literature, sorry, computer architecture can solve that particular problem. Lends itself very nicely to quantum computing, and I think that's where a lot of it will happen. I don't think quantum computing will come up with new ideas, as in the first pass it might, because of the machine learning tools you can evaluate on that lead to more things, but as a solution to a problem. At the moment, it's addressing problems which current hardware cannot really address because they're too complex or too big. That's where it'll probably come through, in my opinion. Anyway, my unlearned opinion.   Wouter Klijn  29:41 Yeah, interesting. So I think what part of the reason that you think it is not a quantum winter is because you talk about a sense of recovery, that we're in a stage where actually quite a lot of factors are working. There's some exceptions to that, maybe a low volatility. Not as robust at the moment, but it's basically a period of recovery, rather than a period leading up to our problem. And then I thought about that, because in the context, as well as the broader sort of monetary policy, we had a period where there was very loose monetary policy. It basically prevented the recession. That was the most widely predicted recession we were going to have. Is there an element there where perhaps there is the system had didn't have the time to flush that out, and there's a bigger crisis building because of that, the monetary policy has basically prevented the crisis from happening.   David Walsh  30:41 Yes. So there's probably two strands, if I can answer that in sort of two different ways. There's always been talk post any kind of major sell off or major economic disruption, and the support that's provided by by government institutions like quantitative easing, post GFC that prevent the natural run of capitalism, the creative destruction of capitalism for taking place. Yeah, really, companies that should have should go broke. I mean, should have been allowed to go broke. And we didn't get much of that. We had Lehman Brothers, right, but that's pretty much it. And Bear Stearns, obviously. So there's, there's that issue. I think there should have been. I mean, nobody wants to see this sort of thing happening. But in practice, if you believe in a capitalist system, that's a natural result. And things go wrong. Things are not working should be stopped, and things are working should replace them. Now, the creative destruction idea that wasn't really allowed to happen through implementation of lower interest rates, deliberately low inflation, productivity was very low. That stimulated a lot of and simulated a lot of growth in some areas, which turned out to be good, but prevented others from recycling the capital being recycled into more efficient places. So definitely, that's, that's an issue we've seen. I think, I think that probably explains a lot of the, or some of the growth we've seen in tech, in particular, a long runway of low interest rates of the market getting used to low interest rates and willing to buy longer dated cash flows and earnings that's certainly been built into the prices for a lot of tech companies in environment which is much more strict and higher interest rates and short term, it's unlikely that we've got the same runway that they've had. So you can sort of see that they would have performed the way they've done, and it's been great for a lot of reasons. Do I think a sort of thing is going to continue? That's really a different, much more, much more interesting and complex question, because I don't. I think in an environment we're seeing higher interest rates. Inflation is sticky. Despite posturing, interest rates are probably going to stay higher longer term. Certainly in Australia, we've seen that that's an inflation story, as much as anything else that will probably tend to play out in in a slowdown of growth plays nicely to value style. Getting back to what we talked about earlier doesn't mean it's building up something else to happen. To get into your question, I'd probably think that one of the the main things we've seen associated with the results of those long, long growth those companies didn't go broke. They probably should have. We've seen that in the past, but also the exuberance we've seen in Tech has played itself out in excessive spending, both in the past and into the future, on CapEx for data centres and for growth of hardware, extrapolating into the future, things which probably shouldn't be extrapolated in the way that they have been, and I'd be quite suspicious of that can't be continued, particularly the capex side, which just seems outrageous and unlikely to be able sustainable both, not just from environmental perspective, something from terms of finding the cash to invest in these for the return on invested capital you expect you probably won't see. So my expectation is a lot of those things will be scaled back, that those those dreams will not become reality. We won't have data centres in space, none of that going on, which I found also hilarious when I heard Elon talking about it. I think it's much more that those things will be scaled back. We can't have a sort of CapEx, we currently can't live with the depreciation that comes from that capex, in accounting sense, into the future. So I think those things be scaled back to be more reasonable. A lot of those businesses we're talking about do generate cash. They are next generation. They will be there in the future in some sense, perhaps not those companies, but the ones that come after them will be around. It's no questions technological shift, but it won't play out the way it's playing out at the moment.   Wouter Klijn  34:22 It doesn't seem at the moment, though, that they're scaling back, because I think they recently announced a combined US$600 billion in more capex that they're planning to spend, yeah, and at the same time, people have sort of said, Oh, it's not so much of a problem, because these companies, you know, the cash flow positive and have a lot of equity. So it wasn't, you know, a debt fueled spending, as some of the crisis have been in the past, but some of these companies are now starting to raise debt.   David Walsh  34:48 Yes, yes, that's right. There's 100-year bond or something that was Google listed the other talked about the other day. There's certainly been some debt fueling, I think a free cash flow for these companies is not as high as they thought. Open AI is a good example. Microsoft has plenty of cash, but the free cash flow, since companies is falling at the same time as the capex is increasing, the only way continuing to capex is to raise capital through debt or equity, and debt being the way they're talking about I'm confident or respectful of the market mechanism here. I think the market knows this, and it's already starting to price in some of the issues associated with this, this exuberance we've seen that's been going on for some time has probably rationalised itself a little bit, and I think it's more like that. These plans will simply be scaled back. There'll be some remnants of it. There are large data centres in the Midwest of the US and so on, which are being built now, and probably will continue to be built, some sense. But that long term growth of CapEx to solve a problem which doesn't yet exist simply to serve these things seems unlikely. So my view would be, it's more likely the air would come out of the balloon rather than a popping.   Wouter Klijn  35:47 So this type of big, you know, more macro orientated developments, how does that feed in with sort of your quantitative process? Does do you build signals on the back of that, or is it more it informs the broader portfolio.   David Walsh  36:01 Yeah, so it's more. It will not really find its way into portfolio construction wouldn't really find its way into alpha generation unless we can find something which we believe will consistently work through the cycle. It should really be kind of all weather. If it's thematic change that's happening then, then it's less likely to find its way in, it'll be more noticing what the risks are, understanding the processes and the outcomes that we see. And then when clients are curious, we can inform them. Team members are curious, we can inform them and understand how it works, because we know we can't predict the market well enough to understand a lot of these sort of underlying moves that take place, and the impact they can have on on returns, on portfolios. So just as being informed about the market, rather than making changes to the process, what we do in the process should be longer term. I don't think there's any real need for us to try and implement macro factors directly in, on thematic grounds like that. If we find something that's useful, very happy to do it. But I don't think there's going to be macro factors. There's too few macro drivers to make enough breadth in the portfolio decision making to allow you to put them in as an alpha factor. One thing I would talk about which has spurred some research that I've been thinking about more recently has been this capex idea. So there are certain regulations which are used around the world, accounting standards regarding revenue recognition, when you recognise revenue, and how you measure that. And it seems to me that revenue recognition is an area which is not well understood in the in the technology side. And if you recognise revenue at the right time, then you probably are understanding much more about the underlying development of the company and the quality of the company that goes with it. I don't think revenue recognition is very well understood in the IT sector at all at the moment, and how it's actually working. It's just a exuberance pay for the future growth story. So that leads me to think, How can we better incorporate revenue recognition more broadly across the market, across the portfolio, not just in tech.   Wouter Klijn  37:53 Yeah, yeah. Interesting. We looked at this quantum winter concept, and that's more about, you know, how different factors behave at the same time. Do you also keep an eye on sort of market structure at sort of a higher level? And the reason why I'm asking is because we've seen, especially in Australia, because of changes in regulation, because of mergers and peer awareness, that funds have been using more systematic strategies passive, but a lot of the time it's more passive and enhanced. So there's more money flowing in that side. Does that create distortions that sort of affect your process?   David Walsh  38:33 That's an open question, a good one, and an open question, the extent to which the growth of passive money, or very low risk, active risk, funds, ETF flow, retail flow, the impact that has on overall market structure and the pricing in of of ideas and what's driving them. That's definitely an issue that's been emerging, particularly in the last 45 or 10 years or so, and more recently, with the growth of index portfolios. The flow into index funds and the flow into benchmark hugging funds has a number of different effects. You'd imagine. One of them would be that conventional things, which we priced in, are now being priced in by fewer investors. Which case it should create an opportunity. There's less efficient markets. You'd think that's possible. One answer. The other reason these things never get priced in that no one buys them because you think it's a good idea, but people stop buying that because just go to the to the index, which case you're betting on the wrong horse. And that's possible, too. The emergence of these sort of things causes distortions, a lot of inflow, a lot of capital chasing fewer names. Market goes up and up on the back of these pricing issues that we see, this, this sort of flow issues we see, I can't see that changing, and it's definitely going to have an impact. It's just very cloudy as to what the impact might actually be. I think you can broadly read that the market becomes, as I said, less efficient. And there's an argument, also an interesting argument is. Well that it actually becomes potentially better for investors in an environment like this. And the reason for that is goes like this. If your index funds are growing, it means that the ability for stock to be borrowed is increasing. So if you're going to borrow stock and short it, you can now do more of it. So availability of shorting is higher, which means bad news should be priced in more easily. See the logic. So that would suggest that the short sale constraint and the ability to borrow is being reduced by the growth of index funds. Now, whether that's be true or not, I haven't seen any evidence on that, but you can kind of get the get the logic behind it. So it's too many things at play at once, on average. Definitely, it's been a change to the industry. It's not going to go away anytime soon. I would say that it's going to make everyone's investment processes more difficult, because less is being priced in by the things we used to get priced in by and more as being simply just buying at the close to meet a benchmark.   Wouter Klijn  40:51 Yeah, yeah, yeah. Fascinating. So if I might end up with a slightly tricky question, because we talked about the quantum Intuit. You don't like that term because it implies cyclicality, yep. So we get it, it's not cyclical. But we did recently a poll at our equity conference, and quite a few quants in there as well, and said, if it was to be divided in four seasons, if it's not winter, where are we at? And we got the majority that actually said, summer. Oh, right. Where do you sit?   David Walsh  41:21 Yeah, well, I think we've definitely come out of a period when quantitative investing was not front and centre with a lot of asset owners allocations for a variety of reasons. It could have been the performance from way back during the GFC. It could have been through some more volatile periods. It could have been quant winter that inverted commas quant winter period. But we certainly seen a lot of factors working at once, and a lot of emergence of quant businesses over the last few years that have really driven good performance have gained great reputation and have shone in the light of or perhaps in the lack of light from other managers who've struggled to perform. Deep failure, managers haven't done so well. Strong growth, managers haven't done so well. So that emergence, along with the idea that machine learning and data becoming more available, lends itself more towards popularity for quant investing. Are we in summer yet to use your analogy? No, I don't think so. I think we're in the upswing. I think there's still a lot of scepticism about the long term performance of quant factors have with quant models, have? We've certainly seen strong demand in our quant processes, consultants, clients have been very interested. I think what that means a lot of people is from one person different to another. You know what that quant process means? So some think of it as being very idiosyncratic factors that are all quite unique and different, and all driven by AI and black box and who knows? Others think of a simply risk Premier. And that variation probably won't resolve itself, but it also tends to lead to a lot of uncertainty, what, whether you're where you are, in that, in that, in that, in that seasonal period. Yeah, we're talking about, I think we're not there yet in terms of summer, but we're certainly growing towards it. Quant performance has been good. The risk controls are important. Technology is driving a lot of it. I can definitely see it being a, being a strong period for quaint investing for the next, certainly, next few years.   Wouter Klijn  43:17 Yeah. So spring, perhaps?   David Walsh  Let's say spring.   Wouter Klijn  Let's say spring. Well, David, thank you very much for coming to the office, and thanks for this conversation.   David Walsh  43:24 Oh no, that was fantastic. Thanks.    
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  129: From The Archives – Fiona Trafford-Walker 17.02.2026 47min

  In this episode, we go into our archive to October 2019, when we interviewed Fiona Trafford-Walker. Fiona was one of the key consultants behind the success of Frontier Advisors and spent 25 years with the asset consultant, advising many of the largest funds in Australia. She has been named several times among the most influential consultants in the world and was a driving force behind the fight for equitable fees in the industry. In this interview, we delved into the changing role of asset consultants, questioned whether too much time is spent on manager selection and examined the struggles of value-style strategies. Fiona has since retired, but is still active in the industry through various director roles, including for Victorian Funds Management Corporation, Perpetual and as a member of the IFM Real Estate investment committee. __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights __________ Overview of Episode Overview Fiona Trafford-Walker podcast: 2:30 I'm an accidental asset consultant 4:30 You're named as one of the most influential asset consultants in the industry. What makes a good asset consultant? 5:35 You have to be willing to collaborate 7:00 Technical skills are very important, but equally important is time in the markets 7:30 The changing role of asset consultants over the years 9:30 As asset consultants have increased their senior staff, have conversations become more focused on strategy? 10:30 There is still the need to have a blend of specialist and generalist skills 11:50 Are we already heading to having a panel of asset consultants? 13:00 Is there a good balance between the time spend on manager research and that on asset allocation? 14:30 What type of data should inform changes in asset allocation? 16:00 There is not much you can do about geopolitical risk; predicting what politicians are going to do next is pretty hard. 16:30 But trade wars are a real thing that have an effect on markets 18:00 Are the struggles of active managers, particularly value managers, structural or cyclical? 19:00 There seems to be a need to tweak the value process to allow for the new capital-light business models. But at what stage do you get style drift? 21:30 Frontier Advisors took the decision to build a platform with all their research on it, quite a brave step in an era where softcopies get distributed easily. 26:00 You spent some time arguing for lower fees in the industry. Are we at the right level? 27:30 The real change has been the internalisation of asset management by some funds. 29:00 Can internalisation refocus asset management on the long term? 30:00 Bottom draw mandates 31:00 To what extent should asset owners engage with the companies they invest in? You are on a number of boards and see both sides? 33:00 Governance certainly has changed as asset owners realise they are the beneficial owners 35:00 To what degree can you divest from companies as a fiduciary? 38:00 The challenge of developing retirement products 41:00 At the moment, the willingness to do things together [as funds] isn't there. 42:00 What is next in store for you? 44:00 What issues come up in mentoring new asset consultants? Full Transcript of Episode Wouter Klijn  01:12 I'm here today with Fiona Trafford-Walker, who is a director with Frontier Advisors. Fiona, welcome to the podcast. Fiona Trafford-Walker  Thank you. Walter, happy to be here. Wouter Klijn So 25 years of Frontier advices, has it gone quickly, or do you think it's a long time ago since you started out? Fiona Trafford-Walker  01:28 I think the answer today is both, when I think back that it's been 25 years, I feel like, wow, that's such a long time. It's about half my life. And if I think about it like that, it feels like it's a very long time. But also, I think it's gone very, very quickly when I think of what it was like to start the organisation with Ray King, obviously he was very integral to starting the asset consulting business inside industry fund services, which became frontier. And I remember very clearly the first day walking to the office in Carleton. There were two of us in this room working out of there. And then I think of how, you know, we grew over the years. Some terrific people came on board, and then all of a sudden, it's 25 years later. So in some ways, it feels like it's a long time. Otherwise, it feels like it's gone very, very fast. Wouter Klijn  02:13 Yeah, if I can take you back a little bit to the start of your career, I read this funny quote one time that you did an interview with The Sydney Morning Herald, where they asked you how you became an asset consultant, and you sort of made this comment where you said, yeah, it's not really something that you aspire to in university. It sort of happened. Can you tell us a bit about that? Fiona Trafford-Walker  02:33 Yes, that's definitely true. I'm a great accidental asset consultant, I think, for a few reasons. One, it's not something back, you know, 25 years ago that people really knew that much about it was a relatively new career. Back then, the asset owners were much smaller. The system was very different. And I was interested in financial markets research, and I grew up in North Queensland, where the career prospects for that sort of thing are obviously relatively narrow. So I knew I had to move, and I knew it would have to be Sydney or Melbourne, and so just applied for a number of different jobs. I remember going for my interview again with Ray King, because he has employed me twice now, and sitting in the office at Towers Perrin in Sydney. And you know, Ray was asking me all these questions, and I couldn't answer most of them, and I thought I'd completely mucked up the interview. And next thing you know, they're offering me a role. It was a research role, and it was in the investment consulting business in towers parent, but sitting alongside that function, and my job was to do specific research that might help the consultants provide advice to their clients. And there were two of us in what we called the Global Research Unit, which I used to think was kind of ironic, given there were two people in Melbourne in a global unit. And after six months, the person I reported to Ron Bird, decided that he would move into funds management. And so I think they looked at me and said, Oh, well, we'll just move you into the asset consulting business. So I moved in, and I was there at Towers Perrin for a couple of years, and I just really, really enjoyed that work. I think what resonated with me was the chance to do research and practical research that could then be used to influence client portfolios and then outcomes for members. And I think I just not made that connection well enough before in those first six months. So I moved into the asset consulting division, and then in the middle of 1994 when Ray left to start industry fund services, I moved over with him, and the rest, as they say, is history. Wouter Klijn  04:32 So you've been called one of the most influential asset consultants in business. What makes a good asset consultant? Fiona Trafford-Walker  04:40 I get asked that question a lot now, and I think, I think what happens as you get older, people ask you all these questions, and so I've had to actually think quite a lot about it, because it was not something I ever thought about a lot beforehand. For me, I just did what I thought was the right thing, and it sort of happened to work out. But as I look back, I think. There's a few key characteristics. One, I think, is you have to be able to listen to people, and not only listen, but you have to hear. So listen to what they say. Sometimes their words aren't exactly what they mean. So you have to be able to read the room and understand what a question really means, and then you have to answer it and be clear in your answer, depending on the audience, use the right kind of terminology. So for example, in a trustee meeting, where you might have a lot of people who don't have an investment background, speak in very plain English so that people can understand what you're recommending that they do equally. If you're speaking to a much more technical audience, for example, internal team, then you tailor the way you speak to answer the questions and have the discussions. So listening and hearing and communicating, fundamentally, I think, is really, really important. The next thing I think you need to be really good at is collaboration, because as an investment consultant, asset consultant, you're giving advice, and a client may or may not take that advice, so you have to be willing to work with them to get a good solution that works for them. And sometimes you might go in with the best of intentions, the best advice you can possibly develop, but a client might say that doesn't work for me for these reasons, and so you have to always collaborate and move and shift and evolve your advice to make sure that you can continue to influence the clients. I think also, there are some fundamental skills around you know, the technical skills you really need to have, and they have changed over the years. So, for example, when I first started, I think we still use lotus, 123, but I'm not actually sure, because we didn't use it very much. And then we graduated to excel, and when we were interviewing people, when, for example, about 15 or so years ago, we'd interview people, and we used to do these tests in Excel, and they would have to do a VLOOKUP and those sorts of things. Whereas the technical skills nowadays, not only in the use of various pieces of software, but also the financial technical skills, are much, much stronger, and we see the young people coming through. They've clearly exceptionally skilled. And for people like me who don't necessarily have all of those technical skills, it's about other experience and skills you can bring So, experience with clients, time in the markets, I think that makes quite a big difference. And I look back now over, you know, nearly 28 years of of being in the markets and seeing things, and I think having that perspective is also something that's quite valuable. So you Wouter Klijn  07:23 show that have there have been some changes within the essence consulted industry, and I think some of those shifts have been quite big. As the pension funds become larger and become more almost financial services companies. How does that affect the role? Fiona Trafford-Walker  07:42 It's had a very profound influence. And if I think back over the various phases, so the first phase, when I first started, you would be the expert in the room. You would take your papers, the clients would thank you. They would pretty much do everything you said, and you would go away again, and then you would come back to the next meeting. And as those businesses became more sophisticated, they employed their own people. The work shifted. So some stuff that we used to do, they then took on. And at first it was some of the more straightforward things, for example, processing applications and letters and those sorts of things. But increasingly, you've seen a lot of skill developing in those internal teams. And so the role of the consultant now is very much to work alongside those teams in what I think is a very complimentary manner. Because if you think about it, and the way that I think about this, and I know that I'm absolutely biassed in thinking this is that I think there's always value in an external perspective. But clearly I'm biassed because that's what I've done for 25 odd years. But I look and think if you want to really kick something around, you know, getting people who are working for you, inside your organisation also working for you, but from the outside, you're all still working for the same reason, the same purpose. So I think working alongside those internal teams has meant, though, that the level of skill, the level of experience, the specialisation, has really had to change in asset consulting businesses. So your business model has gone from one which was probably a more typical pyramid, where you've got a few senior people and many more junior people, to being like an inverted pyramid where we've got many, many more senior people now who all can have a counterpart type relationship with the other people in the funds. And sometimes I go to some of those meetings, and they are talking at a level that is really, really deep. These are highly specialised people, and that's one of the most profound changes. I think. Wouter Klijn  09:35 So does that focus in the discussion then also shift to a more strategic type of discussion where you talk more at a high level about decision making, rather than the implementation. Fiona Trafford-Walker  09:45 Yeah, it varies. So some of those discussions, if it's specialist to specialist, they go so deep that I can't follow them, particularly on some of the newer areas, and that works for them. And that might be about a technical. Matter. It could be about implementation operations. It could also be strategic, if you sit alongside that. Though, when I think about strategy for the funds, I think that there are a group of people who can step back from that specialisation and bring what I call a truly generalist perspective. And it used to be, everybody was a generalist, and then everyone said, Oh, you've got to be a specialist to be successful, whereas now I think you can be successful and be either, or, some lucky people are actually both. That's pretty unusual, though. So people who can sit at the really the CIO type level, to sit back from the portfolio, to think about how the whole thing fits together, that's where a lot of the strategic discussions still occur. And those skills are not as common in the industry as they were perhaps, perhaps 10 years ago, as people have changed and people have left, but there's still that need, I think, to have the blend of of the generalist and the specialist, so you can have all kinds of conversations about how you make money for your investors, how you protect their returns, or, you know, whatever your goals are. Wouter Klijn  11:01 Yeah. Now a number of years, I did an interview with Damian Maloney, who was then the CEO of Frontier Advisors, and he sketched a vision where, or a vision a future where he thought assets consultants will no longer have this exclusive role with one particular fund, it's more likely that it becomes like law firms, where there's a panel of different asset consultants and they specialise in different things. How far along are we in that? Do you think Fiona Trafford-Walker  11:28 We haven't got in our client base many of those kinds of relationships we tend to rather than working in a panel? And it might be because there aren't that many consultants you can actually put into a panel, we tend to work with the internal teams who might then go and get specialist advice from someone for a particular reason. So for example, if they're doing an infrastructure deal, they might go and work with a traffic consultant or an airport consultant, something like that. But the concept of a panel where you have panellists who might be doing similar things. We haven't quite gotten to that, but I think broadly, there is a sense of a panel where the internal teams that are very active internally and, you know, and that's not the majority. At the moment, there's still lots of funds that are, you know, run very, very leanly with a lot of outsourcing, but those internal teams, I think, are increasingly surrounding themselves with expertise as they need it. And then, of course, the trustee surrounds itself with expertise as it needs it. So we have relationships with internal teams and also with boards and investment committees. So you're seeing a little bit of the panel approach in that sense, but not where you kind of line up and you go and get one report from one another report from another. It seems to be much more targeted. Wouter Klijn  12:41 Sometimes, asset consultants are seen as gatekeepers, probably especially by the fund managers want to get on the approved list. When you look at the dimension of the time spent on manager selection and, for instance, asset allocation, keeping in mind sort of the research that's done on the impact of asset allocation. Do you think there's a right balance there, and to what degree, if you do focus a lot on asset allocation, can you be dynamic in that? Fiona Trafford-Walker  13:10 Yeah, look, I've never thought that there was the right balance we you know, one of the very first papers that I did was really to try to replicate some work done in the States, about, you know, where do returns come from, and particularly where does the volatility of returns come from? And there was some early work done which showed that particularly the volatility of returns came from the asset allocation, and within that thinking about your strategic allocation, because that was the nature of that paper back then. This is what this is, 25 years ago that has evolved to being around strategic and dynamic asset allocations. That said, the role of active money management in that can still be really value additive. You know, it can be the cream in the coffee, so to speak. And so anything that helps you get you where you need to go is worth looking at. So for me, it's about the balance of time. And I think that over the years, you know, we would always have been better to have spent more time on asset allocation, like, what's going on the world? How do you position your portfolios? And for some reason, it was just never really seen by the industry as something where you should spend a lot of consulting dollars or internal dollars. I think that's changed now with some of the numbers are coming out, and you can see the difference in performance. That said, my personal perspective is there should always be room in your portfolio for good money managers who can make money over time for their clients. And I think that the time on manager research to find those firms is well spent, but probably we, collectively as an industry, spend too much time trying to find out who those firms are when. If we could deploy some of those resources into working out what's going on in the world and how to set your asset allocation, and I think dynamic is a really, really important dimension, then that probably would be better over time. Wouter Klijn  14:57 So what should inspire some of these. Changes on the dynamic asset allocation. And I think particularly about we did a poll recently amongst investors and asked them what the top risks are from whether you're going to make your return or your liabilities. And the number one concern was geopolitics. And I can sort of understand from there could be a tail risk potential event. But then, when we asked if anybody made any changes based on geopolitical events, there were very few that actually did. How do you incorporate it and what should inspire changes in an asset allocation? Fiona Trafford-Walker  15:35 Geopolitical risk, I think is really hard. I mean, I feel quite lucky. I work with some terrific people, and particularly the director of investment strategy, Chris Trevilian. He runs our Capital Markets team, and they think a lot about some of these tail risks, not only some of the structural changes in markets and in economies and in the world. So for example, things like demographics and climate change and others. Then you do have things like geopolitical risk. You've got quantitative easing and these sort of weird things that create enormous amounts of noise, and they do change the way that market and market participants respond to things. So we look at geopolitical risk and we think, well, we can't do much to manage that like it exists. We have to think about, how do you defend against it? Diversification is a good way of defending against it. But if you're trying to predict what politicians are going to do next, it's pretty hard. But then sometimes those risks creep into what I've loosely called real things, like the trade wars, for example, now that that is a real thing having a real impact on markets and on economies and on exchange rates and and and on people who are fundamentally affected by what happens in, you know, their own businesses. You know, small businesses in rural USA, for example, and businesses in China, and increasingly, businesses here. So we try to put the things we can understand but not control into one area so the least we know what's going on, and then we try to work out how might that squeeze out and affect the advice we give clients. And geopolitical risk has featured in a lot of the quarterly market outlooks that we do, but we try not to set portfolios based on things like that. But you have to have an eye on it these days. It's a brave new world, I think. Wouter Klijn Yeah, that said there's an argument that, you know, fundamentals should come to the fore at some point, like at some point, but it's been a bit of a long time now. Fiona Trafford-Walker  So, you know, the rubber bands getting longer and longer, but we are in very unusual circumstances, and I've spoken a lot with investors about the absence of value working in the markets for at least the last 10 years, and there's a number of changes within the market that could make the argument that this is a more structural development. One is, of course, the capital life model of technology companies. There seems to be also more stricter regulations on how much management of a company can tell a fund manager without having to disclose it to the rest of the world. So there seems to be a number of elements that are not really in favour of active management. Wouter Klijn Are you concerned that this is a structural issue, or do you think this is mainly still a tale from QE and cheap money. Fiona Trafford-Walker  18:21 I think it's probably the latter for the most part. But I do think that, you know, there are some structural changes going through markets, and I think technology is one of them, and understanding the impact that that will have on, for example, people who work in organisations and the work that they do, and how that might be displaced and what happens with them. So I do think there are some fundamental changes coming through, really, on the more of the social side, and that will change the way that companies operate, the way companies think, and also, I think the what asset owners and shareholders think and expect. So we did quite a big paper a couple of months ago just looking at active management, because the last 12 months was really, really terrible, and I think the worst year in the last 20 so it's really easy to look at that and go, Well, it's broken. But I think again, if you look through the fundamentals and think good active managers, if they're doing good research by good companies at decent prices, then the value style over time, to me, still is something that has a lot of merit, but, you know, maybe there's an openness to something like, you know, a new value style that does allow for some of these structural changes. And I think that technology, and, you know, machine learning, robotics, AI, those sorts of things are complicated, and they will change business models. And I think being open to that is probably the best defence. Wouter Klijn  19:43 So there might be some changes within the investment process, within value. To what degree can you adjust that process? And at what point do you say, wait a minute, you got style drift going on here? Fiona Trafford-Walker  19:57 Yes, the old style drift used to be something that fund managers were hung, drawn and quartered for. I don't hear people talk about style drift that much anymore, to be honest with you. I mean, maybe someone like Fraser Murray, who runs our equity research might hear that more than me, but certainly when I used to do manager research, that was something we were very vigilant to look out for, mainly because when you're putting together portfolios for clients, you have managers playing certain roles. And so if one manager you think is going to do something, but they creep to do something else, it does cause you problems with your overall portfolio, because you end up with too much of something you might not have wanted. That said, I think that it's always healthy for any firm, not only a money manager, but even our consultant as well, to say, well, is the way we do things still sensible? And so if you are going to have any kind of drift in your business, and we are drifting now, maybe called pivoting, I don't know, which is a very cool thing to do, you talk about it and go and engage with your customers and clients and say, look, we've been doing things this way for such a long time, but we think the world has changed, and we're going to evolve to do something different. And I look at the business model at Frontier, for example, and the work that was done, you know, when Damian was a CEO, which is going back to 2011 around technology, we were always way behind on technology. And He came in and sort of had a look again, the value of an external perspective coming in and saying, we need to really wrap that up. And would have been easy for us to say, well, we're a consulting firm. You know, technology is not our thing, but in fact, that's been incredibly empowering for us. But you've got to take your staff and your clients on that journey so it becomes something you can do together. And I think it's the same philosophy about money management and styles. Wouter Klijn  21:45 Yeah, the technology platform, in a way, was quite a brave step, because I remember that when it was introduced into the market, and the idea that clients could log in and see research there, that they thought, well, if they see it on that system, then it's very easy to print it out and it gets all spread around and lose IP and but I think at the moment, it's actually turned out to work quite well. What do you think made it work? Fiona Trafford-Walker  22:13 Oh, look, you're absolutely right. When we first talked about doing it. And, you know, back back then, the way that we used to think about consulting, and I think all the other firms would have been the same, is that you that you, you had your processes and people and everything, you developed your IP, and you protected that very zealously, and that's what you sold. You sold time, and you sold IP, and that's all you had to sell. So when Damian came in and said, you know, we should actually put this on its head, we were like, wow, we're going to be kind of giving IP away. Is that? How's that going to work? I think the philosophy that we had was that if we shared it, we would back ourselves to continually develop fresh IP and fresh ideas, and that people, in seeing how open and transparent we were, would say, well, these are good people. They do good work. I want to work with those people. So the sharing of IP was something that was that Damian drove back then in a very different way to the way that we used to collaborate and share the IP. It was one of the hardest transformations in the business, though, for a few reasons. One is we did actually have a database, which we affectionately called the prober, because we would be out there probing managers for for information about their processes. And the prober was just a an Access database. It was a very internal database. It was full of typos, grammatical area errors, inappropriate things that should never have been written. Thank you. Mike fish, and so we we decided we needed to go back at least three years to build something that people could see what they were going to buy. So we printed off all the notes for the last three years, and a number of us then went through and actually edited every note. It nearly killed us. It was just it was very difficult, but we ended up with something that has, I think, become, if I do say so myself, I think it's become the standard in the market for you know how you communicate with clients, how open you are, how how you can prove the value that you add. And I think that then led to being not only an internal system, but an external system on manager research, but now increasingly on capital markets research. So all the asset allocation we do is all done through the system, and that system is being enhanced all the time. So it was a very big transformation, and it was not easy, and it really took probably about five years from when we started to getting to the end and saying, I think this actually works pretty well now, but it was a very significant change and and it's been very, very positive, yeah, and it's enabled us to get efficiencies which we would never have been able to get before. So the concept of productivity actually is now quite a valuable one inside, inside frontier, whereas before, we just could never work out how to be much more productive, other than getting other people to do the work. Now we have this major tools. Wouter Klijn  25:01 It's very important. So in a way, it motivates people to constantly look for new ideas and new research and produce that Fiona Trafford-Walker  25:09 Yes, yes. And if I think back to one of your early questions about what makes a good consultant less so individually, but as a as a firm, you know you have to think of new ideas for your clients, and you don't need new ideas all day every day. You really need a couple of really great ones each year, maybe even one a year. I'm not even sure the number, but if you know you have a process that develops IP good ideas for clients, then the clients will look at you and say, Yes, I want to deal with those people because they're smart. They'll help me do my job better. So I think that that has enabled us to think in different dimensions about development of IP and ideas. Wouter Klijn  25:47 You've also been quite active in the whole debate around fees and been driving funds to look at those arrangements. Can you tell us a little bit about how you think where we ended up is the right space? Because partly, there has also been a large unexpected impact from regulations with the introduction of my super. Fiona Trafford-Walker  26:06 Well, not only my super but things like RG 97 and other things. So if I think back and it's 10 years since I wrote that first paper, and 10 years since Ken marshman, who was my counterpart at Jana at the time, and I sat down and had discussions about this as an industry issue, and the perspective we always took that did get a little bit lost at times, was it was always about net returns. It was just, what did you pay to get those returns? And was there a fair and transparent sharing of the, you know, the economics? So we developed six principles, which were very much around fairness, transparency, the right to commercially negotiate, all those sorts of things. And I think, though, as I look back, and I'm actually very close to finishing a paper that sort of updates on where we are 10 years on, I think on some measures, it's been very successful. It's made people think about just how much they pay for what they get, and is it worth it, and some things are worth paying for. You know, there are some terrific firms out there that do great work. It's research intensive. They deliver for their clients, and yes, you should definitely pay for that. But there are others where you sort of think, well, does that really a good sharing? And I think it's enabled a lot more discerning, I think, between firms that are worth paying for and those that possibly need to just sharpen their Proposition A little bit more or think about the products that they offer. So I think that's helped the biggest shift, though, I think that has caused real change in the funds management community is the internalisation by the asset owners, and that had sort of been flagged by a few some, in fact, some did manage money internally back then, but it wasn't a very public thing, and it's been increasingly flagged by some of these very large asset owners. And I think that as that became a lot more prevalent, I think the funds managed community look, looked and thought, well, the money is going to flow from us to them, and that's exactly what you've seen. And so that, I think, has made people sort of sharpen their thinking about, not only about their products, but about, you know, the economics, the prices they offer. But it's pretty hard to compete, in some cases, because the internal model is a relatively cheap model. I think what I would like to see in the next five years is full transparency from the asset owners who do manage money internally, just to be clear, that they're the same standard is being applied around the search for excellence. You know, by whether you're in an inside an asset owner business or you're outside, in many ways, what you're really doing is transferring risk from outside to inside. So you just want to be clear that that turned out to be a good thing. Wouter Klijn  28:44 Do you think that there are any concerns over whether the standard might slip? You could also, because that's a discussion that's often had where you say, well, it's very hard to fire the internal team because your colleagues work with them and they have influence. But you could also think about it. Well, the industry has for a long time been focused on very short term results, and maybe this will enable to put some strategies in place that are much longer term, that look more at buy and hold type of strategies, and potentially drive also some change there. Fiona Trafford-Walker  29:18 Yeah. Look, I really hope so. I think that you know the certainly institutional investors like super funds and other long term investors, that the one major advantage they have is time. And if you have time on your side, then that's an incredible opportunity you can exploit. And a big way to exploit time is to be a truly long term investor and to ride the cycles of business out. If you've got a company going through a tough time, understand it, but don't bail because your tracking error has gone up, or you've got a report to provide to a trustee, or something like that. And so in many ways, it's not completely fair, because, you know, that's not necessarily the way that an external money manager gets treated somewhere. I think it depends on how well they sell their story, but for the most part, the focus on the shorter term numbers, I think, has not been a positive thing here. I do think with internal money management, that it's a great opportunity to enable true long term investment to occur. And I used to call them bottom drawer mandates. And my idea, like in the mid 2000s was you would just go and buy chunks of businesses and literally stick them in the bottom drawer, good quality businesses just doing their job, performing well, clearly, if there's some kind of event, yes, you need to get it out of your bottom drawer and have a look at it. But otherwise, it seemed to me that the ability to provide capital for such long periods would be very positive, not only for capital markets, but for the community, society. For business, this flow on effects are quite significant. If businesses know they can truly invest for the long term, then it's just a win win for everybody. So hopefully we'll see that. I think increasingly we are seeing in the processes being developed by the asset owners, that definitely is something they're capturing. So that's really positive. Wouter Klijn  31:04 So with the internal teams investing, they're closer to the market as well. And one of the things that is interesting, I think, there, is that they become much more aware of their responsibility as an owner of these assets, and engage more with the companies. To what degree do you think that that's desirable? Should they engage and try to get better outcomes in as far as they can? Or should I just leave companies to do that? Fiona Trafford-Walker  31:32 Well, for me, it's about responsible ownership, and I think, I mean, I see these things from two perspectives now, because I'm actually on two company boards, and I'm also on the board of another investment organisation, and so I see a perspective I didn't have before, which has been really, really valuable. I think companies need to be allowed to just get on with the running of their businesses, just in the same way. Our Super Fund is a company, and should be allowed to do the same thing, but at the same time, they need to be accountable for what they do. Need to be transparent and to move with the times. So, for example, the shareholders are saying, What are you doing on climate change? Well, answer that question. Be clear about it. Commit to being responsive if if they have questions about, How do you treat your workforce? Well, answer those questions. And I think there's a bridge to be made between the asset owners and corporate Australia. I think it's they still have to work at how to kind of operate with each other. That said, I don't think that you want the shareholders kind of sticking their noses in too much, and vice versa. We have to learn to coexist. I think, Wouter Klijn  32:47 Yeah, I think it's interesting, because in the recent years, we have seen more emphasis on governance, and sometimes it can be a bit vague in what exactly people mean by that, but at the same time, there's some real consequences to ignoring that part. So this morning, we just had news come out that some of the pharma companies are now being held accountable for the opioids in the US, and I think Johnson and Johnson has to pay more than 500 million and but there's another company, and that has apparently offered a 12 billion settlement to settle all of the cases that are against it, that's that's obviously having a real life impact on these companies. How do you look how that has developed over the course of your career? Is that really true, that there is more emphasis on it, and is there a clear way of doing this? Fiona Trafford-Walker  33:40 Yeah, oh, there's definitely more emphasis on it. I think, I think, like when I first started, the fund managers couldn't, you know, had the relationships with companies, and they decided how they would vote and and that was something that was highly delegated. But as the the asset owners got bigger and bigger, and they realised, well, we're the beneficial owners of these shares, we ought to decide some of these things or be part of that conversation. So they started voting their proxies, but that typically was around things like remuneration, or a director standing, or something like that. Then the next wave, though, has been, I think as responsible investment has become, really quite a powerful movement, I think, for one of a better word, where they're saying, hang on a minute. There's a lot more going on in companies, and we own large chunks of them. And you know, for example, many have signed up to the United Nations Sustainable Development Goals, the United Nations sponsored principles, responsible investment. And that means you have to do something. You have to ask questions, put your money where your mouth is, literally. So we are seeing significant change, I think now, particularly by the big asset owners, to think about where they put their capital, what businesses are they supporting? We have a number of clients who think a lot about the just transition in a climate change context, because. Because clearly many of them have members and employers who might be affected by that so thinking, Well, how do they participate in that process? So might not be something that happens quickly, but something over time, and how can they help them make that transition as effectively as possible? So that is much more powerful today, and I think that's entirely appropriate when you are the trustee of multiple billions of dollars of other people's money, you have to think about, you know, how you how you invest it, where you put it, what you expect companies to do with it, Wouter Klijn  35:32 Yeah, in the local context, we've seen a lot of emphasis being on cutting out tobacco companies from portfolios. And it seems that the next discussion is focusing more on a low carbon environment or portfolio. To what degree do you think that these types of actions align with the fiduciary responsibility as well? Because yes, there's obviously great risks attached to it, but there's also a point where you say, Okay, you can't just keep cutting out chunks of portfolio. How do you deal with that? Fiona Trafford-Walker  36:05 I find that one really tricky. So I, I would always rather engage to help improve something. But there are some businesses. So for example, tobacco is one is they're always going to make cigarettes or vaping or whatever, and other things called so they're not going to fundamentally change their business model. You have to decide, do you want that in your portfolio or not? And some of those things, for me, anyway, get into kind of an ethical debate about whether that's good or bad. Some of it, though, is more tangible. So for example, you know you can point to, you know, things like lawsuits and, you know, future lawsuits. And so it can become quite a real thing. So it goes from being ethical to being actually something much more financial. Tobacco, I think, is in that category. But most, most businesses, it's not that straightforward. It's so for example, AGL is one I think, that got a bit of press a couple of years ago, where the easiest solution would be to say, well, we don't like what you're doing with coal, so we're just going to divest. Whereas a better solution was, which actually, I think, is what occurred, is to say, how are you going to transition? And they committed to a transition plan. And so, you know, you've made an impact there by saying, all right, you know, how do we help this company transition over some reasonable period so that we get where we want to go, and we've influenced the business. To me, that's a good use of that, of that power, and that, you know, the votes. But I think it's from a governance point of view. It used to be, it had to be, you know, members best interest, and a very fiduciary duty. And I think that has morphed a lot. So the concept of fiduciary duty, I think the lawyers would say it's still the same, but there's now community expectations, and there's a bigger overlay on that now that I think has made some of those decisions a bit easier than they might have been, but I'd always rather engage if you can, some companies don't want to engage, or if they do, they decide they just don't want to listen, in, which case you just invest somewhere else. There's plenty of companies, companies companies to invest in. Wouter Klijn  38:03 Another problem, or more of a challenge that industry is facing today is the development of retirement products. Now, apart from sort of the product issue that there is investment challenges as well to it, why do you think it has been so hard to come to a solution to this? I mean, people have been retiring, right? Fiona Trafford-Walker  38:22 Yes, yes. I think what I put it down to is we all got so excited building what I think is fundamentally a really, really terrific accumulation system. I mean, I think it's easy to beat ourselves up, and you could always do things better. That's definitely true. But fundamentally, the system we have here is really, really good. It's sort of one of the top three or four in the world, as assessed independently, many, many more people today retire with much more money and therefore dignity in retirement than they would otherwise have had. The coverage is much better in terms of the workforce and in terms of women. So I think we kind of got a bit excited building that that we sort of thought, well, we could just take those concepts and apply them in retirement. So, you know, the easy solution was, well, the money was small, so we'll just do a different tax assumption, and we'll put some products that work. And I think we always knew, or the industry always knew, that that was just a bit of a band aid solution. And though, as people think about it, I think the real challenge, though, is in retirement, you need to have much more fun consideration of your individual financial circumstances. In accumulation, you don't necessarily need that. You need to know a small number of things about someone. They choose the right option, they build their pool. But in retirement, you need to know, for example, any other money? Do they own their home or not? Are they in a relationship or not? All those sorts of things. And most people don't go and get financial advice. And so how do you help them in retirement? Build something that I think is the industry calls sort of mass customization. I think that's really hard. That said there. A lot of really smart minds working on this. Now, the money in the funds in retirement phase is growing rapidly, so the Critical Mass is is being developed. And so I think it will not be too long before we see some really, really good products coming out. But yes, I think you're right. It's definitely underdone. Wouter Klijn  40:19 It's an interesting sort of issue, because we had the my super legislation come in, and so there's now this sort of legal definition of what a default option should look like. And I think sort of that concept was taken then, oh, let's do that for retirement. But you can't necessarily do that because of the vastly different circumstances that people are in. Do you think that one solution should be more that it's based on a concept or a platform that has then multiple different solutions hanging under it, or is it possible to have a my pension default? Fiona Trafford-Walker  40:53 Well, look, I think also all those things are possible. I do think that to build some kind of platform, you do need quite a lot of collaboration to get critical mass across some of the funds, to make sure you can do things like pooling for longevity and all those sorts of things. And I think at the moment, the willingness to work collectively and to pull money doesn't necessarily seem to be there. I think the lot of the funds are trying to really do their own thing. So I think there's an opportunity to do something along those lines. I think possibly it's technically a lot more complicated than then it might first appear You're right. You should be able to have, well, we have my Super Why can't we have my pension? And I think it's probably quite technically difficult compared to an accumulation phase. Then again, as I said, so many smart people in the industry are trying to work out how to continue to look after members. I think we've looked after members really well until the point that they retire, and it's that next phase when, arguably, they actually need You more. You know, I think, because that's a can be a tricky time for a lot of people. And as they retire, then, as they age, thinking about, how do they get health care advice? How do they get aged care advice? It's this, we don't necessarily look after people at that point very well at all. I think so. Wouter Klijn  42:10 Fiona, what's next in store for you? I think you recently have relinquished the role of director of consulting and taken on a few board positions as well. What can we see from you in the future? Fiona Trafford-Walker  42:25 Yes, you're right. I am. My role has changed. And so I handed all of the consulting responsibilities and practice responsibilities over to Kim by water in 2017 and as I mentioned earlier, Chris took on investment strategy and and other people took on other things. And so I've been really excited to see how well they've done and how, you know, they've made their own mark, and they've thought about what the company should look like and what those roles should look like, and I think they've all done a terrific job. And so my role has moved to be more strategic. And when I can't do it on this, on this, because I'm not on a video, but whenever I say strategic, I do the bunny ears, because no one exactly knows what strategic means, but it's turned out to be things like working with clients on governance issues or investment issues or behavioural finance issues. It's helping them think about what their internal team should look like, what their delegation model should look like. I don't do a lot of can. I don't do much Consulting at all anymore. On the client front, I mentor some of the staff inside frontier, which has been great. You know, they're a fabulous bunch of people. And I'm on the investment committee, so I think more of that kind of thing is, is really interesting, and I really enjoying that corporate work as well. So that sort of you know that balance would be good, but I'm one thing I have learned over the last 25 years, it just doesn't pay to plan too much. And people often say to me, or did you? Did you plan this? And I'm like, No, I didn't plan any of it. But as opportunities come to you, be open to them. And as I say to people, you just got to be yourself and back yourself and have a go and you know, so I'm open minded to things, and I'll just see what happens. Wouter Klijn  44:07 So you mentioned the mentoring element. Are there any specific things that you see in this new cohort of asset consultants that stand out? Fiona Trafford-Walker  44:18 The biggest thing that I talk to the people that I mentor about is it's their own confidence. And I'm not sure if this is necessarily the people that come into the asset consulting business or whether it's just the people that you know that we attract at Frontier or not, but a lot of the younger people, I look at their CVs and their skills, and they're so, so incredibly capable, but they're also just a little bit uncertain a lot of the time. So I spend a lot of the time talking to them about how to get their capability and their confidence in line with each other. And a lot of that is just helping them think about, you know, as you do things, think, okay, yeah, I did that, and I might not have been able to do that. I. Month ago, and now it's all fine, and you sort of build this on this bedrock of capability and confidence. So that is something that I work with them on. I think that technical skills are exceptionally strong, and I think the key though will be to take those technical skills and turn them into consulting skills, because consulting is a funny thing. It's, you know, it takes time. Some people are naturally good at it. Some people it's not their thing. And in firms like frontier, now there's lots of opportunity to do lots of different things, so you can focus on consulting and research and other things. But it's you turning that capability, the technical capability, into something that you can go to a client and the client goes, Yeah, I want to hear what you have to say, because you're really smart and you've really thought about this, from my point of view. But I think they are very purpose driven. I know that that's a stereotype of, you know, the Generation Z and the millennials, but they are very purpose driven. That's it. I think a lot of people at Frontier repurpose driven as well, so we sort of blend together well, I think. But they get terrific bunch of people, and it's, it's, I really enjoy working with them, and I really enjoy learning from them as well. Because sometimes, as a mentor, it's easy to sit there and, you know, tell people I did this and I did that, but that's not that helpful. I like to hear what what they're doing, what they're worried about, what are they thinking? What's their experience, actually? And, you know, it's big difference. Sometimes the age difference is 25 years. So their world is very different to my world. Yeah. Wouter Klijn  46:35 So next generation is ready to take on the challenges. Fiona Trafford-Walker  46:39 Absolutely, I think they are ready, they're capable, they're willing, and I think, you know, they're excited by the opportunity, but the firm in the next 25 years will look very, very different. I think, you know, changing, evolving, continually evolving, is really, really important, and that flexibility and resilience will be important skills. And I see lots of evidence of that, Wouter Klijn  47:01 Well, Fiona, it was great having you on the show. Fiona Trafford-Walker 47:04 My pleasure. Thank you.  
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  128: MLC Asset Management's Dan Farmer – Active Management, Private Equity, AI and the Early Days at Telstra Super 02.02.2026 47min

  In this episode, I'm speaking with Dan farmer, who is the Chief Investment Officer of MLC Asset Management. We talk about Dan's early days managing an internal Australian equity portfolio and getting involved with derivatives at Telstra Super, almost straight out of university. We talk about some of his mentors, including Steve Merlicek, and the influence they've had on Dan's investment philosophy. We also touch on the merger between IOOF and MLC and the new capabilities this has brought to his team. __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights  __________ Overview of Podcast with Dan Farmer, CIO of MLC Asset Management 02:00 Getting a job at Telstra Super, while still at university. "Imagine a graduate helping out dealing in a small Aussie equity portfolio, probably one of the first internally managed [portfolios] going around" 06:30 How did those first company meetings go, when you were still a 20-something year old? "I thought I was being taken seriously at the time, but in retrospect I probably wasn't" 08:00 The investment philosophy I build up over the years is being active in all areas, whether it is active in asset allocation, using active managers or being active in currencies 12:00 Dealing with market concentration in the US and the Magnificent Seven, while being cognisant of the Your Future, Your Super regulations 17:00 Looking at Private Equity, you really need to take a longer term perspective. Under YFYS, private equity is benchmarked against listed global equities, that has been a particularly hard benchmark to beat over the last few years 25:00 Steve Merlicek told me that if you have high conviction in a position, make sure you follow through on it 29:00 It is pretty hard for a CIO today to be purely an investor; you have to manage your team and there is also the regulatory aspects to it 33:00 Too stringent an implementation of TPA can create its own problems 36:00 We are doing some work around looking whether AI changes active management, where active becomes data scraping with some AI tools applied to it. We haven't reached a conclusion yet 43:00 MLC is the fund with the highest number of retirees. What special insight does this give you? Full Transcript of Episode 128 Wouter Klijn Dan, welcome to the show. Dan Farmer 01:51 Thanks for having me. Pleased to be here. Wouter Klijn 01:53 So tell me a little bit about how you got started in investing. I had a look, of course, at your CV, and you spent 17 years with Telstra before going over to IOOF. Tell me a little bit about how you got started and what some of your key moments were at your time with Telstra. Dan Farmer 02:12 Yeah, look how I got started. So I was doing my masters of finance at Melbourne Uni, so I was in my fifth year of study, and thought I better grow up and get a job and actually start earning some money. So I started looking around, and I got a tip off from one of my college supervisors about a role going at Telstra super, which, at the time the CIO was a guy called John Simkiss. So went over there, got a job at Telstra super, and it was fantastic, great, great time to enter the industry. The Super industry in Australia was really in its infancy. Imagine a graduate out of uni, and I was straight helping out, dealing on a small Aussie equity portfolio that the group was running, probably one of the first internal managements going around in the Aussie super industry. So great learning curve. You know, really cut my teeth on that, that Aussie equity portfolio. So it taught me a fair bit of humility. It's not easy running a direct Aussie share portfolio, so I think that set me in a good stead about how the industry actually operates. Wouter Klijn 03:12 So you said it taught you some humility. What do you mean? What are , Dan Farmer 03:17 It is tough to outperform the market. If you're sitting on the outside, it's very easy to throw rocks and say, well, you should be outperforming in this market and be quite critical of managers. But I think it gave me an insight on the nuances of running a portfolio. It gave me a good insight into risk and look, I think I was very lucky starting off with that role. Also part of that portfolio was using option strategies around individual stocks to provide some protection. So that also gave me probably my first taste of asymmetric risk and using options to control risk. Wouter Klijn 03:54 So thrown straight away into the deep with options and derivatives and Dan Farmer 03:58 Yeah, it wouldn't happen today. Wouldn't happen today. This is back in the early 90s, but had a really good, really good boss in John Simkiss, who used to be Head of Research at UBS Australia. So it was great start. And look milestones at Telstra Super, as I said, the industry was in its infancy, so I think when I got there, the portfolio was two balanced managers. That was it. You know, might have been BT and Schroders. So really went through the whole evolution of moving from balanced managers to specialist Australian equity managers, specialist global managers, specialist fixed interest managers. So, you know, that whole exercise, you know, working with consultants, it was a great time to be entering the industry. And then Telstra Super also went from purely a defined benefit fund to an accumulation scheme. You know, as Telstra was reshaping its workforce, you could just see members leaving the DB fund, and we set up an accumulation Fund, which was a little bit novel at the time for a corporate super fund, but was very successful. And that's obviously, you know, huge part of the Telstra super fund as it is today. Wouter Klijn 05:02 And I think your main role was looking after equities. Why equities? Why did you start there? Dan Farmer 05:07 To be perfectly frank, that was the job offer. That was my toe into the door. And look, I did love the space. And it was Australian equities, which was very relatable. I think it's a great spot for new people to enter the industry, because you can relate to the businesses. It's tangible. The management of those companies are very proximate. So, you know, I was a young, early 20s guy meeting CEOs of, you know, big Australian businesses. It was a fantastic learning curve. And I think I learned a lot more in the direct Aussie shares to start with, and then really put me in good stead with the managers. And it was a terrific spot. I mean, active management was certainly dominant back then. And there was some great, you know, Great Aussie equity managers going around. I think one of the first appointments I made was Perpetual when it was just coming out of the trusteeship. So did that search with JANA and, you know, really had good access to those managers?. Wouter Klijn 06:06 Yeah, so how did those first company meetings go? I mean, did you, did you feel that you were taken seriously, or did you have to build up? You know, some slick... Dan Farmer 06:15 I felt like I was being taken seriously at the time, but in retrospect, I probably wasn't. That's, that's all right. So no, look, those, those meetings were great. And really, I think the industry back then was, it was probably a bit smaller. There was a bit of an acceptance of new people coming into the industry. So I'm sure I asked a lot of pretty naive questions at the time. But, you know, good, good, good respect. But it was, it was interesting because we also, when we're running direct portfolios, going into a lot of smaller companies as well, and they're very hungry for capital. So it was a really good dialogue with a lot of those, a lot of those CEOs and management teams. Wouter Klijn 06:56 Yeah. So do you feel that gives you a different perspective on you know, now, as a CIO of a large company to had that experience of like boots on the ground and and talking to management themselves. Dan Farmer 07:07 I think it does like at the end of the day when we're investing. Obviously, as you climb the ranks of an investment team, you probably become less and less proximate to the actual investments. So a reminder, at the end of the day, when we're investing in an index, you know, whatever global equity index that is, ultimately, that's a series of underlying management teams under a series of underlying business strategies. And hence, one of the , I guess, philosophical beliefs that I've built over the year and we run in the team, is a belief in active investment management in all its forms. Be it being active with asset allocation, using active managers where it makes sense in that particular asset class, you know, being active with currency, active with style selection. So I think that grounding in direct shares, and the fact that it is a very differentiated asset base, and there's a lot of idiosyncratic risk in there, really filtered up, you know, throughout my career, and just how we think about managing money today. Wouter Klijn 08:08 Yeah, do you see a change in the role of active management today as back when you started? Because we obviously seen a lot of changes in markets, in the Super system, new regulations coming in with Your Future, Your Super What is your current view on active management? Dan Farmer 08:27 Yeah, look, still see a role, very much a role for active I mean, the industry has changed, and it's, it's a big topic, particularly at the moment where there's obviously, at the moment, high concentration in in equity markets, and the concentration is correlating with some high valuations, so it is putting some challenges on on active managers at the moment. Now, I've been around long enough to see a few cycles of different forms of this, and I remember the 2000s, where, you know, we had a similar concentration wasn't quite as high, but, you know, very similar in the sense of valuations high. Think a little bit different this time around in terms of what's driving it. You know, we are seeing earnings in some of those, you know, tech stocks, which is driving a lot of the concentration and valuation stretch. So it's a bit different. But ultimately, when we look at our active managers, you know, stripping out the concentration effect, we still generally see them as adding value against their benchmarks. So we actually are spending a bit of time thinking about what's the right mix of systematic, more risk control, lower tracking-error managers, your traditional fundamental bottom up managers, active managers, getting that mix right. And going back to probably you know, some of my heritage in options and active management, what is the, let's call it the, ultimate asset owners risk, or us as investment manager, in controlling the risk that those active managers have when you put them together in aggregate? So we have a number of active managers in each equity asset class. You know, start, you know, we're doing some work around controlling the risk where you do have concentrated markets to just cap some of those potential outcomes you can get in these conditions. Wouter Klijn 10:08 You had an interesting example there where you look at the managers and stripping out those big tech stocks. So do you almost take a separate approach, where you look at the market ex-Mag Seven, and then have a separate strategy for that? Dan Farmer 10:21 Not per se, we were looking at that, that ex-Mag Seven active management, performance, really, for interest. And coming back to that question about the role of risk control in that when we do have these particularly concentrated equity, equity markets, at the end of the day, as you mentioned before, we are benchmarked against Your Future, Your Super benchmarks. So ultimately, that's what we're aiming to be. So for us, it's what the what is the right mix of systematic, quantitative managers which have actually done quite well in this environment. Yeah, they've been generating outperformance your fundamental, bottom-up active managers, which have found these concentrated markets hard, just finding it difficult to buy those highly valued tech stocks. And then, of course, what's, what's our role as the ultimate owner of that mix in terms of managing that risk? So we've, we've been really fortunate at MLC to have a really strong derivatives team capability within my investment team. So they're putting in place some derivative strategies which are somewhat complicated. I won't go into the full weeds, but we use dispersion trades, where we put a trade on which basically looks at the dispersion of the Magnificent Seven stocks to a basket of almost call them inverse Magnificent Seven stocks. And if that correlation widens, we get paid either way, so it's non-directional. So we're doing things like that. It is our role to try to look to manage some of the risk at the total equity asset class level. Wouter Klijn 11:51 So I think we spoken about that trade a little bit earlier in a different interview, so you still have that on. Is that how you deal with the potential of, is there an AI bubble? Dan Farmer 12:02 Yes, we still have that trade on. It's not as big as we would have liked it, because it's been a very successful trade, and we have that on, and we're looking at other outperformance options, different trades, to put that in place. Now, what we what we want to be careful of is that we're paying our active managers active fees, and we don't want to just undo the positions they have on. So we're trying to get non-directional, non-linear positions where we take some of the risk out of those positions. So if the AI stocks continue to run, we benefit where our active managers may be a little underweight some of those and vice versa. If, if the stocks fall, we're not undoing the manager's trade. We get that performance back. So in aggregate, I should say our equity performance in global equities, which is most pronounced with concentration for our largest fund, which is our MLC MySuper fund has actually been adding alpha, because we have a 60% of that equity, international equity exposure in systematic strategies, 40% in in traditional fundamental active and then we have some risk control over that. So in aggregate, we've actually outperformed in that portfolio through this environment. Wouter Klijn 13:08 And I think that derivative capability that came from the merger between IOOF and MLC, So previously, there wasn't that capability there, did you you know, from your early days, having already managed derivatives, that you thought like, finally, I now got this extra tool in my toolbox. Dan Farmer 13:27 Yeah, it was, it was terrific coming in as being appointed to CIO of the joint group, because there was a lot of great capability, you know, the really strong private equity capability in MLC, really strong alternatives capability in MLC, and then the derivatives capability was really exciting for me. As I said, it's a space that I used to be in my younger days, and could see the value in client derivatives to manage, to manage risk. And the team, you know, really had a strong capability. They're doing a range of things than more traditional, just FX hedging, that's more your trading. But as I said, some of these risk management positions which really do tie into both our dynamic asset allocation positioning, so the derivatives team are certainly in and around our thinking on how we want to position our active asset allocation and come up with ideas, rather than just doing a straight cash, physical tilt, you know? Can we execute that, either through derivatives or futures in a more efficient way, or give us a different payoff that suits our view? And then also down, as I said, down at the asset class construction level, where we may have industry biases, country biases, for instance, another trade that, another piece of work that team helped with was a, was a banking basket we saw in one of our portfolios, Aussie banks somewhat expensive. So that team was in and around building a bank basket. Wouter Klijn 14:51 I think CBA was the most expensive bank in the world? Dan Farmer 14:55 I was probably a bit polite, but yeah, it was very, very, very expensive. So we actually built a basket of foreign banks that kind of proxied Aussie banks, put some risk around it, and use that as well to solve for some of our asset class construction positioning that we wanted to fine-tune. Wouter Klijn 15:12 Are there any other trades like that that you're currently looking into that haven't been put on yet? Dan Farmer 15:19 We're looking at, it's about performance options. Looking at that, we are doing a bit of work, as I hinted at around, when we look at our active manager portfolios in aggregate. And we, you know, believe in active management when we do get into these markets where concentration is is pronounced, you know, do we want to control for other things, like country, you know, is a simple way to manage some of that risk. Just country risk. Look across how active managers generally underweight the US, if you just controlled for that risk at an overlay level, you know what improvement that makes. So we're doing a lot of work around that, that piece. And I think that dispersion trade idea that, or dispersion option that I talked about. It's got other applications that we're we're looking at, but it doesn't work all the time. It depends on pricing, depends on the basket you can put on. But it's that , it's really trying to keep the deep diversification that we want in our portfolios, but just adding a bit of extra layer of risk control down into the portfolios. Wouter Klijn 16:21 Yeah, the other capability that you mentioned was private equity. What is, your view from an asset allocation perspective on private equity as an asset class, because we have seen some problems with being able to exit companies and having to set up continuation vehicles. What is your experience? Dan Farmer 16:41 The experience has been good, and I should say, winding the clock all the way back to that Telstra super I mean, my boss, Steve Merlicek, was very keen..., we were early investors in private equity way back in the Telstra Super days, IOOF, we started private equity. And then, of course, MLC acquisition comes along and I find myself with a great existing private equity capability. So you can, you can get a sense, I'm quite I'm positive on the asset class. It is a long-term asset class, so you need to bear that in mind. And I look back on the performance of the MLC private equity capability, and that's, we've got four people in New York, six in Australia. So it's a reasonable commitment the business has made to that and that team is basically establishing really strong GP relationships for the fund investments, but then also about 40% of our private equity exposure, our largest MLC, My Super fund, 40% of that private equity exposure is co-investments. So the team does a lot of detailed work on co-investments, and getting a those really good opportunities and B at a more attractive price point. So private equity and look in Your Future, Your Super land private equity is benchmarked against listed global equities, which has been a particularly tough benchmark over the last few years. But I think you really need to take a longer term perspective, if you can, to look through those periods. So I look at our our private equity programme, I think it's outperformed listed, listed equities, including the rally we've had recently by round about, I think it's around about, 3% per annum over the last 15 years, including the run up we've had over the last couple of years in listed markets. And then the private equity programme, look, we're starting to see activity. We've had a patch where exit activity has been quiet. As you noted there in our programme, we're starting to see exits pick up. Some of it is to continuation funds, not our continuation funds, but others. So we're starting to see some, some exits there. And, you know, we're starting to see the return profile pick up again with that, with that activity, which is great, and we expect to see that. And there's, you know, we think, I think there's some real kind of permanent, structural reasons, you know, we're in the more lower, lower mid market space. So, you know, gearing is not such a prominent feature of the value proposition in private equity. The value proposition is really around pairing up with great GPs, usually early in their life cycle as a GP. So we're an important investor in their funds, and really making sure those GPs are very active in the terms of their management interaction with their underlying businesses. So really getting strong management teams in reshaping the businesses, helping those businesses, you know, back with their own strategic plans and their own mergers and acquisitions, to really grow those businesses. So we've seen that value come through in our private equity programme, more through the EPS growth than, let's call it financial engineering. Wouter Klijn 19:45 Yeah, yeah. And when you look at private equity as an asset class, I mean, you run multi asset portfolios, what is the role, and how do you tie it back to other asset classes? And one of the reasons why I'm asking this is because. Um, recently, I did an interview where they basically said, Okay, if we look at a portfolio at the total level, and not necessarily TPA approach, but if you, if you look at the total portfolio, private equity is very growth orientated. And so what does that mean for your equity holdings? Are you going to have a bit more of a skew towards value style, bit more conservative equity. Or does that not tie together for you? Dan Farmer 20:28 Look, so obviously when we build the total portfolio, as you say, we run through the typical capital market assumptions, strategic asset allocation process. So and we're solving for when we're thinking about the allocation of private equity at the top level. We're solving for a lot of things, you know, liquidity. How much illiquidity can we bear? The reality is, what's the fee, fee load that we want our portfolios to have? The optimizers, in a purely quantitative sense, the optimizers love private private equity because it's, you know, lower, lower volatility, and it has, you know, our capital market assumptions do have an excess return which it has delivered. So we tend to be, yeah, so we will tend to hold in most of our , call it balance, to balance growth portfolios, kind of 5% allocation of private equity. So it's, it's meaningful, but not, not massive, in terms of what does that mean for the rest of our equity portfolios, we probably don't think about it so much in the value/growth factor sense. Our private equity is mid market, so we probably think about it in a bit of a market cap sense. So how much do we want in our listed equities in that small and mid probably where it does show up is more in the total risk I mean, private equity is always going to be, given Your Future, Your Super benchmark, a very high contributor to overall tracking error, just because there is kind of a mismatch with the benchmark that you're going against over shorter periods. So hence, things like, as I said, we have 60% of our global equities in systematic equity strategies. So they're not passive, but they're taking, call it, 50 to 80 basis points of tracking error and far more risk-controlled. So you can get a much better handle on what benchmark risk you're going to get out of those managers, compared to your, to your, to your active managers. So it it shows up in that mix of the styles we run our active equity portfolios in. Wouter Klijn 22:24 And recently we spoke about you're doing a bit of a review of the MySuper option, and looking to increase growth assets a little bit there for younger members. Does that also translate in more private equity in those options? Dan Farmer 22:38 Not necessarily, and we're still working through that, that work, so our corporate super team are doing a broader enhancements across our master trust, MySuper offerings. So working through that, but it wouldn't necessarily lead to a bigger, a bigger allocation to private equity. Wouter Klijn 22:59 Fair enough. Fair enough. Now, you mentioned earlier, there in your Telstra Super days, you worked with Steve Merlicek, which he became CIO there, and then, I think you followed him to IOOF afterwards, where he became CIO and you joined him. How was it working with him? And do you see him as a mentor? Because, you know, we're still the early days back then. Dan Farmer 23:24 Steve is, Steve was great. And I keep reminding Steve, he dragged me across to IOOF, he brought me across to IOOF. So Steve was, Steve was, yes, certainly got me into that side of the market. But Steve was a, Steve's a great mentor. I still see Steve regularly, and he's always, he's just invest investments in his veins, so to speak. So he's always talking about individual stocks he's looking at and investments that he's making. So he's super active. And I think Steve probably taught me a lot of important things around team and managing money. So he had a few key sayings: "Keep it simple, stupid", was one of his favourites, which was really around, we're here to we're here to add return. Stay focused on on investment outcomes, which sounds obvious, but there's a lot of distractions in the industry. So Steve would always pull you back to, well, what does this mean for the portfolio? What are the investments looking like? And I've tried to keep that. Another good saying that he had, which I've continued to follow, is: hire people that are smarter than you. And like, I could say that's not hard for me, but it is important to hire really good people and be confident to give them space and empower them to do what to do what they do. Yeah, so Steve is, you know, I think, really integral. And just some of those basics around investments, and I think probably one of the big positions we put on back in those days was a currency, a currency position. So Steve was very much encouraging the camp: If you've got a conviction in an investment thesis, make sure you have the courage to follow that through. Obviously, take the risks into account. No one has perfect foresight. But if there's a, if there's a position you have high conviction in, make sure you reflect that and have the courage to put that in the portfolio. So, you know, eg, when the Aussie dollar was above parity against the US dollar, Steve took position of go zero hedging, which was, you know, worked out really well, but that was pretty bold, pretty bold position at the time. So that those examples of back your conviction. So, yeah, Steve was a mentor, for sure. Yeah. Wouter Klijn 25:45 How would you define your, your way of running a business and investment business as CIO? Dan Farmer 26:00 Look, there's a few different aspects to being a CIO today, I think certainly in the investment part. So I try to, and this might sound a bit strange, but I try to make sure I'm actively, heavily involved in the investment side, so going to all the investment meetings and being involved, but not necessarily dictating micro terms. So I see my role as two-fold: so being in and around the investment strategy, making sure the actual investment process strategy, the way we make decisions, is working well. How do we think about making decisions? What are our approaches to making decisions? So that very high level, is our strategy really strong and our process really strong? And that's been probably particularly important in my CIO career. Where we're at the IOOF, Insignia, MLC role, we've had a lot of growth through acquisitions and mergers, so bringing teams together, so just making sure the process is strong, is an important part of my role, and then obviously getting involved in the actual investment decisions. And I see primarily my role is to challenge some of the discussions, come at things from a different perspective. I'm talking to different sets of people than my team are, putting, putting some different ideas in and challenge the process to make sure it's robust, and try and make sure we've got good thinking in the day-to-day decision making. And then ultimately, if there's hard calls to make, they'll fly up to me to make those calls. So that's the investment piece. And then there's obviously managing the team. And as I said, like you need without a really strong, capable, empowered group of talented investors around you, I don't think any CIO is going to succeed unless they have that that that support around them. So making sure the team are free to focus on what they need to focus on. So help to the degree possible, try to shield from a lot of the noise that's in and around businesses, and give them a good, good, empowered environment. So I really try to empower my senior investment people to take ownership of their portfolios, which they do, and really drive a lot of decision-making with me coming along beside them, so making sure I've got the right people and they're in the right environment to make strong decisions. Wouter Klijn 28:15 Yeah. So my colleague Teik, he recently explore the idea of is the CIO of today, a manager or an investor, but from your answer, I get you're both, or somewhere in between? Dan Farmer 28:27 Try to be, I like to think it's a bit of both, like I don't think you get, I don't think purely, it's very hard to be a purely investment [CIO], I think these days, because you do have to manage the team, and there's also regulatory environment, everything else that comes with the role, but my passion is, is ultimately the investment part of the job. I love looking after the team. I'm lucky to have a great team around me, but it's a bit of both, and I think they are interrelated. So I think, you know strong, strong investment outcomes is part of having the team, hopefully in the right headspace with the right structure to help support that investment decision-making. Wouter Klijn 29:05 So how much delegation do you have in terms of, you know, delegation from the IC and the board, because you mentioned earlier, Steve was very much about conviction, and if you have high conviction in a trade, you should explore that. How much room do you have to implement conviction trades? Dan Farmer 29:25 Yeah, and I think we're lucky with our boards and committees that they give us an appropriate amount of delegation, and they understand a lot of our committee members, both from our super fund trustees and our investment manager trustees, have been in markets in some shape or form themselves. So they're very..., they understand the practicalities of running money effectively. So we have delegations around asset allocation ranges, so myself and the team are able to move within predefined ranges around our strategic asset allocation. It varies, but call it plus or minus 10% so quite, quite reasonable ranges. Now we don't necessarily use those full 10% ranges, but we're able to move around without, without having to..., we report everything back up, obviously, but we don't have to go up for that those asset allocation moves. We can reweight managers within ranges hire and fire, depending exactly where the manager is. But hire and fire would typically go to the go to committees for that manager, hire fire function. But we do have delegations. The committees have given us delegation for many of our funds. If there's a manager where the team's walked out and there's a real problem then I have authority to exit that manager straight away, if it's it's a situation where it doesn't make sense, it's a clear-cut case that we need to get out of that manager. So we get a quite a bit of delegation, and the committees get very interested in how we position, etc. Good, well, I'm very lucky in the good, good committees that understand how these things work. They get involved where they need to be, and they'll often get involved where it's policy, strategic stuff, as opposed to the day-to-day minutiae of how the portfolio is run. Wouter Klijn 31:08 Because I think delegation is one of the things that people look at when they are starting to implement TPA, the total portfolio approach. It's a bit of a buzzword these days. What's your view on TPA? Are you trying to implement it or? Dan Farmer 31:21 Well, it's, it's, it's an interesting one, and probably each person you asked about TPA has got a different definition of what it is, without sounding too flippant. But look, I think at the end of the day, everyone's running some form of it, like we we ultimately live or die by how our total portfolio outcome operates. So we don't have a strict form of TPA, but certainly asset class PMs, when they're building their portfolios, interact very closely with the Diversified PMs. So I've very much quite like as flat as possible team structure so we don't get too siloed in that we have an investment team member that's running a particular asset class that doesn't... What I don't want is to have people running parts of the asset class portfolios where they don't necessarily understand the drivers and dynamics of the top level diversified pm so we have quite a flat structure, and really try to make sure that the asset class PMs feel a high degree of ownership on their portfolios. But they understand when we almost call what we do call the Diversified PMs are their clients. They want to understand their their clients' needs of what they're building at that top level. And that dynamic is working well, there's, I think it brought up. You always want a little bit of tension between this is a great idea at the asset class level, at the top level, at the top level, but I've got that risk elsewhere, and having that dynamic. So we've, I think we've got a pretty good operating rhythm there. I think two, two of a stringent implication inputs implementation of that total portfolio can create its own set of problems if it gets too strict and too fragmented and too siloed, because it becomes, I think, a bit of a capital allocation challenge at the at the top, if you're not getting that dialogue across teams. So we, we look at, absolutely, look at the total portfolio level, but we try to do it in a more of a in a flat team structured way. Wouter Klijn 33:17 Because one of the things with when you look at different approaches to TPA is that it's this effort to get everybody to think about, you know, what, what impact does the investment have at the total portfolio level? And sometimes I think, isn't it the CIOs job? Dan Farmer 33:32 It's really the communication that you want to have, that communication between where that asset class, PMs portfolio is ultimately landing, and what role is that having at the total portfolio level? And we absolutely measure risk, you know, the contribution to risk from all of those portfolios, the managers in those portfolios. So we have very good, as you'd expect, very good transparency through to where the risk in alpha is coming from. And then my role as CIO is to try and make sure we've got great communication. Great communication channels, and there's constructive and healthy tension between asset class PMs, this is a great idea. We want to do a diversified PM say, hey, that might not fit because of this reason, and just making sure that no one's getting lazy in the process, which they're not, Wouter Klijn 34:18 Yeah, for sure. Now, we spoke earlier a little bit about the impact of the technology stocks on the equity markets, but if we look broader at AI, do you see a role for that in your day-to-day job in the asset management industry? Dan Farmer 34:34 Yeah, the use of and it's a topic actually my leadership team and the whole MLC and Sydney business has been looking at is, which I'm sure most businesses are, is, how do we implement this? So we've been doing a lot of work in the team just on a few things. How do we use, how do we use existing tools that we have in the AI, tools that we have in the organisation, just for, let's call it efficiency. Just speeding things up, which every business, and I think that's probably going to be from an investment point of view, a bit of a theme next year, as we start seeing a bit of that efficiency turning up in in either cost saving or ultimately in margin in businesses next next year. So in our business, we're doing a lot of work just on the efficiency part. We're trying to challenge ourselves to how to think bigger and beyond just the efficiency piece, because I think that's just almost has to be done. So what does it mean for how markets are invested? And you've seen in the past, we were talking before about indexation as passive, as a strategy. I'm not quite old enough to have been there, but old enough to be around it that running passive money was actually probably a technology issue. When you look back long enough to get the data of what's the market cap of each stock, how do you weight the index before you had so as technology grows, how we invest can change. So we're trying to think a bit bigger about well, what does it mean for your traditional active management? It becomes more about how much data can a manager scrape and apply some reasonable AI to it? So don't have any strong, strong outcomes to that thinking yet, but it's something we're alive to, that the way, at the end of the day we're processing information to arrive at a decision. You know, does the dynamics of that change? Is it about how much, how much data, how much information can you get? What AI logic? What else can we apply to that to arrive at investment outcomes? So I think that'll be for us, a really interesting space over the next it's probably next 10 years, really. But you know. Wouter Klijn 36:40 So are you looking there into: is it harder for active managers to have an information edge, or to, you know, gain insights that other people don't have? Dan Farmer 36:49 Could could be and that's what we're trying to think about. And it doesn't mean those active managers will evolve as well, many of them will. So it's about, how do they evolve? Does it actually create new and different opportunities for those managers as you get that , let's call it, data richness improve and AI, injecting itself in different ways into the process. It'll just mean, you know, they need to be and need to be alive to that as it evolves. Wouter Klijn 37:20 Because one of the applications that I found was interesting as well is that fund managers have been using it as a as a learning tool as well, where you know, if they look at a new sector, it might have taken weeks to come up to speed to know exactly how all the supply chains work and what the key elements are, but These days, you can get at a reasonable level in, like, a matter of hours. Do you see your role there? Dan Farmer 37:47 Yeah, so it's almost not quite a graduate in your pocket thing, but it's, it's a little bit like that. So your basic , you know, provide me a written summary of this particular industry or this issue. Now, we're highly conscious that you have to have someone interpreting that with some degree of knowledge, like, there is it, if you just took that as verbatim truth, that would be a pretty risky approach, approach to take. So we've had a, you know, a few experts come in and just remind us that AI is not always, you know, factually correct. It can sound convincing, but it may not be correct. So be aware of that. So we are using that, but in a very in a knowledgeable way that we have senior people looking clearly, applying judgement over the top of that. And really, the day to day at the moment is probably one of the things that, as we've looked into this become more apparent to me, is distinction between it just AI and automation as well. So we've, we've had a lot of things, let's get AI to do this for us. And as we've looked at it, well, really, this is just an automation project. So, you know, it's, it's interesting, kind of where the slice, where AI will, will, will come in first. Wouter Klijn 39:02 Yeah, the information that supplies the always have to check it a bit. It's not just hallucinations, but it's often also just plain wrong. I was doing an exercise yesterday where I looked up the bio of another CIO of a different company, and the first result was, of course, an AI summary, and it's plainly told me that this person was the former CIO, and had left in 2021. But he's still there. He's been there since the last 10 years. So I'm not sure where this information comes from. Dan Farmer 39:32 Well, that's the thing, and it's, and it sounds very convincing, so it's, it's treat it with care Wouter Klijn 39:36 So what's on your agenda for next year? Dan Farmer 39:40 Look, always, always a big year. So our CEO has put out a strategic plan, and we've got, you know, the investment team's got elements. It's, it's more heavily involved in around that. So our private equity capability, which was mentioned earlier, we're really keen to grow that into new channels for a few reasons. We think it helps support the programme. You know that programme benefits from fund flow. Being bigger participant with those GPs helps us get greater access to co-investments. So we're looking at, you know, private equity. We've, we've launched a co-investment, more closing a co-investment fund for we've got a private equity retail, always open evergreen Fund, which is, which is growing and performing, performing well. And thinking about our, which is another initiative that we're pursuing, our Managed Accounts business, which is, is growing very well. It's just ticked over. I think, $4 billion in our last update. You know, thinking about ways private equity alternatives can be safely built into that, into that managed account programme, because those asset classes have been really good contributors from both a return and risk perspective for our diversified funds over very long sweeps of time. So we would like to get our managed account members access to that. So we're thinking about ways of pursuing those opportunities in a, in a in a very managing liquidity, managing all the various risks that come with that. Wouter Klijn 41:15 I hear some echoes in there from current discussions on private credit and liquidity and offering it to more the wealth space, is that the issue you think about? Dan Farmer 41:25 Yeah, we're thinking about that. And we're thinking about it really. Or the piece I'm thinking about with the team is offering that in a diversified, managed account where we're controlling the asset allocation along with our clients and the construct of those so it's about: how do we do that, in a, methodology which addresses some of those? Making sure liquidity at the total level is managed, you know, at very comfortable levels. You know, making, you know, the valuation policies strong, which it is that the valuations are coming through. So all of those topics, but at the end of the day, we look at it and go, what's what would generate a better outcome for our clients? And we're running with private equity. We're running alternatives in our main MySuper funds and our wholesale funds performing very well important components. So the challenge to us is: Well, how do we make sure all our clients can get access to that in a, you know, you know, in a very thoughtful way? Wouter Klijn 42:19 Yeah, yeah. So you're not offering daily liquidity on these private equity funds. Dan Farmer 42:25 No, not the standalone No. So we're around all of that. So that's No. And again, it's just about setting those things up properly in the first instance, that they're robust through time for those, for those types of issues. Wouter Klijn 42:37 So this strategic plan that you mentioned, I think it's 2026 to 2030 strategic plan. Is there an end goal there, where we want to be this big by 2030 or we want to have achieved these type of metrics? Dan Farmer 42:54 Well, we certainly want to be one of the biggest players out in the industry, from my perspective, in the investment team perspective, it's really about our clients having a great return experience and feeling very confident in the process, so whereby, we can deliver great outcomes to our clients across all the different products we offer, and be transparent about how we're doing that as much as possible. Help the clients understand what we're doing in portfolios. And we've, we've got a tool called Investment Central, which allows our adviser clients to look into most of our portfolios for the managers' exposure. And we think that really helps build that understanding and trust in the products. You know, our goal would be to have our clients think: hey, this is my obvious place to go for investment solutions. Wouter Klijn 43:48 And I think one focus of that strategic programme as well is the retirement phase and having that smooth transition between accumulation and retirement. Now I did see at one point, there is a statistic that MLC is the fund with one of the largest number of retired members. Does that give you special insight into, you know, there's the regulator wanting funds to develop retirement products. Do you have a special insight in what the key elements are that have worked over time for the retired members? Dan Farmer 44:21 You know, I think I had a similar stat where, I think where the group is the largest pension or retirement income payer outside the federal government. Think they're your statistics probably, probably correct look. And I think there's a lot of different elements that go into that. From an investment team perspective, it's probably an extension a lot of things we've talked about. So there's for an investment perspective. It's for our MySuper, default options is the glide path. We've got the correct shape and trajectory on the glide path, you know, our diversification. So as you get into retirement you want low volatility. Some of those strategies I've been talking about, like the alternatives, where we have insurance-related investments and some opportunistic credit, which are really good diversifiers, they generate good income to create that smooth ride for retirees. So we think about those allocations as we go through the glide path, but it's really much more than that, and this quickly gets out of my area, but it's the digital experience that the retirees have around that it's things like: is it the retirement boost when you switch from accumulation of pension, making sure they access that which members can, and then optimising the structure of the portfolio, not so much from an investment perspective, but the product, I should say, to optimise the ability to access Age Pension as as you get older. So there's a whole lot of aspects around that retirement piece. I mean, the business is clearly working on that. The Master trust really going through a good enhancement programme around all of those aspects going forward, you know, large part to create, you know, really do the work now for members in the accumulation phase and those getting close to to really optimise their experience in retirement with with our products. Wouter Klijn 46:18 Yes. Fair enough. All right. Well, thank you very much, Dan, for coming to our offices. It was great talking to you. Dan Farmer 46:24 Thank you and thanks for having me. It's a pleasure.
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  127: Frontier Advisors' Kim Bowater – Consultants in a Changing Industry, AI and Gender Diversity 19.01.2026 43min

  In this podcast, I'm speaking with Kim Bowater, who is the Director of Consulting at Frontier Advisors. Kim has spent 23 years at the firm and saw the asset consultant grow from a small advisory firm with just 13 people when she started in 2002 to the leading asset consultant it is today. She is one of the driving forces behind a number of key initiatives that have supported Frontier's growth, including the establishment of a technology platform that allows clients to access research online and the initial set up of the retirement business. In this episode, we discuss how the continuously changing industry affects the role asset consultants play, the impact of AI and gender diversity within the investment industry. Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights  Overview of Podcast with Kim Bowater, Frontier Advisors 03:00 I come from a science family; I'm the only one that went into finance 06:00 When I joined Frontier there were 13 people 07:00 Frontier's new independent CIO service 10:00 You led the first phase of Frontier's technological overhaul that saw the implementation of a digital platform for clients. How did that come about? "I put my hand up." 14:00 We are a reasonably open book in terms of our research and ratings 16:00 Does this platform allow you to address knowledge management of the organisation 15:30 We've developed an AI agent, called Frank, that allows us to access all of our data in a streamlined manner 20:30 Ashby Monk said asset consultants might be in trouble with the rise of AI. Do you agree? "No!" 23:00 You've started Frontier's retirement business. What are your thoughts towards product development and investments? 25:00 Retirement is a meaty problem 26:30 Annuities haven't been helped by the low-yield environment that we've had for so long, but in principle, we do think they have a role to play 32:00 The industry has changed quite a bit, how do you look at the future growth of Frontier? Where is it going to come from? 38:00 How do you look at the gender balance in the investment industry today?   Full Transcript of Episode 127   Wouter Klijn  00:00 Kim, welcome to the show. Thanks. How are you pretty good, pretty good. Thank you very much. Thanks for having me. So why asset consulting? I think you started originally out as a actuarial consultant. How did you become involved with the asset consultancy side?   Kim Bowater  00:18 Yes, well, I am, yes, I did maths at university and took up an actuarial consulting role, which was coming from a scientific kind of family, a bit of a leap into the unknown. It worked with defined benefit funds, so in the superannuation space. But after a few years, I felt like I was more attracted to the asset side rather than the the liability side. So started the CFA course, and then kind of naturally moved into to asset consulting. It was, it was relatively kind of organic, one step at a time, then then in an intentional path. But here, but here I am still.   Wouter Klijn  00:59 So what sort of science is your family into?   Kim Bowater  01:02 My father was a a senior lecturer of Applied Chemistry, and my mother was a Pharmacist, and she had a science degree as well. Yes. So there was no one in finance in my family. I thought, let's give something we've got. We don't know what it is, but we'll give it a go.   Wouter Klijn  01:20 Is that your form of rebellion?   Kim Bowater  01:22  Yes, they were intrigued too,   Wouter Klijn  01:25 Fair enough. And now you've been with Frontier for 23 years, so you don't see that too much anymore in the finance industry, where everybody has like to be your gigs. So 23 years, that's, that's quite a long time. And you've, you've, now, you know, climbed all the way up to part of the leadership team, part of the Investment Committee, but when you sort of look back on that period, was there anything that stood out for you? Is like, these are some of my standout moments?   Kim Bowater  01:55 Yeah, I mean, it's, it's been a good journey. I think Frontier also changed a lot, and our clients, particularly in the Super space, have changed a lot over 23 years. So it feels like a role that's had a lot of change in it, rather than kind of just one firm. I think when I when I started, we were under the leadership of Fiona Trafford-Walker, who, you know, many people will still remember as a leader in the industry and frontier, had a had a really nice culture. I thought client focus, kind of team oriented, but forward looking, kind of challenging ourselves and and I think kind of one, it's not necessarily a serious tan at moment, but I'm quite proud of of the fact that we've managed to have a culture that's endured with those characteristics. That's something I'm quite proud of. Frontier has always been a good place to be part of, and we still hear that today.   Wouter Klijn  02:58 Yeah, I think Fiona was one of the first people that I interviewed, I think, for this podcast series A while ago. But yes, it's still one of my favourites.   Kim Bowater  03:08 I think also, you know, just thinking about the evolution of advice, the different environments we've been through, you know, COVID, GFC, all the evolution in the superannuation space that's impacted on investment processes and governance and portfolios is something that, you know, we've really focused on working with clients to help them succeed. And I think, you know, I feel that's been a really rewarding journey, I think, for funds themselves, as well as for ourselves, who are, who are also here to kind of create good outcomes for members. We've we've done very well, you know, in our in the external survey of asset consultants, which has been the Peter Lee survey for a long period of time, and that's always been a kind of standout moment for me and the team, you know, to receive really positive feedback from our clients that we're actually, you know, adding value, because you're always a step remote. Step removed as an advisor, in a way, I think, as well from, from looking at Frontier as it's grown, you know, when I joined, there was maybe 13 people. Oh, wow. It was a pretty small, you know, we all did something, you know, we did a range of things. It was mostly super now, you know, two thirds of our clients are outside of super across a whole range of areas. We're working with clients in New Zealand and Japan the Pacific. We have an office in Japan and now recently announced a new independent CIO service. You know, all of those are really significant kind of standouts.   Wouter Klijn  04:38 That was quite an exciting announcement. Because, I think to a degree, it does change the business of Frontier a little bit. Because I think so far, Frontier has been able to provide advice, but not necessarily implemented advice. And now with this team up, where you bring in the investment team of state Super 14 people come. Coming over, you actually will be able to implement that as well. It's quite a bit of an evolutionary step for the business. But what do you see, sort of the future? How, how do you think that this might add to growth?   Kim Bowater  05:12 Yeah, I mean, it's exciting. We've always, you know, we've been an independent, kind of institutional advisor, so not not having implemented product business, and we're going to continue to be an independent advice led consulting business. And this really, you know, in our mind, extends the reach of that it's not implemented product solution, but we have found that there are asset owners. It's less, less kind of common in superannuations that have grown and have internal teams, but outside of super and some at the smaller end, perhaps, you know, want external advice, want an institutional advisor, but don't really have all of the tools to implement it or execute a bit reporting or custody or execution. So this just provides some extra service levers that we can work with organisations that need those components. It's still, it's still advice LED. It's recommending portfolios that really align to their needs and objectives. And previously, the only other solution they've had is to go into an implemented, like a Balanced Fund, kind of wholesale, kind of group product. And this is, this was providing, I think, a really, potentially, really attractive solution. So from a from a growth standpoint, I think it extends the reach of our our institutional advice, to the border, to broader markets where they need some additional service capability as well.   Wouter Klijn  06:38 Yeah, yeah. And from what I understand, this mainly is targeted, sort of the smaller end of the spectrum, like the charities, maybe some family offices. Is that right? Yes, yeah. And does that also allow you to then tap more into sort of the private wealth space?   Kim Bowater  06:53 Yeah, potentially, we've been working in the private wealth space for a while now. That's obviously a growing area, and they're also, you know, a group's interested in in working with an organisation like us as they've got bigger so and they they also can have other additional needs, like reporting and various things that that this can assist with. So it just provides a greater flexibility of us to to help our clients with all of the different aspects that they need.   Wouter Klijn  07:25 Yeah, and it's very aligned structure as well, because State Super has now become a co-owner of Frontier, yes, and it's been a long-term client as well.   Kim Bowater  07:35 So it's yes, it's exciting and and to have you know a team with Charles and 14 people join us is really exciting, too.   Wouter Klijn  07:44 Yeah, yeah, for sure. So if I may take you back a little bit about your journey at Frontier and changing essence consultant environment, I think what I saw one big change that Frontier has gone through over the years is when it started to implement the technology platform where, basically, clients could log in, find recommendations, find all sorts of information, and also with the help of a few foreign partners, I think, on this platform, and You were actually the one that led the first part of this project, weren't you? Yes, how did that come about?   Kim Bowater  08:26 I put my hand up, or it might have been volunteered. I can't quite remember. I mean, the the genesis of it really was we were, we were finding that, particularly in superannuation, as investment teams were growing, that there were the people that we were advising to that, you know, had their own, you know, had a range of working needs. So some of them would want, you know, direct, curated advice from us. Some of them wanted to do their own research, but leverage our breadth of work to do that. So technology really enabled a different mechanism in which kind of the work that we were doing in our research teams could be shared, and it could be utilised in a way that, you know, individuals wanted to. So the first project was really looking at the manager research database, and we had an internal system. But this was really looking at, well, how do we, how do we strengthen that and have a really good system that can be used externally? So it was, it was an interesting project. It took a lot of mapping, and I think it strengthened our own internal processes as well, and kind of built it out so it could be evolved from here. So be that into kind of areas like private wealth or offshore in Japan, it's been really good to have done that, that really early work. And it's It now includes, that was just the database really to start with, but it includes a range of kind of tools and and systems, portfolio analysis, you know, real life. Sets database all sorts of different things that we use internally and that our clients can use. So it's really added, I think, a dimension of flexibility in terms of how clients can work with us.   Wouter Klijn  10:12 Yeah, usually technology doesn't make the headlines in this space, but I remember quite vividly when I realised how important it was when I actually was doing an interview with one of your competitors, and the news had just come out, and I sort of brought it up, it's like, Oh, if you've seen the frontier is doing this, and they're like, it's crazy. We never, we never give our research reports out, and we have one copy, and we hold it very tightly. We never put anything online. And they just have a system where you can log in. And they thought, you know, this is going to make it really hard to get back and talk to fund managers, because if you give them a negative rating, they'll never talk to you again, and now you're just putting it all online. Was that ever a consideration, a conversation, that maybe the reports would more easily be disseminated?   Kim Bowater  10:59 I mean, it's a secure system, so we were not worried that it would kind of be available to everyone. But, I mean, ultimately we were, we were not, you know, closed about, you know, what our ratings were. So if we were asked by a manager, we would, we would talk about that. So I think we've always kind of taken an approach of, you know, we've all got a role to play in working with with asset owners, and we should be transparent about how we're thinking about things. And, you know, I think that builds better relationships, even if you start with a negative rating or not rated situation we were, I mean, there is a, there is something to be said around, you know, do you want to do? Do you want to do all your thinking and work before you kind of get into a communication with a client about a new idea, or manage a recommendation, or, you know, investing in Bitcoin, you know, that sort of thing. Do you want to kind of have done lots of work before you even have that conversation. Whereas this has all that meeting notes, it has a whole range of things. It has thoughts processes in along the journey, so to speak, and and so that was a conversation, because I think when you're just providing advice, you kind of do a short list. So it's managers, you do a short list, you provide a recommendation, and it's kind of the end of the process. But we were finding, you know, particularly for asset owners, with super teams, with client with teams, investment teams, with more sophisticated internal processes as well. You know, they were wanting to have a conversation very early in the stage in the process. And so, you know, we're a reasonably kind of open book. We'll start kind of with, you know, we we have, we've got these questions about a topic, and then, you know, ultimately you get to the end of a rating or a view to invest. But I think it's important, with all the questions in the world and things that we don't know, investments are, you know, inherently uncertain in terms of where they'll go in the future. So I always think, you know, being able to ask the difficult questions that you don't know the answer to is just as useful as you know, having done all the work and having the final answer that you think   Wouter Klijn  13:15 yeah, so you haven't got any pushback from managers on...   Kim Bowater  13:15 No, no. And you know, we try and you know, we try and be transparent. We, you know, in terms of not just our ratings, but, you know, areas of focus as well. With our research programme, there's a lot of managers and products out there. We can't cover everything. So we just think it's useful to have a two way dialogue with that universe. And yeah, no, they haven't. They haven't had any any particular pushback, yeah.   Wouter Klijn  13:44 So it started out as sort of organising the database, but over the years, it has grown quite a bit. And I think you already mentioned there's a lot of different tools in it, meeting notes. What is your current thinking about what sometimes referred to as knowledge management, because, to a degree, it retains the institutional memory of Frontier as a business as well, where, I think previously, sometimes when you know in an organisation, when when somebody leaves a lot of information leaves with them, but having this in place, in sort of central place, does retain some of that has your sort of ideas about knowledge management changed in that perspective.   Kim Bowater  14:28 Look, I think it's been, it's been an ongoing quest, you know, to manage your data and knowledge well. And you know, technologies continue to evolve. We're in a process of really centralising all of the data and and knowledge and past work that we've done on the cloud, and really looking, you know, you need efficiency of data access, security, data governance and being able to extract better insight. So having things. Obviously dotted about in in the manner of old, is is not the best way to extract data. And so we're, we're in the middle of a centralization project at the moment. We've also got a private AI tool, which we've called Frank, after an internal competition   Wouter Klijn  15:20 I've met Frank, I think, at the last annual conference.   Kim Bowater  15:24 And you know that that that allows that kind of data set and knowledge to be to be accessed through that tool and and for all of us, really, in a more streamlined manner?   Wouter Klijn  15:36 Yeah, now AI is something that is obviously on a lot of people's minds in a moment more whether it's a bubble and it's about to burst. In terms of application to this, to the data, where do you see the biggest gains? I mean, you just mentioned this agent that has been developed, but where do you see, sort of the biggest benefits? And part of the reason why I'm asking it is because I was reading a report recently from MIT, which basically looked into companies running AI pilots, and it's sort of concluded that 95% of businesses got no benefit out of it, which is not that great number. So keen to hear what your experience is.   Kim Bowater  16:20 Yeah, look. I mean, I think it's a, it's going to be a journey, and we're in a really, really relatively early phase. So, you know, Frank, for us, is a really useful tool to, I think it'll create efficiencies in data access. You know, it can apply style, kind of guide to it. So there's just a kind of wording benefit. We view generally AI just to kind of take a step back, it's as a strategic priority. We think it's an area where there's a lot of change, where we need to be thinking about what it means for our business. So we're working on that, that strategy at the moment, and we're also thinking about a lot from an investment and economic standpoint, I think we have a range of kind of projects underway. A lot of it's kind of in that kind of efficiency space, or in the can, can we use it to provide a different perspective to the one we might have come up with in a qualitative sense, and understand why? So it's a kind of robust, adding robustness to our own processes. But all of that's quite, quite new, and we're seeing it, you know, kind of expand out into so many different areas in the world and businesses. And there's obviously a governance and a risk aspect to it as well. So we're using it as a tool, a supplementary tool, but you know, I think we'll take learnings from that and continue to develop it from there, without kind of getting too ahead of ourselves on it.   Wouter Klijn  17:52 So I did a recent podcast with Ashby Monk from Stanford University, the long term investing Institute there, and he is very interested in AI, and in think he has some projects going on with some businesses on the side as well. But I basically asked him, Where do you think AI would fit within sort of the pension industry? And he started describing basically the idea that you could use it to get alternative viewpoints, in the sense that you could very specifically make it a specialist, but also more general at, you know, board type of advice. And he started describing where it could be used. And I said that again, this sounds like an asset consultant. And he sort of agreed. So I said, So are they in trouble? And he said, Oh, they might be. Are you? Are you worried about that it gets to a point where, you know, it replaces advice.   Kim Bowater  18:44 Yeah, no, no. Look. I mean, who knows, who knows where it will go, and I suspect you know potentially some of the power of it in things we can't, you know, yet envisage, but I do think it's potentially useful to provide separate different perspectives and all of those things, but investing is such a challenge, thinking about particularly the total portfolio and how all the different components come together, where the risks are, where the opportunities are, what the different competing things to weigh up, you know, risk and return and fees and all of the things, particularly in Super that you need to weigh up, you know, it's a complex problem, and AI, I think, should be useful in in processing some of that. But I don't think it takes away from, from, you know, the insight that an experienced investment person will will have, and I don't think, you know, investment committees will, you know, have an AI advisor that they'll be as comfortable with compared to a, you know, an experienced asset consultant, where they're looking for an independent perspective from their from their internal CIO.   Wouter Klijn  19:55 It can obviously lead to some efficiencies, but I think at the moment, as well, the system. We're still at a stage where it makes a lot of mistakes. Yeah. So I find that whenever I use it, I almost spend as much time correcting its mistake than I actually gaining in benefits. And it sort of has this idea that we still need more evolution in that space, because at the moment, it's like broadly right but specifically wrong. And yes, but I'm very interested in this space. So yeah, we'll be interesting to see what happens there. Another sort of big development is, you know, the retirement space. Obviously, the regulator has put out some requirements there for people to at least develop sort of a strategic plan. I mean, it has changed a few times. There were sippers. Now there is covenants, but the idea is that we need to basically have a more mature approach in that particular space. Now, I think you've also set up the retirement business for frontier. Tell me a little bit about how that started and what sort of your thinking is towards this space. Do we need a whole range of new products, or is it more tweaking for a specific set of circumstances?   Kim Bowater  21:13 Yeah, it was, yeah. Some time ago, we started to think about retirement in some ways, from an investment or product standpoint, given where we're from the investment side, and what, what that meant in terms of the member experience. What was different about it is the, you know, you think a lot about my super and different options and their collective vehicles, but retirement has a an, you know, a lot of of challenges that go to the individual member and what they need. And I think the so we, you know, life cycle is, is more common than it was back then. But that was something we we did some, some work on and, and then also, you know, in retirement, what, what does a member actually need? And what would that mean for for the investment product? And there's always that challenge around different circumstances and pension and all of that sort of thing. It's been really slow, I think, and in its evolution, part of it is, you know, there's been a range of other things that supers also been focusing on, but I think we're now getting into a stage where we are seeing, you know, the maturing of the system, lots of members moving into retirement and and so, you know, I can see why the regulatory focuses has been increasing. So the retirement income covenants now been out for three years, and I think what it's captured is the kind of multi dimensionality of the of the issue, you know, understanding the members need. So there's, there's a whole thing around, kind of, what data do you have on the members, the cohorting of members, how do you communicate with the members? Like, what, what is the fit for purpose assistance, which may go to product or advice? And then kind of, what's, how do you assess whether it's been successful? So moving, getting all of those elements lined up and interacting is a, you know, is a meaty challenge, and and when I think the the industry is is still working on but, yeah, it's not specifically, I think a product problem, though, obviously, investments need to be made and solutions need to be found. But it's, it's the combination of, you know, the advice putting understanding the cohort and their needs and then having their solution to put them in, the ongoing support from there.   Wouter Klijn  23:42 So there's been a lot of talk about the product space. And obviously one type of solution would be something that's akin to an annuity. But then again, I also think then of the UK experience, where for a long time, annuities were mandatory, and the moment they stopped that it was kind of like everybody. So they're not a very popular product for most people. Do you see a role for annuities, or are they just not popular enough?   Kim Bowater  24:10 Yeah, I mean, I think I've always felt like there's, they have a role as part of the solution for a particular type of member. We we've done a couple of kind of workshops with groups of funds over time, led by David Carruthers at Frontier, and one of those was about longevity and what a longevity solution would look like. And you know, because in principle, it does seem to make sense for those looking for some certainty, I don't think it's been helped by kind of being in such a low yield environment for so long, and where other markets have been so strong. Because I think when you weigh up the relative choice, maybe just being in a Balanced fund or a slightly more conservative fund looks pretty good and you don't have to lock up. Your money. It may be if we hit an environment where certainty, you know, has more value, that annuities will will have another, another kind of flush of interest, but, but I think the the most recent work that apron ASIC have done showed, you know, quite a lot of people approaching retirement age don't feel like they have sufficient funds. So you would think that that certainty would be valuable, but it's, again, it's, you know, with the covenant providing the tools for members to kind of work through the various solutions, I think is, is where the purpose of an annuity, and potentially the arguments that would make members pick it up will come retirement.   Wouter Klijn  25:45 Is quite a complex space, because there's a lot of different levers to think about. But from an investment perspective, is there a chance that we may be also overthinking this? Because when you transition to retirement, obviously you're going to have an income stream coming out of it. But at the same time, you're probably going to be needed to be invested for still quite a number of years. If you're retired at 60, you probably got another at least 10-15, years where you want to have some exposure, probably through growth assets. That's the time where your balance is the biggest. So you get the most benefits from it as well. And at the same time, I also think some of the conversations that you know you have with members on just the super animation side is is hard enough to explain the differences between the investment options later on, bringing in income streams, annuities, you know, pooled vehicles. Are we maybe just overthinking it? Yeah.   Kim Bowater  26:43 I mean, potentially, you know, advisors have always had this kind of, you know, historically, this bucketing sort of approach, where you just have some money in cash, and then you have the longer term in a in something that's more growth oriented. And, you know, there's an intuitiveness to it. From a member standpoint, it doesn't necessarily need to be an incredibly complex solution.   Wouter Klijn  27:04 Yeah, I think it was the old equip that used to have this approach where that plan is just, if they had to start from basically from scratch, they would just do a third, a third, a third, third cash, thirdly, fixed income, first growth assets. And that seems to still work pretty well, yeah, yeah. In that sense, maybe it is all too complicated with adding a lot of product.   Kim Bowater  27:27 And I think, you know, we have seen, I think, in life cycle or age based default type structures, they used to de risk quite, quite early into retirement. And I think they've recognised the point that you've made, which is, you know, there's still a long period in retirement to go. So you don't necessarily want to de risk, you know, at 60, you want to maintain your growth exposure, because you've potentially got another 20 plus years to go, as long as you can kind of take the, you know, any volatility that comes with that you're you can be better placed over the long term to maintain a, you know, a good, balanced portfolio.   Wouter Klijn  28:09 Yeah, and you mentioned earlier, as well the life cycle funds, which is sort of an instrument vehicle, where you could potentially see a stage where you could have this seamless transition, where you don't have to necessarily think about it, because once you get to retirement, it's already de risk. You just have to change sort of the structure that it's helping at the same time it's it's kind of interesting to see that around the time that my super came out in the legislation, a lot more life cycle funds came out as well, which, okay, you need a new default. So that might be a good starting point to think differently about. Are we still on the right track at the same time, these things are very hard to compare with other products. Is there also a bit of a you can hide a lot in a life cycle fund?   Kim Bowater  28:55 I think there's probably a range of of rationales for a life cycle product, the super industry certainly become, you know, more peer aware and competitive, and, you know, there's a lot of focus about making sure you're a strongly performing fund. So in some ways, that's that's kind of fed through the industry from a from a regulator perspective, I think funds also, of course, need to judge kind of what's their membership base. So if your main membership, by default, goes into my super you know, what do you do if, say you've got a lower risk, an older, more conservative membership base, on average, compared to, you know, a younger more risk taking potentially membership base in another fund and your those two defaults are being compared against each other. It may make more sense to have a life cycle product that can respond within the default to the different types of of members. It exist and still being kind of comparable, you know, in a, you know, balanced survey type construct. Yeah, I think, you know what I originally when we first did the work on life cycle, what I liked about it was that it had a sense of from, just from the member perspective, that this, you know, age is something you do when your assets are bigger. You know, you don't want to be losing taking on too much risk. You might want to, you know, have more moderate risk, and the fund is managing that for you without you having to think sort of people don't spend a lot of time thinking about their super default option and whether it's fit for purpose. You know, after a decade of when you set it, and I think that's right, because we still see in Super a tendency for for members to increase switching in challenging market environments. And that's often the worst time to switch, because they do it at the bottom. You know, it happens at the bottom of the market after the GFC, a lot of people we didn't see, you know, they didn't switch back for a very long time, so that the risk of not having enough in retirement is really coming to bear there because of switching due to risk concerns. And so if you're in a life cycle product where some of that risk concern is is being abated because you're near a retirement and you're in a bit less risk than you were naturally, I think you know, it can provide a greater sense of, you know, willing to stay with it for members when you get into more tricky environments.   Wouter Klijn  31:29 And I think the same is true for sort of the younger cohort, where I think a lot of life cycle funds tend to be a bit more aggressive there. So a lot of growth assets in the early years, which you know if I think if young people make a choice, they tend to go more conservatively, rather than more aggressively. So it's probably good to have that setting up front, that if they don't do anything, they're in a high growth asset. And I think that's recently David spoke about that as well, where, separately, with his work with the actuary Institute, where they're looking at what is the chance of actually making your investment objective? Well, if you're in cash, you're not gonna make and that's a different risk than how volatile is your investment, right? So it also works for the younger cohort. I think there maybe finishing up. We can look a little bit about where frontier is now, obviously away from the early days where everything was super it's a much more diverse business. Now. There's a big insurance business that has been built up. You've been active in the private wealth space. What is, sort of your sense of where the industry is evolving? Because at the same time, we have the consolidation fewer funds, and we've seen also more fluidity, I think, between what was used to be silos. We had the retail funds, we had the industry funds, we had private wealth. But now people tend to move more across. So all of the organisations seem to get more sophisticated. What does it mean for your client base, what is sort of your outlook on where you might grow, and how the first fight it is?   Kim Bowater  33:07 So I think, I mean, we've really broadened our business. So we obviously have a heritage in superannuation, and that continues to be quite a large part of our business, including offshore as well. But we've really broadened and as as a business, as a consulting team, into more specialisation of asset owner type. So we have quite a an experienced insurance and liability driven team, mostly of actuaries that really are very in tune with investing for those sorts of requirements and what that that market is, and we have a team that's focused on the smaller asset owner space, be it, you know, universities, that They can be quite sizable, charities, family office, wealth, and I think with that group, which is kind of quite diverse in and of itself, what we're seeing when they've come to us over time is they they've got to a size where they can kind of contemplate an institutional advisor, and they want to really strengthen their arrangements, their governance, their portfolio, make sure It's fit for purpose. And that's kind of where we frontier comes into play. And I think what we're seeing is the growth in in assets enables that so in wealth as well. We're seeing a movement of talent between, you know, super and consulting and wealth, and we're certainly seeing wealth really look to kind of strengthen its own processes and portfolios. And that's that's really important. I think that's really exciting for the investment industry. Fund managers as well in Australia, you know, who have been in the institutional space and in a consolidating supermarket, but now you know, have this. Broader opportunity set as well, and and, you know, wealth platforms that are really looking to kind of make sure they're they're bringing a strong, robust institutional quality to their client base.   Wouter Klijn  35:12 Yeah, yeah. So we started off saying, you've been 23 years with Frontier, you've seen a lot of change in the industry. And I remember reading earlier this year for International Women's Day, you you wrote a piece that when you finished your CFA in 2001 there were only two women in the Melbourne chapter for the CFA. I think that has changed a bit. But what is your view at the current state of sort of the gender balance in the investment industry. Are we getting there, or are we still a long way off? I mean,   Kim Bowater  35:47 it's certainly a lot better than than then. That was a bit of a surprise, because, you know, in science and, you know, actuarial, actuaries and such, it was much more balanced. And it took me a little while to figure out too, because frontier was always, you know, had leading female investment, people with Fiona, but others like Kerry Williams and Sarah Khan, so we were a bit of an outlier and and often, you know, people mentioned that specifically as having kind of more women, which was great, I think. But yeah, it took me a little while to realise the investment side was, more broadly, was was a bit poor. And I think we're seeing more women, particularly in asset consulting and in asset owners. I think then the fund manager side, it's still, it's got better, but it's off a really low base. And I think there's a range of data we continue to track that. I think the CFA does work on that as well. Lot of male oriented, dominated investment teams. And I just think, you know, diversity of thought and diversity of perspective is really important in investment decision making, and you can't just have and likewise, you know, gender has a role in that, and just to kind of having one woman is not sufficient to to open that diversity gate and for other types of diversity too. So I think there's, there's definitely more to go. I think there's a lot more, you know, senior, experienced women and in the industry that people can look to, and that's really important too, to see what success looks like, and see different ways of being in a senior role. So I think that will feed on itself still. But you know, every organisation should be thinking about about that aspect. It's something we cover in our manager research as well. We think, you know, just continuing to discuss that topics an important way that change occurs.   Wouter Klijn  37:42 Yeah, it's interesting to hear you say that you didn't initially realise, because obviously Frontier has that heritage. And I mean having Fiona Trafford Walker there, I think she, you know, is one of the big figures of this industry. Was there a point where you sort of went like, oh, not every organisation has a Fiona. Is there sort of that realisation that you went, Oh, this is actually quite a unique situation. Yeah.   Kim Bowater  38:06 No, it was, well, I mean, certainly at the I mean, investment teams when I started at Frontier, were very small. They mostly male, but very small, so it wasn't kind of a fair judgement. But, you know, boards and investment committees were mostly male fund managers. Teams were mostly male. I remember going on a research trip. We're becoming a range of asset classes, but mostly private markets. And, you know, I think we met with around 30 firms, like, so, a lot of different investment people through those meetings. And I got to the end, I thought, Oh, we've met with, like, maybe three, three, you know, maybe not 300 people, maybe over 100 people from investment teams. And I think three were female, right in the whole trip. And I thought that's yeah, it just kind of once, you kind of didn't notice it for a little while, then you're like, Oh no, that's not Yeah, that's just low, that's a low level. So it, it kind of came to to bear from a couple of different, different elements, but I think a lot of work's been done on that. I think organisations see the the merit in, you know, a broader perspective and team and, you know, so we're, we're on a, we're on a positive journey, I think, with it, yeah, yeah, excellent. I don't really know what it is about investments that would make it like this, to be honest, but   Wouter Klijn  39:28 Well, I do remember that one of the early podcasts that actually Daniel grioli did for me, he was talking to Denise Selden, fund manager in the US, and she started out with, I think, encore on the stock exchange floor, and that was at a time that women were not allowed to, like, visit the same cafeterias or something. I think there was a sort of form of segregation. So at least we've come a long way since. But yeah, we still got some way to go in other aspects. Yeah. But Kim, thank you very much for your time. It was great talking to you and yes, thank you for coming on the show.   Kim Bowater  40:06 Thank you. It's been great.
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  126: Professor Scott Donald – Should Trustees Use AI? 05.01.2026 40min

  In episode 126, Scott Donald, Professor at the Faculty of Law and Justice of the University of New South Wales, breaks down how artificial intelligence is reshaping the work of superannuation trustees. Efficiency is the big draw, but legal and ethical risks mean trustees are moving carefully. AI is already embedded in parts of the finance sector, from document summarisation to risk management, yet its tendency to hallucinate and behave inconsistently remain serious hurdles. Scott explores where AI can genuinely add value and discusses its application to investment strategy, compliance and even private-market valuations, while stressing the need for strong human oversight. Enjoy the show! Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights Overview of Podcast with Scott Donald, Professor at UNSW 02:00 Using AI as a trustee is a little bit different because you are managing money of somebody else 04:00 AI can be applied where a trustee knows what information to look for, but just asking it to go and look for something can be quite dangerous. 07:30 Trustees have an obligation under the SIS Act to form an investment strategy. I think it would be very dangerous to use AI here. 10:00 Risk is where you don't think to look; AI can help with that 12:30 AI models don't really hallucinate. They don't seem things that are not really there, because they don't care about the truth. 14:30 In contrast to a fund manager, a trustee often has to answer to the Australian Financial Complaints Authority (AFCA) and they will ask you to justify your decision. 'The machine said it', is not an answer that is going to work. 18:00 How human interaction with an AI model occurs is actually quite crucial and we haven't really grappled that to the ground yet 24:00 Should trustees use AI at all? "I think they should consider it, because it can drive down costs" 30:00 Most of the AI systems out there are trained on datasets that are massive, compared the data in a super fund 37:00 As investment and legal professionals, we have to be aware that some of the skills that got us to where we are now are no longer worth the cost to us to acquire Research paper: Donald S, 2025, 'Artificial Intelligence and Super Fund Trusteeship', Company and Securities Law Journal, 41, pp. 137 - 157 Full Transcription of Episode 126 Wouter Klijn  00:00 Welcome to the [i3] Podcast. I'm here today with a return guest, Scott Donald, who is a Professor at the Faculty of Law and Justice at the University of New South Wales. How did you come to research this topic?  Scott Donald  00:24 Look, it's very difficult to avoid the issue of AI. It comes up everywhere in the news, talking to trustees about what they're doing, the plans they have for next year, and so on. So for a lot of Trustees, it's a really important issue. Trustees typically don't have enormous resources to spend on things, and they've got an enormous list of things they've got to get through. Yeah, so it's, it's a natural place for them to look for efficiencies and ways to get things done quicker, more rigorously, perhaps cheaper. So just hearing it on the on the grapevine, that they were really interested in this, but, but also a little bit nervous. Yeah, you know, what were the risks? How, what, what, from a legal perspective, might be some of the issues. And so that was really how I started to get engaged in this is to think, Well, we know trusteeship is a little different. Yeah, it's not just about managing your own money. You're managing money for someone else, and that that does change things a bit. So that's how it came about. Wouter Klijn  01:22 So did you find that they were already dabbling in AI, or were they more curious?   Scott Donald  01:27 I think most of the big financial institutions are well down the track of thinking about how they can employ AI in different areas. And so the trustees that are part of those big institutions were hearing things or being told that they should consider different ways of organising their operations. But just generally, even at conferences, you'd see people talking in groups, or maybe the presentations from people who are spruiking the advantages of AI. So they were coming across it in lots of different ways, and there'd be very few boards, super fund, boards, managed investment scheme, boards that aren't think, haven't thought about, haven't discussed, how might we use this? Could we do that? Could we do this? Or could we do that? But it's hard to get independent advice on it, because the expertise in the area is so much in the hands of those who are selling the various products that you know you're sitting there as a trustee with lots of other concerns to do with the administration of the trust, to invest and so on. And now you've got, well, hang on, what do I do with AI? It's, it's, it's not an easy area to get into, yeah.  Wouter Klijn  02:32 So what are some of the obvious applications of AI for a trustee? I could imagine that, you know, they get large amounts of documents to read. A core of AI, at least with large language models, is sort of the summarisation capabilities. Can they just chuck it in AI and tell them what they should know?  Scott Donald  02:52 Well, sometimes that's always very tempting, and sometimes it's a better idea, and sometimes not so much. I mean, AI is very good at collating information. You can send out to search things, find things. It's helpful if you know kind of what the lay of the land is beforehand, because it's not quite so good at disclosing that it hasn't actually found something, or it hasn't known. And we'll maybe talk a little bit later about sort of hallucination and the way it can create apparently information. So I think certain types of summaries, it's very useful for, I think some of the trustees that we've been speaking to who are using it to in very controlled environments, so places where or circumstances where they know what type of information is likely to be relevant, they know what type of information they need to bring to bear on a decision, then I think it's much safer. I think just asking it to go and look for something could be kind of dangerous. I don't know if you've ever tried to plan a trip somewhere using it, or tried to find the date for something, it quite happily will come back and tell you the wrong answer, and not really. You've got no way of second-guessing whether that's right or not. Yeah. So, so I think that that kind of summarisation is useful, but you need to be really sensitive and thoughtful about is this an area where we know what sort of information we're likely to find. So, you know, the insurance companies have used AI very effectively to understand better the nature of the risks and the sorts of information they need to work out what the underwriting risks are around around their book, but they're looking for specific things. They're interested to find patterns that they might not have seen otherwise. That I think works quite well. I think if you were just trying to do it in an area where you know, perhaps you didn't know what sorts of answers you wanted to find. You might be a little bit more. Might be a bit riskier for you. Wouter Klijn  04:49 Yeah, so I think in your paper you list a few areas where it could potentially be applied, and I picked out a few that I thought were interesting for. Sort of the investment environment, and one of them is investment strategy, mandate, compliance and private market valuations. Now those sound kind of complex topics. Is that sort of an obvious area to apply? Scott Donald  05:16 Ai, let's start with the investment area. I think, for instance, if you're a superannuation trustee, you actually have a responsibility under the under the SIS Act to formulate an investment strategy. That particular act is one. I think AI, you'd be very nervous about using AI for, because the actors said you as trustee, and therefore, you know your directors have a response, a legislative responsibility to do something, which means that if it's ever comes into question as to how that was done, you need to be able to demonstrate how you might have gone about it. So the highest level investment strategy story that that, I think you need to be careful about how you might use it. But beneath that, you could fund funds and investment managers, investment managers and investment firms have been using AI for some time to go looking for trading strategies, to go looking for risks, to go looking for other sorts of things that maybe wouldn't be apparent using normal kinds of analytical techniques. And I think it can be tremendously powerful there, because at that point that's really kind of a flow down from the overall strategy. And I think you can, you can certainly use it there. And hedge funds and investment managers and others have been using it there quite productively for some time. Yeah, and that makes perfect sense.  Wouter Klijn  06:33 I think the area of private market valuations, there's this a lot of focus on that by the regulator. They want to see more of it, potentially more look through. How can AI be applied there? Scott Donald  06:47 Look, one of the nice things about listed markets is you've got lots of people looking at the data from lots of different angles, asking lots of questions. And so any finance theorist will tell you that an efficient market hypothesis, you know that all that information is going to come to bear in private markets, you don't have that quite so much. And if you're trying to work out what the value of a property is, and all your all the leases and all the rest of it, and drawing all that information together can be incredibly time-consuming. People make mistakes, not just machines, and so, you know, it's error-prone as well. So I think some of that data collection, again, where you're looking for particular things, where you're looking maybe through lease terms and so on, trying to work out if there's anything unusual in any of those that might give you concern about risks. I think it could work very well. Ultimately, though, in something like a valuation of a private asset, again, you're probably going to want some kind of expert human looking at it and going, Okay, does this make sense? But maybe looking having that person look at what the AI has come up with to say, Well, why is this coming up with a different answer? Or what's what sorts of signals that are coming through the analysis that an AI model can do that I wouldn't have seen otherwise. Wouter Klijn  07:57 So it's sometimes that third opinion, second opinion, to just have a look at things and maybe come up with areas that have been overlooked. Scott Donald  08:06 I think so. I think there's, I mean, one of the challenges in risk management generally, and it has been for as long as I've been part of the industry, which is now approaching 40 years, is risk is where you don't think to look right? You can measure the all the data that's coming out, but that will tend to tell you things that you already sort of sense. Occasionally, you'll see something what you really the real risk, the one that really kind of keeps you awake at night is the one that you haven't seen. And AIS go about their tasks slightly differently. They can find things that don't jump out at you as an analyst, or perhaps don't get picked up in the econometric models or the linear types of analysis that typically we do. So I think there's a real opportunity there. The challenge, though, again, is, is that those risks have to be tied down to something. So you have to have some way of understanding why might that be a possibility? Because, I mean, we can all, we can all think of risks that are wild and outlandish, but that's not really the point. It's actually trying to work out how it might play out. What might, what might the cause be? How might it play out in my portfolio? How is this something that I should be really concerned about? And some of that modelling actually is something that, you know, it takes a bit of time to do that, but an AI can do that quite well.  Wouter Klijn  09:23 Now, you mentioned earlier that part of hallucinations, and I think that is sort of the key part to tackle with bringing AI forward. Now, I had recently a conversation with Alistair Barker at AustralianSuper, and he's looked a lot into AI, and he sort of made an interesting remark where he said, You need to allow AI to hallucinate, because otherwise it will never come up with novel answers. You just have to manage that. What is your take on it?  Scott Donald  09:50 I'm going to take a peculiarly lawyerly approach to this, so it might be a different one might come up slightly different, and that is that as law. Is we care about why things are decided the way they are quite a lot. And so for us, process is very important. Yes, it's good to get the right answer, but mostly the situations where a lawyer gets involved, the wrong answer has been arrived at, and we're trying to work out whether there's been a breach that is culpable in some way, that somebody has acted carelessly or in some other way, and that's where the issue of whether something's a hallucination is actually quite important. And as a lawyer, and if I was a philosopher, I'd say actually, aI don't hallucinate. When you hallucinate, you see something that nobody else sees, but you believe it to be true, and the AI models don't do that. They don't care whether it's true. That's not part of their register, right? They all they're trying to do is identify patterns. The semantic truth of something is not something that's important to them. Yeah, and that's really a big problem as a lawyer looking at a decision system, because I don't want to be on the defending side trying to say, Oh yes, Your Honour. I We employed this. We've employed someone who doesn't care about the truth. You know, we wouldn't employ a person who said that. They just look for a good answer. They don't care about the truth. You always. So I think, I think that's important. And so if you think about the different types of errors that can get made, the hallucinations, one where the person thinks it's true, but nobody else you know the objective truth tells you it isn't a lie, is where you're trying to you know it's not true, and you're trying to convince somebody else that it is true. The law doesn't like those but the AI model isn't doing that. Typically, it's doing something else. And I hope you'll excuse the French here, but it's BS'ing, right? Because it's saying something, and the truth, or otherwise of it is not of relevance. It's been given a task to find something, and it's and it's projecting that back to you, but actually, the truth of it isn't, isn't the key, and that's a problem that really is a problem in certain circumstances, for a trustee, particularly, but also for a judge, actually. And this is why this, this is why you're seeing the kind of frisson that you're seeing through the court system at the moment and through the legal profession, is actually truth matters, and a desire to not tell lies matters. So the nature of the of this is actually quite important. And so I would be very nervous if I was defending somebody in the end, and it doesn't care about the truth, it just tells us what it thinks is the best answer, and we go with that. Worse still, if I can't explain how the model got to that answer, and that's so the opacity and the non linearity also pose challenges, and what we've got to remember is that often trustees is different from an investment manager, but for a trustee, you'll be up answering questions to AFCA (Australian Financial Complaints Authority) or to a court, where they will quite they will actually expect you to justify the decision. So the first thing that AFCA does is to say, Okay, there's been a complaint made against you, Mr. Trustee, or miss trustee, could you please explain your decision? The machine said it or the machine, the machine said no, or machine said yes, is not an answer that's going to work very well in that context. And so to the extent that trustees of super funds are using these machines tests to assist their decision processes. They always need to have in the back of their mind that if it's a type of decision that could be challenged at some place like Africa, so it could be an insurance decision, TPD, insurance, or some other kind of it needs to be something that they can be really confident, that they can defend, because otherwise you're just gonna be writing checks to disgruntled members. Yeah, and that, and that doesn't seem sensible, so I think, I think an awareness of where the risks lie in different models, and there'll be different risks, is really crucial. Wouter Klijn  13:55 And sort of comes back to the idea that maybe a machine helps with a decision-making process, but you're still, the end, responsible for their decision. Trustees, in particular, they carry that responsibility. They can't just hand it off to a system. Scott Donald  14:11 That's true. I mean, I still think there are things that trustees can use them for quite, quite intensively. The one of the issues we've talked my colleagues and I've talked to trustees about at some length, because it's a bit, it's a bit subtle. Is okay? So what is the kind of human input? Where do you where do you have that occur, and what's and how thick is it, if you like, because it seems to me, you know, the human in the loop argument, oh, well, that's right, we're gonna run the machine. Then somebody's gonna, Scott's gonna sit down. He'll have a look at it, and he's an expert, so he'll work out whether it well, hang on, a second process of review has to have different criteria than the original decision process. Otherwise, it'll just come up with the same answers, right, right? So the nation of notion of a review is inherently that you're looking at something from a slightly different perspective. So what is that perspective? Why haven't you already built that into the into the. Into the system, because it's a system that you can programme how you like. So you could, you could add that in there. So that's the first thing. The second thing is, if Scott's going to spend only 20 minutes or 10 seconds or 15, you know, I have a really short time looking at this thing, what's how much is he going to catch that the machine that's been probably spending less time, but actually using a lot more rigorous analysis has come up with. So you don't want it to be too narrow, because it's gonna you're gonna still let through lots of problems. On the other hand, if it's too thick, not only do you have cost implications, but you also have then the possibility of going before a court or tribunal and saying, Oh yes, you know, we run, we run the machine, and then Scott spent an hour reviewing it, on average. Over the course we dedicated two people full time to review these decisions. If it's too thick, the court may say, Well, okay, so the model doesn't matter, then I just want to understand what those people did, and we're right back where we started, except you're probably spending those people probably spending less time doing what we now call a review than they did making the original decisions. And so it becomes, again, much more vulnerable to legal challenge. So I think thinking about how human interaction with this model can occur is actually quite crucial. It could be quite subtle as to exactly how you position it, how you explain it, how you track the circumstances where human intervention occurred or didn't occur. And I think, I think we haven't really kind of grappled that to the ground yet in terms of all the different types of ways in which we could use these models, because it could make it could actually make quite a difference. You could end up undoing the good work that you've done by not being able to explain it, or by not really, kind of getting that human machine dynamic, yeah, established properly.  Wouter Klijn  16:47 And I think there's a number of issues with sort of answers that AI systems come up with, because there is definitely a tendency for the machine to want to please you, so you're not necessarily going to get a whole different perspective on a certain matter. But what I also found is that it can be quite inconsistent, and I'll give you a little example, because I've been playing around with it, but I use a lot of images for my newsletter, and sometimes I get very blurry, low resolution images, so I thought I'll take one and see if it can sharpen it up a bit and give me a better quality picture. And surprisingly, it did it perfectly, and I suddenly had this really clear, high res image. This is great. So I did it again the week after, and it told me, Oh no, no, I can't manipulate images of real people. I'm like, you just did that last week. No, I didn't had this argument with this AI system, but it just came up with a completely different answer. But what do you think of that in the context of, you know, if you having to justify yourself in front of a court, and it can be wildly inconsistent responses or decisions from these systems. Scott Donald  17:55 It does rather undermine the kind of argument that you're using it, because it brings rigour and consistency to your to your decision making. It's which, which often is why people want to use it and quite rightly, right? So that that that can be a problem, I think another problem that people haven't quite I think the technicians understand it, but people in our industry, perhaps the less across it is some of the value in what we're asking these models to do is if we can get them to actually learn organically from their from the experience, so that they evolve as more information, either in the local in the kind of the local environment, or more generally, in the sort of the world environment can be, can be brought to bear on it. That means that the decision that you make today is going to be different than the decision that you might make in two weeks time or whatever, and we're kind we kind of used to that, like we as human beings. We make decisions in that way. But it does actually make it perhaps difficult to go back and actually, if you haven't tracked exactly why it was a decision was made by the machine on day one, day 15, and day 30 and day 200 it'll come up with different decisions, and you won't necessarily be able to track back. So actually, tabling, tabulating, kind of how we got to particular decisions is going to be really important. We can't ask the it's how. I suppose maybe we could ask the machine, what were you thinking two two years ago, or two weeks ago? Or, you know, when this particular event occurred or this particular decision was taken, I think we're much more used, certainly as lawyers, we're much more used to interrogating people about those sorts of things and getting a sense of and accepting the uncertainties and ambiguity in witness evidence than we would be trying to interrogate a machine to tell us that particular machine that we've already said doesn't really care that much about the truth, and just one the truth and just wants an answer that fits the the rules it's been given as best as possible. So yeah, I think it's a real issue.  Wouter Klijn  19:51 In the paper you you mentioned the aspects of risk and where you look for risks. And I kind of had to giggle a little bit, because. It describes that risk is mostly found in situations where a lack of accuracy has negative consequences. And I thought that's pretty much everything.  Scott Donald  20:09 So if I, if I employ an AI, an LLM, to write a newsletter to my to my members, and I choose a word that's not quite the best word that it could have been chosen or that, then, it might not be as clear. It might be ambiguous. I haven't done the best job of communicating with my members, but I can probably live with it if I send in a report into APRA describing my portfolio position and my AI has decided to fill in a gap that wasn't because the data wasn't there. That's what I mean by that being a problem or, like, there's real consequences to that. I was recently in a situation where I had to submit some things on a particular date for my university. In my university, gar, we had a particular day I had to do. So I was really struggling to find what date it was for this particular year. So I just went into Google thing, planning actually to go right through to the University website. But I won't mention the name, but a very well known AI gave me a date. Luckily, I didn't believe it, because it was eight days later than the date that I was supposed to actually submit. That would have had terrific consequences, as in, terrifically bad consequences. So I think even even in certain simple things, the concept, the consequence of it being wrong, a greater whereas in other in other circumstances, they're probably not. If I get an AI to rewrite an email that I've already half drafted so I know what I want to say, and maybe it doesn't do a terrific job, and that's not a big risk. I've already thought about what I want to say. I can look at it and I can either correct it or go with what's there, and it may be better than I originally came up with, but if I'm going to use it to try to value a complex derivative, and it ends up in some weird place, yeah, that could end up costing me a lot of money. Yeah. So I think there's, I think there's a sort of sense that, again, it's knowing what the risks are with the model that you're using and thinking very carefully about the institutional context and setting that you're going to be using it in, and trying to think, well, is that risk a problem here? A model that generates the wrong outcome in a hedge fund may not be such a big issue. There's not, there's a lot of proprietary trading going on. You know, it's some, some of that's going to work. Well, some it's not. If I've written something very carefully in my PDS that goes out with my manager investment scheme that says I will do X, Y and Z, and for some reason, I've done X, Y, Z and Q, again, context matters in terms of those sorts of risks.  Wouter Klijn  22:44 So do you think that trustees should use AI at all for important tasks and decisions? Scott Donald  22:51 I think they should consider it. I think, I think the consideration of it is really, is actually really important. I think there'll be places where they can they really can drive down certain costs and also improve certain types of interactions. I think some of the member interactions that they can have can work very well. You know, one of the challenges we always have in the superannuation industry is providing information to people in a timely way that's helpful to them in a format that they can understand and I think carefully directed. I think AIs can help us to have those sorts of interactions, or at least in a different set of interactions that maybe complement what we already do. Would I be having them answer questions from a regulator where the where the accuracy is absolutely crucial? No, I certainly wouldn't be doing that because that that could have all sorts of adverse consequences.  Wouter Klijn  23:45 So when we talk about setting sort of guidelines around how to interact with AI and where to use it, I sort of earlier spoke about sometimes it can be quite inconsistent. Is it possible to sort of develop a general set of guidelines around this, keeping in mind that this space changes so rapidly. Some functions that were there a couple of weeks ago are no longer there. There's new functions. There's changing functions and applications are the guidelines always behind the ball. In that perspective? Scott Donald  24:18 I think they all regulation, to some extent, is likely to be chasing, trying hard to catch, to keep up, and something to some extent that's to do with the design of the regulation, as well as, to what extent do you want to try to discourage certain types of conduct? Or it's not, it's not all about punishment. It's often about trying to encourage certain things and discourage others. So I think regulate, regulating anything is hard, and regulating something that moves at the speed that AI moves at is particularly hard. What I would be really keen to see people do, though, is sort of look inside that label, because there's so many different things AI gets used for. And. Think you really need to understand, okay, what is this? What? How are we going to use this particular piece of technology? And if it's just an LLM to improve our responses to questions at the annual members meeting, for instance, then that implies a certain set of guide, you know, the certain things that you would certainly set up as guidelines around for that. If it's an investment strategy thing, it's slightly different. If it's something that's going to be informing or even powering your determination of insurance claims from members, then I think it's different again. So I think I'll be pleased, I'll be happier when I see people stop talking about AI models so much and really focus on the specific tools and apps and models that they're using, and think about them a bit more carefully, because I think there's big differences across the across that diversity.  Wouter Klijn  25:49 Yeah, I was just about to ask you about different AI models, but more so on the side of security. So there's, of course, the systems that we're familiar with, but they tend to be open to the public, and you have to be careful with what type of proprietary information you put in that. And you can also build a closed system where it doesn't go outside the organisation. It only deals with the information that you feed it. But there was a well published study by MIT earlier this year that looked in how successful pilot programmes were with AI, and surprisingly, they found that the companies that use off the shelf systems tended to do better than systems that they were trying to build themselves, and whether it was due to costs or complexity, but they found the off the shelf systems work better in terms of that trustee environment. Do you think that there's Do you lean to any particular model?  Scott Donald  26:48 Again, it depends on and depends on how you're using them. When you start to look at what AI is doing, potentially for you, and just in kind of very abstract terms, and particularly where it's embedded in some kind of decision process. We know it costs money to train AI to do something, and you either, you either pay that money up front and you're aware of it, or there, or there's some other way in which the money is being paid. It's like when you go to a poker game, if you don't work, if you don't know who the Patsy is, it's you, you know, if you don't, if you can't work out how they are no nothing is free. So if you can't work out where the money how you're paying for something, then be careful, because it's coming from somewhere. So you're paying you're paying for this technology somehow, and you're typically paying for it, more or less in sense as what a micro economist would call a fixed cost. And you would do that if you thought that the incremental costs of every decision, the marginal cost was very low. And so it's kind of this classic efficiencies of scale, economies of scale, right? It works really well on a cost basis, if it's a, if it's a sort of problem or process that you're going to run often, and it's a relatively stable process. So you don't have to keep training it. You don't have to keep throwing in, oh, hang on. Say, Oh, hang on a second, there's just been a new law passed, or there's just been a new regulation, or a new whatever. So you don't have to keep modifying the model from outside. So there's certain types of decisions I think that work better on that efficiency if you only make the decision infrequently, and it's in a volatile environment where the conditions change all the time in ways you have to then it's going to cost you a fortune to do so. I think it's, again, it's when you look at the sorts of decisions that superannuation trustees, for instance, make, which is sort of where the paper is mostly looking at, there are some decisions that they make very frequently on very similar bases, and that's the sort of place where you might go. Actually this could, this could work quite well there. Now we just need to be careful, though, because when we talk about training systems, most of the AI models are trained on data sets that are massive compared to the sorts of data sets that we have within a super fund. And particularly if you're going to say, well, for reasons of confidentiality and privacy, we can't really allow our member details to get beyond our own walls, right? Our biggest funds only have 2 million members. 2 million data points is nothing for a big AI to churn through. And if we're talking about decisions made with respect to say, insurance. It might only be a few 1000 of those each year. We don't really have the data sets that are going to be very effective in generating really sophisticated, rich models. So how do we get around that? Can we find some other way that we can work with some others who might have some data? We certainly know we can't go to public data because that's going to that's going to breach the confidentiality that we have. I mean, one of the things, and again, this is probably too detailed, but one of the things that you know we all do when we sign up to invest in a super fund or a managed investment scheme is we find sign the application form, and on there it says, you know, you consent to your data being used in particular way. Not all. Those consents actually work in terms of allowing people to use the information that's there for AI. So if I'm a trustee, some of some have now woken up to this, and so they've amended what they write there to try to ensure that they can use data in certain ways. But if I haven't, the very real risk that I'll get sued by someone who says, I just found out that you put my data into this model, and that's now informing some other data set that I didn't give you authority for. And that's the sort of stuff that regulators love, because it's really easy to prosecute so so even very practical things like what's what's written on the application form, you know, something as mundane and as prosaic as that is affected by these sorts of considerations.  Wouter Klijn  30:45 Yeah, yeah. So what's next for this research? Have you been talking to people about establishing guidelines or using this for a basis for that?  Scott Donald  30:53 Look, I mean, UNSW has a programme that's public, that's announced with with one of the big fund providers, and that's and that's giving both both parties an opportunity to learn from each other. My objective in in raising this was not so much purely to to inform that process, but just generally, to alert people who were, you know, hearing that from management and from other sources that they had to be thinking about how they might use AI and that trusteeship and really were starting to get a bit nervous about what that might mean and where the risks might lie, and to and to encourage them to actually think very carefully about what sorts of processes, what sorts of uses they might put this Technology to some of them in there's some very, very smart people working at the universities who really understand how these models work. I've seen some of our, some of our and UNSW, I've seen some of the people there. I've seen them on television and thought, wow, that's really insightful. What they don't know, though, is how that engages with business or with different types of decision context, institutionally. And so I really encourage people to try to draw on that and not just take the kind of headline marketing speology that you get from some of the providers, but to actually really drill down and go, Okay, how might we use this to make a difference? What really are the risks? How might we, how might we address that? How can we talk about this, to the people that we have, our stakeholders that we have to talk to? And, you know, once you start doing that, you start to realise it's not just, you know, there's something involved to it. There's actually, it's me costly to go through that process of thinking about it. Take some time as well. So, but I think, I think you have to, I think at this point, certainly, when I'm speaking to my students at law school or speaking to trustees, there's a sense of, we can't stick our head under the sand and pretend this is going away. It's actually there. It's actually has some really important applications, and the fact that it wasn't here in quite the same way five years ago. Is not a reason not to we just have to invest in our knowledge and understanding.  Wouter Klijn  33:06 Yeah, do you use AI in your own job every day, every day? Absolutely, what sort of tasks?  Scott Donald  33:14 Well, it's embedded within a lot of programmes where I don't even see it really. I mean, a lot of the Google searches have that sort of stuff in there. And from time to time, I'll be interested in understanding something that I haven't come across before, and that's a first cut. Sometimes I'll chase things down. I don't very often use it to large language models to run over my writing. I find I'd do enough writing as it is that I'm not too worried about that. But yes, in a pro inappropriate ways. I've used image generation models as well for Occasionally, when I'm doing presentations and I can't find the image that I want to sometimes I'll use it for that. That's fine.  Wouter Klijn  33:51 I've heard of an interesting application where students are using AI in novel ways, and not so much of what we hear about. They write an essay for you, but more in terms of learning and changing the way they learn about certain topics. So one application was where, basically, they trained in AI to be a specialist in a certain particular topic that they were studying, and then had a Q and A session, essentially with this artificial expert. And by that, it reiterated certain content that they were trying to memorise. Have you seen some of that? Have you seen other ways of students using AI?  Scott Donald  34:29 Oh, yes, we I mean, for quite a number of years, I've done things like given students an essay question and then shown them what what a simple AI answer would look like, and then get them to critique the AI answer, and so it that's really helpful, because that really forces them to think critically, as opposed to just descriptively about a particular asset question. So So yes, we do. I think that that sort of stuff can can work very well. And I mean, I still remember when I was I was young. About 30 years ago, researching for my master's degree, I used to go into the bowels of the London School of Economics, and if I found two or three cases that were relevant to my thesis at that point, that was fantastic, and it was a great day, and they were dusty, and I probably ended up with all sorts of mites and other sorts of things from books that hadn't been opened for decades. These days, students can find that same, not three cases. They can find 300 cases, if they exist within seconds. So the skill that I had and the perseverance of being able to go in those particularly dingy corridors is no longer worth anything. I think we need to realise that actually some of the stuff that we as slightly older, more experienced investment professionals, legal professionals, governance professionals, some of the things that have got us to where we are now are no longer worth what they cost for us to acquire that we're going to be able to do certain things, like rephrase an email very quickly, and there's no value in doing that anymore, because a machine can do it, can Do it far quicker and far better than we can. So why would we Why would we do it? Why would I still go down to the bowels of the LSE to find a case when I can sit at my desk and type in a few keywords into one of the legal databases, and I've got everything there.  Wouter Klijn  36:14 Yeah, as long as it hopefully doesn't hallucinate any cases. Scott Donald  36:18 Well, that's where you then would sit and check and go and go through. So we learned to do different things. We learned to think critically. We learned to check the veracity of the data. I never checked whether any of the little leather bound books that I found in the basement of the LSE were actually the real copy or some, some spurious version. I just assumed that, because they were there, that they were right. Maybe I should have, but I never tried to cross check it or anything. But now, obviously verifying sources is very important, because the potential for not just AI, but for all sorts of alternative versions of facts to come, to come to light is much greater. So, yeah, yeah, for sure. So I think, I think it changes this. It'll change what analysts need to do, security analysts, investment analysts. It'll change what, what we all need to be able to do, because we'll need to be able to do something different and better than what the machine can do.  Wouter Klijn  37:18 Yeah, yeah, for sure. Well, plenty of food for thought there, Scott, thank you for coming to the offices and thank you for the discussion. Scott Donald  Thank you very much.
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  125: The Devolution of Neoliberalism – UTS Finance Department Roundtable 03.12.2025 1u 5min

  In this special edition of the [i3] Podcast, in collaboration with the UTS Finance Department, we explore how the neoliberal model of economics, which largely ignored politics and focused on financial metrics, has eroded over time and made way for the rise of populism, which has exerted its influence on economies around the world. Why did the guardrails that neoliberalism provided slowly disappear and what are the consequences of this? Is there any model that will replace it? Political Economist Elizabeth Humphrys, Geopolitical Specialist Philipp Ivanov and UTS Industry Lecturer Rob Prugue delve deep into this fascinating topic as part of the Circle the Square roundtable series. __________ Follow the Investment Innovation Institute [i3] on  Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights __________ Overview of Podcast 00:00 – Introduction Wouter introduces the special i3 Podcast edition, produced with UTS Finance. He outlines the episode's theme: how the post-war neoliberal guardrails that long supported economic certainty have eroded, creating persistent uncertainty in markets. He introduces guests Elizabeth Humphrys, Philipp Ivanov and Rob Prugue. 03:04 – Origins of Neoliberal Guardrails (Rob) Rob explains the emergence of post-WWII guardrails: Bretton Woods institutions, NATO, the World Bank, IMF and other frameworks enabling stability and collective economic growth. They created a predictable environment but gradually weakened. 06:05 – Australian Context & Rise of Neoliberalism (Elizabeth) Elizabeth describes the long boom after WWII, its collapse in the 1970s, and neoliberalism's emergence. She explains how the Hawke Government in 1983 implemented major reforms—floating the dollar, tariff cuts, privatisation—enabled by strong political capital and union involvement. 10:09 – Global Perspective (Philipp) Philipp explains the Cold War dynamic: US-led order versus the Soviet bloc, with non-aligned states largely weak. Post-1970s Soviet stagnation and 1990s globalisation cemented US dominance, setting the stage for the "golden age" of the neoliberal order. 14:21 – Pax Americana and the Peace Dividend Rob discusses how guardrails encouraged discipline: countries deviating too far politically were penalised by markets. But global shifts, manufacturing loss and deindustrialisation gradually hollowed out these systems. 16:02 – Contestation of Neoliberalism & Social Impacts (Elizabeth) Elizabeth stresses that neoliberalism was contested from the start. She highlights social movements in the Global South, rising inequality, and sharp pain in Eastern Europe during rapid liberalisation. Domestic consequences—job losses, wage stagnation—fuelled political distrust. 22:03 – Globalisation, Inequality & a Multipolar World Wouter links globalisation to economic displacement. Philipp outlines four major geopolitical mistakes after the Cold War: Assuming China would remain benign Dismissing Russia Taking the developing world for granted Ignoring the power of nationalism and inequality 27:26 – Where Are We Now? Have the Guardrails Fully Collapsed? Rob argues that the guardrails can't simply be rebuilt—political divisiveness and grievance-driven politics are now embedded. Trust in US institutions and commitments (e.g., AUKUS) is eroding. 30:45 – Are We Heading Toward Chaos? (Elizabeth) Elizabeth argues capitalism is resilient but political legitimacy is collapsing. The promise of neoliberalism—trickle-down prosperity, stable institutions—failed large groups of people, fuelling anti-politics, housing unaffordability and climate-related tensions. 37:17 – Beyond Traditional Politics Elizabeth notes the breakdown of mass-membership parties and unions. Declining voter turnout and low trust create fertile ground for populism and fragmented political identities. 40:13 – Global Fractures & Major Trends (Philipp) Philipp highlights five converging forces shaping today's uncertainty: Economic fragmentation Great-power competition Societal divisions Climate change Technological revolution (especially AI) 45:28 – Technology as an Amplifier Rob and Philipp discuss how technology intensifies divisions but is ultimately a human-driven tool. AI raises the stakes of geopolitical competition, especially between the US and China. 53:14 – What Could Future Guardrails Look Like? Rob foresees three emerging forces: Rise of nationalistic policymaking Oligarchic influence filling the institutional vacuum A tri-polar world (US, Europe, BRICS) 55:24 – Can Australia Rebuild Guardrails? (Elizabeth) Elizabeth doubts that politicians currently have the vision for a new national project. She emphasises conflicts between economic growth, climate needs and powerful resource sectors. 59:24 – The Populist Base Rob asks whether a new base of disillusioned voters is forming. Elizabeth agrees: anti-politics creates a vacuum easily filled by opportunistic populists, on either left or right. 1:02:03 – Role of Media Rob highlights how politically aligned media ecosystems widen the vacuum and intensify division. 1:03:10 – Conclusion Wouter closes by noting the episode doesn't provide solutions, but maps the journey from stable post-war neoliberalism to today's entrenched uncertainty. Full Transcription of Episode 125 Wouter Klijn  00:00 Welcome to a special edition of the [i3] Podcast, produced in partnership with the University of Technology of Sydney's Finance Department, which includes the Anchor Fund, an educational investment fund managing real money, which is run by students and overseen by Associate Professor of Finance, Lorenzo Casavecchia of UTS. So this episode aligns with the second instalment of the UTS Circle The Square sessions, which are a thought-provoking series of roundtables on economic, financial and political ideas. You can find them on YouTube, and of course, [i3] is very happy to support them. So today we will delve into the neoliberal model, which, post-war, has provided guardrails for economics to operate in and allow investors to focus on the usual numbers, earnings, inflation and growth. But these guardrails have been eroding under the influence of various forces, including the rise of populism, and this has led to an almost permanent state of uncertainty. And of course, we all know markets don't like uncertainty. So how did we get here? What has changed, and why did a neoliberal model held together for such a long time in the first place? So this episode sits a little bit outside of our usual investment talk. It's more about the system underneath the data, applied political economics, and we're asking why the guardrails that once held in place neoliberalism have been thinned out and what is left behind. So I'm joined here today with three panellists. So first off, we have Elizabeth Humphrys, who is the Head of Discipline for Social and Political Sciences at the University of Technology Sydney. Elizabeth is a political economist who focuses on the impact of financial crisis and climate change on labour relations. She is the author of the 2019 book 'How Labour Built Neoliberalism'. We're also joined by geopolitical strategist Philipp Ivanov. Philipp has been globally recognised as an expert on international relations, particularly China and China-Russia relations, and he has worked in Russia, in China and the United States. So he will provide us with a global view on this issue. He's also an Industry Fellow at UTS. And finally, we've got Rob Prugue, who is an Honorary Industry Lecturer at UTS, but who most of you probably know as the former CEO of Lazard Asset Management for the Asia-Pacific region. He's one of the driving forces behind the Circle The Square roundtable series. So welcome everyone. Okay, so we're looking at uncertainty in markets, which, to a large extent, has been caused by the dismantling of the guardrails in which the political debate have moved. Now let's start at the beginning. What were those guardrails and what kept politics out of the market for such a long time?   Rob Prugue  03:04 I think the best way to explain this is it's it's nascent, and where I least I see it began, and it probably began post-WW2, when the West in particular, needed to rebuild itself after near a decade long World War and the destruction that obviously it needed to be addressed, and having learned the lessons of previous mistakes such as League of Nations or working in a bilateral World, the West appreciated early on. In order to counter the Soviet force, it needed to unify, and as part of that, it needed to build a system that would rebuild an economy by lifting the ship rather than individually handing out life preservers and life jackets to sectors, or worse, certain people. As a result, guardrails were built to make sure that this was a system that benefited the totality, rather than specific groups, and over time, that worked well. This is not to suggest that neoliberalism didn't have its challenges. Of course, we had wars. Of course, we had economic cycles. Of course, we had large unemployment. But when you compare it to pre-1946, and the fact that you know now, the world had access to nuclear destruction, all things considered, neoliberalism certainly post-WW2 had its benefits, and that peace brought a national prosperity. The guardrails were there, not necessarily as instruments of curtailing growth, but think of it as. Golf rules. I'm not a golfer, but when you go out in the golf there are certain etiquette and rules that are applied. The guardrails have that. But then they built systems and infrastructure to again, manage that. It's as simple as the World Bank, Bretton Woods, World Bank and IMF, the United Nations, the international scope, the World Health Organisation, to name but a few. But then progressively, even domestically, you had these guardrails, and that despite its shortcomings relative to pre-1946, level allowed the West to unite as a group, allowed the west the formation of NATO, the formation, again, of these other organisations. And that benefited many, until it didn't.   Wouter Klijn  05:53 Yeah, Elizabeth, if we go to you, do you want to provide a little bit of a local flavour to that and put it in the context of the local labour policies.   Elizabeth Humphrys  06:05 Sure, I think for Australia and other what I'll call, like highly industrialised countries, not so much like just the what we would call the West. After the World War, there's this long period of growth, largely fueled by the rebuilding efforts in some ways, after World War Two, but that protracted period, like the, you know, in my work and in political economy we call the long boom, it sort of came to an end in the early 1970s with the oil shocks, issues around inflation and other sort of not just issues external to the economy, but perhaps contradictions within the economy that sort of came to the fore. And I would characterise that period as more taking, taking its its lead, perhaps from Keynesianism, like these are these bodies of policies are never implemented, as in a textbook, right? They're contested, they're partial. They vary between countries. But the end of that period, in the early 1970s really, for me, that's when neoliberalism starts to cohere, not just as an ideology, but as a political project that begins to be implemented in different countries, and it looks different in Thatcher's Britain, for example, or Ronald Reagan's us, to how it looks in Australia. And it's really only in 1983 with the election of the Bob Hawke government under the slogan bringing Australia together, that we start to see some of the kind of like Big Bang economic reforms that we associate with neoliberalism, like floating the floating the dollar, foreign bank, banks being allowed into the country, reductions in tariffs, privatisation, these sort of all flow from then. But what's really important to understand is these things are not just about what the ideology of an individual political party is, but often who has the political capital to implement those policies at that time. So even though, of course, Fraser was much more conservative than Bob Hawke on a range of issues, he didn't really have the political capital he was in a war with the unions to introduce the big reforms that were being called for via government, government inquiries, when Bob Hawkes comes to the table and that bringing to Australia together, slogan, it's really to the way I would term it, restore profitability of the system that the rate of profit from investment needs to be restored, or accumulation needs to be restored. And Hawk says we have the answer that, in collaboration with the unions who have been on the front foot in the 1970s demanding a bigger share of the pie, a bigger share of GDP going to workers wages vis a vis to profit. He says, we can help deal with this unrest. And really that's the political context for me that sees this weird situation where we both get the advance of neoliberal, what we would call neoliberal policies that I mentioned a moment ago, but also at the same time, a return to centralised planning, centralised wage setting and bargaining with the support of some of industry, the metal Trades Union, for example. Sorry, the metal trades industry body was really central, as was the metal Trades Union, into bringing in this new kind of arrangements under the hawk heating government, which, of course, longest labour or social democratic government, 13 years from 83 up until 1996.   Wouter Klijn  09:51 Yeah. So if we then draw back to a global picture, and you know, Philipp, I introduced you as an expert on China and Russia relations, do. Can we even talk about neoliberal guardrails in those countries, but also broader? How do you see the global perspective from that?   Philipp Ivanov  10:09 Yeah, well, I think from the from the End of the World War Two, just drawing on what drop told us, you know, you have this dynamic of competition. So you have the two geopolitical blocks. You have the US-led system, and you have the Soviet Union and its allies, and then you have a whole group of non-aligned states. Now we call them kind of geopolitical swing states, using the Goldman Sachs sort of terminology, but back then, they were called non-aligned. So the India and China can be in that category as well. Then us creates the international institutions that Bretton Woods institutions, but it's institutions that are mainly built by the West, but, but right at the beginning, in the 1940s and 50s, there was a genuine desire for this institution to include everyone, including the Soviet Union. So there's dynamics of competition on cooperation. Was still was still there the non-aligned states, and particularly big ones like China and India are quite weak and underdeveloped, so their role in international system is really not that important. So it's really the world is dominated by this, these two rivals, and then as Soviet economy and political system starts entering stagnation. In the 1970s you know, us, led bloc continued to prosper, and with that, the Bretton Woods institutions and the systems that you know that we today discussing as neoliberal systems, largely, you know, by the 1980s you know, the Soviet Union enters into this period of deep and as we now know, the final decline and and the US led system strived and prospered, and it enters its golden age, which is essentially 1980s and 1990s you know, the age of globalisation. And you know, of course, it's uneven. It's an unequal as the rest of for the rest of the world. But we see, you know, by the 1980s we see the sort of this golden age of US led order, including the political order as well that which has elements of neoliberalism. So you have the globalisation, both economic but also political and cultural. You have US Strategic Hege money, essentially, is only one prime one superpower. We have absolute primacy of the US dollar, you know, of US culture, to some extent, of the US, economic systems and rules and structures, you know. And then we start seeing the rise of China. But it's the rise that was back then, seen as benign, you know, the consensus was that the China will become the United States, just like the United States or any other democratic nation, as its economy became a market economy, you know, you we had, you know, from 1990s to about 2007 we have a stable and predictable Russia that relatively benign, with a few exceptions. And then you have convergence of most states, including what used to be called non-aligned states in the 70s, you know, around the US led system, largely with exception of maybe some countries like Afghanistan or Nicaragua and so. And then the rise of the technologies as well, which, you know, played a big role in that convergence, the internet and then social media. So then that's kind of where we ended up by 2005 or so, you know, when I think that order started to unravel. But I think that will be your next question, yes.   Wouter Klijn  14:21 So to what degree is this, this framework synonymous with like, you know, what people refer to as the peace dividend, you know, Pax Americana and the great American Peace. Is that all overlapping? Or do you see this as a separate system?   Rob Prugue  14:36 Any government that swayed too far away left or right from the guardrails, got penalised in the borrowing cost. So whether you're left or right, you had policies that you needed funded. Some of these policies couldn't be self funded through taxation. They needed to borrow money, and so there was a shared vested interest for since basically much. Of the post-war period, until the guardrails began to be dismantled. And within that dismantling of the guard rails, we now began to see certain sectors benefiting at the expense of the rest. And as that continued, we saw more and more disenfranchised so the rust belt of the US, they felt the pain as the factories were being closed and moved to China. Australia used to have some manufacturing. Now we're, you know, now we're mining and service, very little manufacturing. So you can see how this sort of morphed itself very slowly, one drop at a time, until that glass got full. Yeah.   Wouter Klijn  15:47 So Elizabeth, if we take a domestic view at this, how did those guard rails sort of got eroded here? Because I think you tie it back in with some of the weakening of domestic institutions,   Elizabeth Humphrys  16:02 Yeah, I guess, like, I come at neoliberalism in a more critical fashion. So when we're talking about the guardrails, the setting up of those guardrails, or the setting up of frameworks, was always contested in the first place. It's not like we can presume there's a shared interest, even between unions and business or the or even within the corporate sector, between finance and manufacturing, right? These things are always contested politically. So for me, I think we need to think globally that the implementation of neoliberalism had its antinomies. It had the negative things or the negative consequences. And some of this included from what I would call from below, right. So around 2000 we actually see the outbreak of mass social movements moving from the Global South, Latin America, from, you know, the the so called IMF riots, the water wars in Bolivia, into the streets of Seattle and eventually into the streets of Melbourne, contesting the roles of things like the World Economic Forum, the World Bank. We've got to understand this is nearly revisit as contested in both its implementation and it's sort of thinning, as we've been talking about. And the timeframe this happens on in different countries varies. So, you know, we bring up Russia and the Eastern European countries. Neoliberalism comes later in those contexts because of authoritarian rule before that, it comes later to the Mediterranean, because we have Mussolini in Italy, we have Franco actually, neoliberalism is is sort of not delayed, but it's on a different time frame. But the very fast implementation of neoliberalism in Eastern Europe means that the pain that people experience as ordinary workers is really, really sharp. It's on a protracted timeframe that the gap between the rich and the poor. So, you know, we measure these in the Gini Coefficient. This, this becomes drastic, and we get situations like, you know, New Zealand, before neoliberalism, it had a Labour government like Australia implemented in the 1980s it's more equal than Australia. Australia is less less an equal country, but actually neoliberalism there leads to New Zealand having a greater gap between the rich and the poor compared to Australia today. All of these things play out because they have social and political consequences. And I do agree it's not like anybody came along with a plan about how to dismantle the sorts of structures that were built up in the 80s. But I think there's one important thing I always try and remember neoliberalism as a sort of policy platform argued that that a greater amount of decision making should be in the hands of markets as compared to in the hands of government. We understand this as the small state, lower taxes, deregulation, privatisation, but this, this is a shifting of responsibility for a range of decisions, even, you know, floating the dollar into the hands of markets. This has a political consulate consequence that when people in the Rust Belt start to experience the world as they're working harder than ever and getting far less. And you know, my dad at retirement, he was an oil refinery worker. So like, you know, I experienced neoliberalism firsthand growing up in a working class family. They they see their lot as undermined in in that period. And so it's not just a like we can't take a sort of pathologized approach to Why do these people look to politic populism, or why do people look to be dissatisfied with the political system or the financial structures? Is we've got to see it as their experience in the 80s and 90s led to dissatisfactions which play out now politically and so for me, the it's not just about how corporate interests or particular interests in the more elite sections of society or in in global supranational bodies like the IMF, World Bank, UN even the ILO right, which is a tripartite body between unions, government and industry, these things aren't just contested there and understood politically and discussed there. They are discussed every day by people who used to work in manufacturing jobs, or like my dad and all his friends who worked at the mobile refinery in Melbourne, which is now now closed, after decades and and generations of families working there, this leads to to a really sort of, for me, a confused way of understanding the consequences of neoliberalism. We can't just build back what you used to be there. Decisions are made on both what policies are fit for purpose in the moment, which is why you can get people to look the ALP in the 80s, to look to both Keynesianism and neoclassical economics at the same time, they're looking for policies that are fit for purpose. So it's no use having a kind of more paranoid who are the Who's this group of people who are bringing us this new world order? For me, it's a bit conspiratorial. I actually think mostly people, governments, policy makers, business, are looking in a self interested way, sometimes in a national interest, way for what policies are fit for purpose. And to me, that's led to a thinning of policies in relation to what we understood as those classical, more hegemonic neoliberal ideas and policies, but also to the more hegemonic social democratic ideas that have existed through the long 20th century.   Wouter Klijn  22:03 Yeah, and to what degree can we tie this back as well to globalisation? Obviously, when globalisation kicked off, there's a lot more challenges for people to keep manufacturing in their own economies. It goes to cheaper labour, countries that sow seeds for also dissatisfaction and ultimately rise of popular populism. To what degree can we tie that in in this debate, and maybe Philipp for you as well, the other part of his the post sort of war guard rails America was a dominating force at that time. Now we're living in a very different world where, as you indicated, you know, China back then wasn't as big as it is. Now we're living much more in a world where there's a multi polar world, where different forces have different influences that are all eating away at the previous system.   Philipp Ivanov  23:07 Well, we talked about the sort of economic guardrails. We talked about socio economic or social political guardrails. But there's also geopolitical guardrails that were ignored, I think. And there are four, in my view, that are quite fundamental, particularly from the collapse of the Soviet Union. It was sort of four fundamental mistakes were made, I think, by the triumphant West. Number one is the idea of China is the factory of the world. That is, that it's always going to be benign, convergent power that will largely look at the West and will largely follow that path. I think it's been a fundamental mistake, as we're learning now. Number two is ignoring Russia as a decline in power that no longer important, no longer influential. That sort of can be ignored. You know that old thesis by some of the American policymakers, that is, you know, it's essentially a petrol station masquerading as a country. Bad mistake, in my view. Number three, taken for granted the rest of the world, including countries like India or countries of collective Middle East or Africa, thinking that they essentially are converging around globalisation, which they have been, until they start converging, or until they looked elsewhere for alternative governance models or sources of growth or source of sources of equality. Right? And then I think the fourth one is really ignoring the kind of fundamental historical forces of power of nationalism and of inequality. And I think inequality plays a big, big role in that unravelling, you know, but also that sort of that nationalism, that idea that nationalism is no longer relevant and only appears occasionally, you know, around particular issues which we know is not true. And you know, you look at the world now, it's very nationalist world. And the kind of the raw power dynamics are on display. You know, it's the largest number of wars and conflicts at the moment than any time since the World War Two. And you know, the inequality, apart from, obviously economic inequality that we see around the world now. But it's that strategic and power inequality is that there's a sort of this politics of strategic grievance. You know, who is, who is kind of, who is reaping the benefits of the power and influence. Now we see it in China. They call it the age of humiliation that they're trying to repair. And, you know, rejuvenation of the great Chinese nation. That's how President Xi Jinping describes it. It's the sort of the the top of the mountain, if you, if you, if you look at the world, you know, we see it obviously in Russia. You know that the collapse of the Soviet Union, according to the Russian president, was the greatest geopolitical catastrophe of our time. So that politics of grievance caused by that perceived inequality of power, of economic wealth, of sort of influence and respect. I mean, that plays a big role. So I think there's some these are the, I guess, both the guardrails that were we as a collective West forgot to, you know, construct and to follow. But it's also, I think some fundamental mistakes in collective policy making.   Wouter Klijn  27:26 Yeah. So do we have a sense of where we are in this erosion of the guardrails? I mean, are we getting towards the end of an era? I mean, is the rise of populism and perhaps the second administration of Trump the culmination of this development, or are we somewhere in the middle?   Rob Prugue  27:45 I, as I've said before, I can't see how one can unscrambled eggs. I think the divisive politics of today is well ingrained, so much so that even traditional parties right now more so visible on the right than on the left are being it's almost like a hostile takeover by not necessarily an ideologically driven group, but to paraphrase Philipp, the politics of grievance. So Philipp correctly mentioned the politics of grievance as it relates from an international playing field, but domestically, we have it here. Elizabeth touched on that as well, where certain groups felt left behind, and that even continued much further in the 90s and 2000 with more of the regulatory guardrails which were meant to be a levelling playing field, because, after all, even the IRS the SEC in the US are being pulled back the Department of Education. It's almost, as I said earlier, government guardrails are equivalent or synonymous to bureaucracy now, and so how do we rebuild that? I don't think, personally, I don't think we can, because now at least we've gone to, at least with regards to the states that it moves so drastically away from the systems that they themselves built and marketed globally has been dismantled. So if you're outside the US, you now have to ask yourself, all right, we do a treaty. Will that treaty or that deal, still be viable? And we see remnants of that here in Australia, with regards to AUKUS and the submarines, as I think, I can't remember who it was, they correctly pointed out that there's a law in the. West that they must fill their needs before they can sell it to others. That law and the US submarine fleet needs major rebuild probably means we're not going to get those submarines anywhere near the timeframe that has been sold. So I'm not saying that the submarine is it. I would hate for anyone to cherry pick what I said, but rather look the totality, and that is, can we go back, given how massively the US has dismantled it, even within its own borders?   Wouter Klijn  30:34 So what are the implications? Then, for today? Are we, you know, slowly heading towards total chaos? How do we deal with a post certainty world   Elizabeth Humphrys  30:45 capitalism is more resilient than, I think, total chaos, but I know, like progressives are very fond of that, Gramsci quote about that when systems decay, these morbid symptoms appear when there's no kind of hegemonic order. And I do think it's kind of applicable to now in that we, we had a sort of well understood and accepted form of social democratic government of different varieties. Not the US is not exactly social democratic, but it was, it was sort of accepted, and there were consent from the masses. Right? To put it in those terms, for those systems, we're not in that period anymore, right? The government legitimacy is at an all time low in across the Anglosphere, where, where, where we are. And then the point about global grievances is very well made, right? We live in a with the consequences of colonialism that led to an unequal share of wealth and the extraction of wealth from certain geographies and its removal to others, and the build up of wealth in in what we will call the poor the core and and it's not grievances about payback, it is grievances about wanting equality, justice and a bigger share of the pie, is how I look at it. And we should see that they're not just legitimate, but completely understandable. So that promise of neoliberalism that you know that remember Thomas Freeman saying in 1996 that no two countries that have had a McDonald's have ever gone to war. Now we know that this is clearly not the case, right? But that was a promise, right? A promise of a peaceful future from the neoliberal order that trickle down our economics is a promise of something that is desired by the majority, and when they cannot be delivered because of the constraints of the system. I would argue this has this plays out politically. So for me, you know, there's this fascinating study done in the US around what I would call anti politics, and others might call populism, where they looked at these these, they had interviewed people over multiple generations about all sorts of issues. There's massive database of these interviews with ordinary UK people, and what they found in terms of politicians, is that politicians have always sort of been on the nose, right? They've never been particularly loved, but the difference now and Peter Marr, Peter Mayer and and other leading figures in in the UK have said, is the difference is that the political system itself is on the nose. Now. This is the difference in the present period. And so actually, the question of restoring faith in politics and in the Australian political system as well, is is a difficult question to solve. When people feel that politicians are self interested, that they are not from the ordinary people, that they don't represent them, that they're not trusted. This is a massive ball of difficulty in terms of policy making, right? So we get a situation, I think, where people generally want the playing field levelled in all sorts of ways. But can the system actually do this and maintain growth we have in the wings. We in the wings are massive issue around climate change, environmental damage and growth itself, with with vested interests from certain sections which are key in mining in Australia, who make massive profits with very few people employed in those industries. So we, we, there are choices to be made in Australia, and I think potentially because of geopolitical needs, because of domestic profitability and growth needs. Often those discussions about what the future could. Look like in terms of being equal, dealing with climate change, come into conflict with those other things. Like, I don't want to go out and limb, but I don't think we'll ever see those submarines. The timeframe might be never, but it for me, me, the heart of the problem is that promise of in the domestic sense, that promise of the neoliberal future of trickle down, of bringing Australia together, as Hawke said, and the failure for that to eventuate still lives in the minds of people of my generation who grew up in the 70s, but my parents and then, of course, young people now who see that they'll never make it into the housing market, right? And not, I don't mean the the ones we teach at our uni, in our in our courses, right, who come from much more middle class backgrounds, but the chances that your average person owns a house who's 20 today are actually really delayed, if ever. But I do think it's not just about selling bureaucracy. Governments still make choices. So like the the housing discussion about how we will use the future funds to fund to fund housing through investing and earning interest, this is a very different kettle of fish to a policy of just going and building public housing right now, that is an ideological choice about who should do the building and who should own those properties. So there is still a live discussion, I think, and it's not about going backwards, but whether we actually want to say, yes, social housing, public housing can be built by governments with their expertise and owned by them in the future, rather than the private sector trying to solve this problem. So that issue of who, who's responsible for social policy the market or governments? For me, this still persists. It doesn't often get a hearing and election time in those terms. But, yeah, we can't go back. We can't unscramble the eggs in that way, but we actually can go forward in building a different set of policies through, I think, considered debate from all sections of society, you'd hope.   Wouter Klijn  37:17 It almost sounds like you're describing an era where we're moving beyond politics, where people no longer feel affinity with political parties, but more of an era where people are interested in particular interest groups or particular issues, is that maybe where we see the rise of populism as sort of a disguise of the rise of special interest groups, rather than politics as we knew it,   Elizabeth Humphrys  37:44 I think we have seen one fundamental change that the political system that Gramsci was talking about when he was in jail under Mussolini in Italy, of mass membership political parties and mass membership trade unions is over right membership of the ALP, membership of the Liberal Party, these are at all time lows. Membership of civil society organisations have been declining. And this has been well documented across the US so and the UK, most of actually Europe, not just the English speaking parts and so, I wouldn't say necessarily it's a rise of special interest, but the old political order is seriously frayed, if not seriously damaged. Now I think we don't see it as clearly in Australia, because we have compulsory voting, but people voting has been going down. It may pick up at some point, but it is on a downward trend across Western Europe, across the Anglosphere. This is a this, this disengagement from politics and seeing that your views might be represented in a parliament, because that's what not voting is, not thinking you have relevance or that you can can impact this is this is a, this is a really profound issue. And so when we put all that together, this kind of fraying of the political system, disenchantment and outward hatred of the political class in some sections, right? You know, Trumpism is one example. Brexit is another. Palmer and his party here, there are lots of examples of the old ways of doing things, of a two party system in this country being, you know, seriously undermined. Primary votes for the major parties are at the lowest point historically in Australia today, that tells us something about where people see their interests as being represented, and if they don't find an avenue to feel represented, yes, then populism and what kind of anti politics is, I think, one way that. See that play out?   Wouter Klijn  40:02 Yeah, Philipp, maybe you can add to that, because obviously, you know, I think Trump is sort of the biggest symptom of the rise of this populism. Where do you see the fractures internationally?   Philipp Ivanov  40:13 Yeah, well, I think that with what we just discussed is also has, sort of, it can be described maybe a little bit simplistically, and this sort of across the five big trends. So number one, you have the economic fragmentation. And within each of this trend, I have to add, there's contradictions, there's tensions. So you have the economic fragmentation is sort of de globalisation, which is, you know, again, debated and debatable, because within each of these movements of economic fragmentation, we see some contradictions. For example, there is a push for sovereign capabilities or de industrialization, but at the same time this economic independency, or core dependency, still exists, still very strong. Then the second big trend is the major power competition, particularly US, China, but also Russia against the West. But even within this, you know, rivalry still coexist with dependency, and I think the US China relationship is a perfect example of that. Then you have the societal divisions that Elizabeth talked about. You know, despite the growing wealth, and say, across most of the western world, there are these grievances, there are cultural, sort of cultural divisions, the political divisions, religious etc. And then you have the two sort of underlying trends. One is climate change again, which is a really divisive trend, because, on the one hand, it's a global, shared problem, but there are politics of grievances and inequality that play a big role. Who has to pay for for fixing the climate change impacts and issues that are associated with climate change. And then, of course, the technological revolution, again, you have this incredible connectivity. You know, the whole world is converged, even the poorest countries. Everybody is on the internet. Everybody is now going to be a part of that? Well, not everybody, but most countries will be a part of that, AI ecosystem. But there's, of course, there are divisions, there's inequalities. So if there's five big trends converging at the same time in this very compressed period of time, but each of them, we don't even have an agreement on their direction, on the trajectory, you know? So each has this contradictory forces within them, and then, and so it creates this sort of really uncertain environment, and, and I think this is probably the best way to describe it with period that we are now, is this some kind of transition. And the question is, well, not so much a question, but I think we do have agency. What comes after? You know, it's we shouldn't be so sort of pessimistic and and passive that, you know, these trends would necessarily result in, let's say, a major war or climate catastrophe or some kind of societal collapse. We as countries, and each country, it's each government, you know, we have agency and how the next the next decade, will be shaped, you know, and I think that kind of, I think that that message often gets lost, you know, because we are so focused on uncertainty, so focused on reacting to this wave of shocks and issues. But, you know, we have the we have the opportunity to shape it, what the next, what the next decades will will look like, but it doesn't. It's not the message that I think people hear from the political leaders. You know what to going back to what Elizabeth said, and so it creates certainty. Degree of pessimism and passivity. I guess maybe that that is one of the explanations of why people don't vote or don't participate in civil society institutions. You know, or you know that might explain tribalism. On either on the internet or in real, real life, because they people feel that they don't have agency to shape what the next period should look like, including their own life, because they think that these big trends, these big shocks, are just so overwhelming, and they see their government don't have a coherent vision to shape it,   Rob Prugue  45:28 To me, the greatest threat as an investor, I would pose it in a term that I like to use, political convexity, that In the ear of Pax Americana, even through disruptions, there was a path, and the markets knew what that path was. As we started breaking away from the path, we brought in uncertainty. Initially, the market accepted that, but now the market is jumping much more quickly at any any shock than was visible in the past. Some of that may be, as Philipp mentioned, International. Some of it may be domestic, as Elizabeth mentioned, as someone who grew up in Washington, DC in the 1970s I could see much of these transitions. And I was there at the end of the Vietnam War. I was there when the US went off the gold standard. I was there doing Watergate. I was there doing the US embassy in Iran. So I could, as a young adult or a child, I could see that. But now, as touched by Elizabeth, you this, this grievances. There was, there was at least a safety net of some sort, a perceived or otherwise, but there was a safety net. Now I don't think people think there is a safety net, and so is when the, what I call the resource belt, hear about the move towards cop 30, or the push towards solar panels, or even the push towards EV it's kind of laughable that, you know, it's not a debate between Holden versus Ford. It's a debate between combustion and greenies that that's just incoherent. I don't understand that kind of debate. It's we've, we've turned politics almost into religion, where if you challenge my thoughts, you are challenging my beliefs, and therefore you're an enemy. And you're seeing that playing out brilliantly in the divided conservative movement here in Australia, between what I would briefly call the city conservatives and the resource conservatives. And within certainly the resource conservatives, this disenfranchised, these people who no longer feel to have agency. They will listen to whoever promises them, and you'll note that they don't necessarily challenge them anymore. We used to in Elizabeth's father's era, in my father's era, we challenged our politicians. We didn't just take what they said for granted, sure there was an alliance and sure there was a certain level of belief, but we were willing to challenge the politicians. Now you don't see that, and as a result, you see in this this morphing of populism rise up on empty rhetoric and selling scapegoat ism, and you know you're hearing it, because they don't talk about their vision, they just talk about what's wrong, and they make the person feel heard, and that is a huge political pull for someone who feels they have no agency. As a Latino, I remember, you know, I call this ping pong politics, where you go far right, far left, far right, far left. And although in Peru we have five year terms, not four year terms, a little bit longer. You don't, in the last six presidents, five of them are in jail, and not always because of corruption is fabricated or real. It's like, I'm going to get rid of you so you won't come back and dismantle what I'm building. So it's a democratic coup of sorts, where not a coup of military, but a coup A coup of ideology and empty rhetoric. And that's why I have grave concerns of the rise of the populism. And no one on the left should be dancing with joy that the Liberals are being divided in two, because in that that vacuum will be filled. And I rather least you know, have an understanding where you know who's managing that vacuum, than handing it over to empty rhetoric.   Philipp Ivanov  49:58 No absolutely. I totally agree, I guess, on the point on technology, the sort of often we hear about its destructive role in particularly in Division in our society across religious or cultural political lines and but, you know, I think we overestimate in its role. It's definitely a very powerful amplifier of political divisions, or major power competition, any of these trends that I mentioned. You know, technology is a big amplifier and a big, big factor, but we're the one where humans are driving these trends. First and foremost, it's not these trends are not driven by technology. Technology is a tool. It's a very powerful one. And then we're about to learn how powerful artificial intelligence is as a tool, because that takes all that technological revolution to the whole new level, because it plays with cognition, with reasoning, it's something that we have at the moment, at least little understanding and little control of but, but the role of technology should always be discussed in the context of the role of humans. First and foremost, it can't be discussed as a sort of a separate issue that kind of exists in its own universe and drives its own trends and shapes and and influences how societies and nations work. No, it's not like that. It's our tool. We created it, we shape it. And you know, now we've created a new one that we're still learning about and probably will be learning for generations to come. But I think that, you know, taking it to the kind of the world of geopolitics, it is a powerful factor in the way that countries now look at each other, and we know that the technological competition is essentially at the heart of the tensions between the two superpowers that we have now, United States and China. It's really the tension is not about the land. The tension is not really about ideology, but the tension is about who controls the future and who controls the resources and technologies to control the future. And so you know that so our the US China, competition is first and foremost, the technological competition, then geopolitical competition.   Wouter Klijn  52:58 Yeah, so talking about the future. We're in a period of transition. We would it's not really clear where we're going or what the next system will be, but do we have a sense of where potentially the new guardrails will come from?   Rob Prugue  53:14 For me, look, that's a million dollar question, and I will try to take a stab, if I may, and say I could see three things forming at once. Firstly, a more nationalistic approach to the world. Australia, first, America, first, more self serving interests driving it. Then, as the guardrails have been dismantled and left a vacuum, my concern is that vacuum will be filled by oligarchistic approach in Australia, the mining in the US, the broligarx was called the bro look, the tech leaders, where self serving interest will take that role to fill that was previously done by other department, government departments, perhaps, or influence it, or drive it. And then from a global political point of view, from a multilateral world to a bilateral, unilateral world, where you basic, I could see three blocs forming, the US Europe and The BRICS, where you have three economic powers right there, and how the three will intermingle, how the three will work together. Will the EU come as they did under the the Plaza Accord or the Louvre Accord? I doubt it possible. But I doubt it um. Um, and all these things. When you look at it, the totality means that there's greater uncertainty, and greater uncertainty means that the dividends from the Pax Americana are gone. Yep.   Wouter Klijn  55:14 Elizabeth, do you want to contribute to that? Where could potentially guard rails come from? In Australia? Are we just going to have a dominance of mining industries?   Elizabeth Humphrys  55:24 There's not much of a future if we're only relying on that. But I think politicians are aware of that, right, like we've had a century of politicians being aware that Australia is too dominant on primary industries and resource extraction, but it's not been able to resolve that policy, either through the Keynesian long boom or through the neoliberal era. There are tensions particular to the Australian economy that I'm not confident that the politicians even know how to address. I you know my expertise is not in not in what guardrails give confidence to international markets. So I'll leave that to you guys to sort of respond to. My thinking is always about can, can, can governments or political sectors lead national projects that that, that that are that cohere and bring justice. We don't just want coherent projects that trample over minorities. We want these, these, these projects that take us forward. For me, that accord era of Hawk and Keating was the last time there was a truly kind of Grand National attempt to have this project that would address those contradictions of the Australian economy at that point, replan industry, give labour a fair share, protect its wages in a high inflation environment, you know, success or not, or criticism or not. Aside, I'm just saying that, that that, that lack of vision we've lived with what for now for 30 plus years. And so when we look at politicians now whose horizons are quite low, who, who they talk about, like the, you know, the small target strategy in elections, none of this gives me much confidence, but and also we just got to remember it's it's not always just about the individual politician who goes down in the history books. It's often about sections of society, what I would call a social base. Right? The social base of the unions gave the Labour Party its power through that long 20th century that's gone. What social base? What? What large groups in society are going to lead to secure futures? I'm not sure where that is and just on climate change. Of course, it's never about fossil fuels versus green greeneries, greenies. Renewable energy is itself a profit making possibility, right? And I think that that that markets understand this, right? But often we're having this debate about so and so versus so and so. For me, my research is about how climate change and its heat is a massive OHS problem for the future, which the insurers are concerned about, politicians barely on their radar. You know, there's a lot of hidden things, but hidden profit making in the in this. So really, this is a war between people who want to make profits between from renewables and people who want to make profits from fossil fuels. But we don't often really talk about it in those terms. We're talking about tree huggers versus, you know, multinational oil.   Rob Prugue  58:55 But Elizabeth, aren't you also concerned that you talked about the base? Isn't it also possible that there's a new base forming that is that disgruntled, the left, those who are left out, those who have been disenfranchised, and therefore that they're going to be in the populace who are, are are, let's face it, opportunists. They're not ideological driven. They're opportunists. They will tap into that make promises.   Elizabeth Humphrys  59:24 Absolutely. You've not read my work, but you're you're in the vibe of it. If there is a vacuum, it will be filled. And what I see anti politics, or you're calling populism, creates an environment that is not of the left or the right people, then individuals or political parties try and capitalise on that, so we can have both Trump in the US and Syriza in Greece, or Podemos, the mass movement out of the progressive Square protests in Spain. It is not automatic that it goes to the left or the right, and these are they. But the problem for these individual politicians or political parties is if they cannot deliver on their promises, this just leads to, often, their their quick ousting. Right now, Trump has has survived longer than most promising things to the rust belt, but then barely delivering these, tensions can't be paper and over forever. And so part of I think, the the contestation in the US is because Trump can't deliver on the populist promise of those which he was first elected, and now this has led into a much more racialized kind of policy framework and punitive policy framework that we see in the current era. Sometimes I think that even the geopolitics is about managing the domestic, internal contradictions and problems that Trump has. But he's I just really, I just reject an approach that really sees the problems as lying with an individual figure like Trump. So the people want to say Trump's crazy, or pathologize him, or pathologize his voters as being you know, those articles, people who vote for Trump have a 10 point lower IQ. This gets us nowhere, right? They're less educated, they are voting out of their interests, their life experience, and who they're hoping can realise a different future. And in that sense, every voter in the US here, any other country, is up for grabs in in in a period of turmoil. And we want, I think we want civil society organisations, politicians and just generally, community leaders as trying to map out paths economically and socially that take us forward. You know that, and there's nothing automatic about that to my mind.   Wouter Klijn  1:01:59 Do you want to respond to that?   Rob Prugue  1:02:03 One point I would add to that is media. Yeah, you know the so we don't, we may have algorithm and social network, but we have politically divided media as well. On the one hand, you have the right of, you know, News Corp or channel nine, and then on the left you have the guardian, or in the US, of course, you have Fox News on one side and MSNBC on the other. And this has happened for a long time in the UK. It's now spread throughout the world. But all these things and again, make it the vacuum is getting larger and larger, and Elizabeth raise a really valuable point at the end of the day, someone's going to fill it. And if it's filled with someone without a unified vision, then this, this turmoil, will just continue. This, this divisive world of us versus them will just continue to burrow in, and from I guess, a market point of view, continue to drive this uncertainty.   Wouter Klijn  1:03:10 So we end up there with a lot of questions. We never promised any answers. We just tried to describe sort of the movement, from that post war, neoliberalization to where we are now, which is a almost permanent state of uncertainty, but hopefully we've given you something to think about. So with that, I would like to thank Rob Philipp and, of course, Elizabeth as well. Thank you very much for this debate.
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  124: Fidelity's James Richards – Investing in Energy Transition Materials 01.12.2025 40min

  In this episode, I'm speaking with James Richards, Co-portfolio Manager of Fidelity International's Transition Materials Strategy. James runs a strategy that invests in stocks of companies that are exposed to materials that will play a crucial role in the energy transition. And it's not all about copper or lithium. James keeps his investment universe wide and includes commodities, such as animal fats and wood chips. We discussed the spike in rare earth materials earlier this year. We also look at why this is a super-cycle, but unlike the previous, China-led one. And finally, we explore whether this strategy correlates with the Australian economy and its emphasis on materials and style factors, including value. Enjoy the show. Follow the Investment Innovation Institute [i3] on  Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights Overview of podcast with James Richards, Fidelity   01:00 What are transition materials? 04:00 This was an analyst-driven idea, based on common themes emerging in different materials, rather than a product team idea 06:00 This is a different supercycle from the China-driven supercycle 07:00 There is a school of thought that says iron ore is benefiting from the transition. I don't really believe that 9:00 The energy transition will have an element of decommoditisation to it. There will be pockets of price premiums 11:00 Rare earth prices spiked earlier this year as generalist investors came into this market 14:00 In the first six months of this year, China has installed as much wind and solar as 90 per cent of all wind and solar ever built in the US. 17:00 Are we experiencing a uranium/nuclear renaissance? 21:00 This is not a commodity strategy; you invest in equities. Why? 24:00 We are looking to expand the universe rather than contract it, because we think the opportunity set is wider than even we envisaged. Chemicals is an interesting area. 25:30 Correlations with the commodity-heavy Australian industry. 29:00 You can see the way the world is heading, but when we get there is often unclear. You can lose a lot of money investing in a great demand stories that are just uninvestable at this time 31:00 Is this a value play?   Disclaimer: The content in this podcast is for institutional and wholesale investors and is not for distribution to retail investors.  This podcast has been prepared without taking into account any person's objectives, financial situation or needs. It is provided for general information purposes only and is not intended to constitute advice of any kind. References to specific stocks is for illustrative purposes and is not a recommendation to buy, sell or hold those stocks. You should consider the relevant PDS and TMD for any Fidelity Australia product mentioned before making any investment decisions, available at www.fidelity.com.au. Full Episode Transcript Wouter Klijn  01:16 James, welcome to the show.    James Richards Hi. Wouter, thanks very much for having me.   Wouter Klijn So let's start at the beginning. What are transition materials and why should institutional investors care?   James Richards  02:15 You know, I think that the transition is one of the big structural thematics of the next couple of decades, and transition materials are what I call a wide range of commodities and materials that benefit from the process of the transition, and in many cases, the demand driven from the transition, coupled with the fact that it is never been so difficult to bring on new supply of a number of commodities, will create the conditions where, you know what I think could be the next super cycle for a wide range of commodities. And this is a very, very investable thematic, in my view,   Wouter Klijn  02:49 Before we get to the super cycle, can you tell me a little bit about where this idea came from? Because I understand this was more of an analyst driven idea to set up the strategy. Is that right? Yeah.   James Richards  03:00 I mean, you know, I think normally ideas are born in this, in the product team, and, you know, then they go and find a portfolio manager, you know, this one is something that came out through, you know, hours and meetings and the sort of the work that we were doing around, around the commodity space, and the same themes, you know, started to come up again and again, first of all, in copper. But then, you know, we began to get increasingly excited when we saw the same themes coming up across a wide range of commodities, and, you know, as far afield as vegetable oil and animal fats. And it was then that we saw that there was a sort of wide ranging, quite diversified, investable thematic here.   Wouter Klijn  03:41 So what's the story with animal fats?   James Richards  03:45 Well, animal fats is so the renewable diesel chain, you know, particularly in the US, but also also wide. What are more widely, you know, is sealed by animal fats and vegetable oil. And you know, there is a, there is a fine, a finite supply of these things, and so you have to incentivize it. And the only way to incentivize new suppliers through price and, you know, the demand that is in there's been created by stricter regulatory standards and and stepping up of requirements, you know, really places a challenge on those supply chains.   Wouter Klijn  04:22 Yeah. So is that in your portfolio animal fats and oils?   James Richards  04:26 We certainly think that the vegetables animal fats is a very interesting long term thematic,   Wouter Klijn  04:30 yeah. Okay, interesting. So coming from themes that you saw in copper and copper is, of course, a key material in electrification. So is this transition the story to renewable energy? Is it just about electrification, or are there themes involved in this as well?   James Richards  04:51 So I mean electric, if you look at the sort of the current opportunity set, electrification is an obvious one. You know, it has various aspects. You know. Renewables is one obvious aspect. Electric vehicles is another. And if you think about sort of the grid requirements of the increased demand for electricity, you know that that that that also has some pretty found profound implications. But it's not just electrification. If you think about sort of hard to abate areas like like steel production, maritime fuels, aviation fuels, you know, the circular economy is a very is a very interesting area. You know, it's a much, much wider area than just electrification.   Wouter Klijn  05:38 And I think you've mentioned digitization and urbanisation, as to key thematics that are related to the transition materials. In particular,   James Richards  05:47 I think one of the one of the interesting aspects that you get here is that you get demand that is driven by the transition but then you have a lot of other structural demand drivers that are also facing in the same direction and pulling on the same commodity demand chains. And so, for instance, AI and data centres will drive demand for copper and other and other commodities, but also the industrialization of India and Southeast Asia as they start to hit levels where commodity intensity picks up quite dramatically. You know, they're essentially being competition with the transition and data centres for scarce supply of commodities and, you know, and that is quite exciting, I think, in terms of compromises will have to be made. I mean, if you look at the sheer population size in India, and you put a sort of average peak commodity intensity on it, like the numbers are mind boggling. And so, you know, compromises are going to have to be made. And the only way that you get those compromises made, and the signal that you get to to get substitution, and all the ways to get the numbers to work. You know, the only way you can get there is through price.   Wouter Klijn  07:03 So there's a couple of big trends involved. You just mentioned one around the super cycle in commodities. So when you sort of look back over time, have we had some of these super cycles before?   James Richards  07:16 I mean, I do have a history degree, but not much of a history student, so I'm kind of more focused on, on the most recent, which is, you know, the early, the early years of my career were with the China driven super cycle. And, you know, that was one of the reasons, where I saw, you know, clear echoes of what I was seeing, you know, today, you know, versus what I was seeing there are seeing above trend demand for commodities driven by China hoovering up, you know, pretty much every commodity in sight. And you know, decades worth of under investment in commodities at the time. So you had a relatively curtailed supply side. And that's really important is, you know, in order to make money in commodities, the supply side has to struggle to keep up with demand. And so, you know, commodity with 20% demand, keiger, you're not necessarily going to make money if the supply side is a lot, is it elastic? And so, you know that supply side is really, really important, but it is a different super cycle, I think, from from the China driven super cycle. In the the China driven super cycle, I think mainly had winners, whereas in this super cycle, I think, you know, there are clear winners and losers in terms of in terms of demand, you know, and you know, the transition kind of gives the clue to that in thermal coal, demand should decline over time. All demand should decline over time. You know, we're talking, we're talking longer term here. And you know, there are areas like, I think, although there are some demand benefits for steel, you know, the process of decarbonizing steel is quite, is quite difficult and expensive. And so I think there is, there's some difficulties around that. And you know, I'm in Australia, and you know, there's a school of thought which, which says that iron ore is benefited by the transition. I don't really believe that, you know, I think that the iron iron ore, and particularly lower grade iron ore, is one, is one of the commodities I have big question marks on on a 10 to 15 year view.   Wouter Klijn  09:18 Why is that? Because you could imagine, that you know, steel is still used in some of the infrastructure. I mean, you know, you think of windmills, probably mainly carbon fibre, but there's still elements of steel.   James Richards  09:31 Sure. But if you're, if you're going to produce low carbon, low carbon steel, you know, the the miners are working with the steel companies on technologies, but you know, there's a lot of unanswered questions around what the cost implications of those that are, what the capital implications of those are, and who's going to pay for it. And so I'm not I, I think that I find it difficult to see a world that doesn't use Pilbara, Pilbara, but I just don't know exactly what that world looks like. And. And what, and what the what the implications are for their position on Costco.   Wouter Klijn  10:04 Yeah, yeah. So another element of this super cycle that is relatively unique to this one is there's an element of a de commoditization of certain materials. And I think it's an interplay where ESG credentials, geopolitical alignment and some processing capabilities can cause changes in prices and cause some price premiums. Can you explain that a little bit?   James Richards  10:30 So it's something I believe in quite strongly. And you know there is, there's active debate, and you definitely come across people in the industry who disagree with my point of view on this, but, but my point is this is that, essentially, you know, as we begin to look forward for different things in a, you know, a tonne of commodity, of commodity product, the features that we that we need to promote, are going to have to be incentivized in some way. So if you want a low carbon tonne of aluminium, you're gonna have to pay a premium for that. And if you look at the producer's day, you get some people who do get premiums for that. You get you get some who don't. And there are some commodities where it's quite difficult to see these premium but we've seen a really interesting example this year in rare earths, where, you know, the world has priced rare earths for the immediate part, for the last few years on essentially the China price. And you know, supply chain security suddenly come right to the front of people's focus and and you know, the US government has done a deal with with a large US rare earth producer this year, giving a price floor which was very significantly above the China price. And so, you know, if you particularly in a world where you mind about the security of your supply chain, there are areas where you're gonna have to pay a differentiated price, I think, to incentivize   Wouter Klijn  12:06 Yeah, so the rare earths were a bit of a outlier, I think, in recent times, where they spiked up, and I think more recently, came down a bit. But I remember you talked about like the teslaization of rare earth stocks. Can you explain it a little bit?   James Richards  12:23 I've been doing this, this for 20 years, and I'm kind of used to generous participation in in in metals and mining being been sporadic and selective, and multiples generally being quite low. And you've seen, you know, so you've seen in various, in various spaces, this year, the the multiples suddenly expand dramatically, as as, I guess a wider investable public has come into the stocks. And, yeah, I mean, as rare earths were, were right at the forefront of attention, you know, the multiples did expand, you know, very, very dramatically, which is, you know, which is a lot of which is very pleasurable all around,   Wouter Klijn  13:07 yeah, so did you do some profit taking on that?   James Richards  13:09 I think Fidelity would really like me not to answer that.   Wouter Klijn  13:16 Fair enough. So rare earths are intricately linked to China. And I think we've seen in a number of transition materials, where, where China comes up. I saw somewhere a statistic that I already control 70% of global mineral refinery capacity. That makes you think, are there geopolitical elements that you have to be aware of when you invest in this space, because obviously there are some tensions between China and some of the Western developed countries. If they have a sort of a stronger strangle hold over some of these materials that can potentially impact valuations, there might be strategic considerations that come into play. Is that something that you keep in mind when you look at this?   James Richards  14:02 I mean, absolutely. I mean, you know, rare earth, as you said, is a really good example. I mean, it's not 70% processing in rare earths. It's more like 90. And, you know, magnet making is also dominated by the by the Chinese. And, you know, I think, I think, given, the events of this year, people are very, very sensitive. You know, people have, certainly, over the last two or three years, have become a lot more sensitive as to where their supply chains are. You know, we've seen, we've seen several geopolitical events over that period increase that consciousness and and so if you, if you want trade routes to and supply chains to shift, you're going to have to incentivize that. And there are some areas, you know, and we talked about about rare earths, where the process of that incentive incentivization has begun, and you've seen stocks, individual stocks, benefit quite significantly from that. And there are some where it hasn't so. And you know, China dominates with the world's processing of a number of metals. But, you know, you look at copper smelting, and and, and some other, some other processing industries, and you know, there aren't, at the moment, huge incentives being offered. And, you know, and the there is limited incentive to build new capacity in the West, and in the longer term, we're going to have to think about whether that's right or not, and how we change that.   Wouter Klijn  15:32 Yeah, yeah. Now another potentially geopolitical, and definitely a political topic is the Trump presidency. Of course, we have seen the impact on, you know, the energy transition in the US, where less attention for for renewable energy. But how do you look at that in terms of investing in the transition materials? Does that impact your strategy a lot?   James Richards  15:57 It's great. Stat in the in the bhp commodity review at mid year, you know, it said that. It said that China had installed, I think, as much wind and solar in the first six months of this year, equivalent to 90% of the wind and solar ever built in the US. And that is, I mean, mind blowing. And you look at quite significant rollout in other Asian countries, Africa is beginning to, is beginning to instal some meaningful amounts of renewable energy as well. And so you definitely have some gives and takes, and even in the US, like I'm not going to comment on policy, on policy, but you've seen some areas where which have been much, much stronger than than expectation, as well as some areas which are probably where our demand expectations have dropped a bit.   Wouter Klijn  16:52 And what about the tariff war that we saw earlier this year? I remember you were speaking at one of our events in February, and there was a lot of questions around Trump, but a tariff war hadn't happened yet. And, you know, materials, commodities, it's a global trade. Did that get a bit of a knock from them?   James Richards  17:11 Well, we obviously saw a lot of volatility in the in the first in the first half of this year. And you know, the lack of visibility was, I think, difficult for producers and customers were kind of feeling their way to a degree. But I mean, kind of, if you think about what you actually saw, speculation about copper tariffs led to a huge amount of the world's visible and invisible copper inventories heading to the US, tightening the global market and and and so and so, arguably, was copper positive. And you know, there's still a large, a large amount of inventory sitting in the US, which you know, would need shifting if it was to come available to China or the rest of the world. And you know, tariffs can create new profit pools and and as well, as well as reduce, reduce other ones. And so, like, I think, for an active portfolio manager, you need to watch change and when, regimes shift, you need to be mindful, but more often not, they create opportunities as well as risks.   Wouter Klijn  18:26 Yeah, yeah, for sure. Now, Trump is not the only one that sort of affects the energy transition. We also seen a lot more demand coming from the rise of artificial intelligence and use of artificial intelligence, especially data centres where, you know, they're quite energy hungry operations. How do you look at that? Is that affecting you? Think the transition could derail it? Could it, you know, delay it? What's your What, what's your take there?   James Richards  18:55 I mean, it's, it's something that that we factor into the way we think about commodity demand and, and, you know, is, is it's nice to have in many cases, rather than utterly central to investment cases. And, yeah, as I said, I think earlier, like we see AI and and data centres as, as competing with, with other significant structural drivers for in some cases, you know, quite scarce supply of commodities. So, I mean, it's definitely, it definitely, for me, a positive, but it's one of a number of positives. It's not the it's not a main driver, and it's not massively significant, particularly in copper today, so and so the relevance is still to come.   Wouter Klijn  19:41 We have seen that some of the key players, such as Amazon and Google that they're looking now at nuclear energy generation. And I think in some of the white papers you've written, you talk about uranium as potentially experiencing a structural demand Renaissance.   James Richards  19:58 And I think that's happening all. Already like, because obviously you had a long period of decline, you know, from which lasted for a prolonged period of time. You know, partly because of nuclear accidents in the past, but people have begun to understand that, particularly as you roll out renewables, you need a base load of low carbon power, and nuclear is an obvious source of that. And so you've seen, and again, like the tech players, are nice to have and definitely additive to the demand story. But what you've also seen is a series of governments change their view around around nuclear, and in some cases, make u turns. And you've seen, again, like China, just drive nuclear power growth, which leads to significant amounts of uranium demand. And then longer term, obviously, and you know it again. It's a It's tomorrow's story, rather than necessarily today's you've got, you've got the innovation of small modular reactors, which I think changed the use case for for nuclear. And are tremendously exciting potential, you know, tremendously exciting potential innovation.   Wouter Klijn  21:18 So how do you look at nuclear, or, more specifically, uranium as the material in the context of your strategy, because I could imagine that some people also invest in this type of strategy with an element of ESG in the back of the mind. It's not necessarily an ESG strategy, but there are elements there where you can think the E is obviously very relevant when you invest into the energy transition. But at the same time, uranium also has, you know, dual use. It has some issues with pollution. How do you look at it from that angle? Do you get questions around that?   James Richards  21:55 Less so than you think. You know, sustainability is important to us, and you know, I kind of often say that, you know, I've been an ESG analyst for a lot longer than the most because if you think about metals and mining, it's, it's inherently an impactful activity. But a lot of what we know, what we could now call ESG, have been, you know, business issues for for the majority of my career, availability of water, how you get on with the local communities? You know, they're not new issues, just because we now call them ESG. And so, you know, this has always been a part of how we think about about stocks. You know, safety. You know, if you're running, if you're running an operation properly, you should be able to keep your employees safe. And so and so. We apply those same frameworks to to Uranium companies. We don't punish uranium for for its use, for its potential use in weapons, because we do see it as critical to the to the transition.   Wouter Klijn  23:00 Yeah. Now, if we delve a little bit into the way you approach investing in this space, this is not a commodity strategy, necessarily. You invest in stocks. You invest in equity. Why do you choose this route and not go to the raw materials?   James Richards  23:16 I feel, I feel quite passionate about this because, you know, I really feel that commodity based strategies are the wrong way to do this. And there are various reasons for this, you know, one is, I think liquidity can can force you to make compromises and into going to areas that you don't necessarily want to go into. Because, you know, in several of the interesting areas that we're talking about. There isn't really a liquid, a liquid instrument to play. Rare earths is a good example, very difficult to play as a commodity. And then, you know, as a I would say this is an equity person. But you know, the way that we choose stocks is focusing on, ideally, the low cost, high quality assets, ideally with growth, with solid capital allocation. And we're looking for, ideally for assets that generate free cash flow through the cycle. And so, for instance, you can, you can own a commodity, but if you own a low cost producer of that, of that commodity on a flat commodity price, you can own quite a decent carrying yield. And obviously, if the commodity then does what you expect it to and goes up, then you have leverage to that. And if you're growing as well, then, then, then, then you get further leverage. And so as long as I think you are picking the right kind of stocks, you know, I will always believe that equities is a superior way to do this than commodities.   Wouter Klijn  24:57 And how do you sort of limit or define. Your Universe, because we talked earlier about animal fats. I know there's, I think wood pulp as well, is in material in your portfolio. How do you sort of limit it to the relevance to the energy transition?   James Richards  25:15 We've intentionally looked widely because, you know, I think, I think you can think about this matter too narrowly, and the the impact it's going to have on our on our lives, you know, getting to where we need to get to is not narrow and so and so we are constantly looking for new areas, and particularly less well understood areas. You know, chemicals is a really good example in that you have there a space where you ask management teams about the relevance of transition to their portfolios and and I haven't yet got that many really good replies. And so chemicals is an example of so we're looking to expand the universe rather than contract it, because we think that the opportunity set is even wider than we've envisaged. And as you say, we've construed this, the opportunity set is more widely than most.   Wouter Klijn  26:09 Yeah, what sort of chemicals are involved in energy transition?   James Richards  26:13 Well, this is, I mean, this is, this is the point is that I don't think that that people have a good grip on, you know, polysilicon is an obvious one where, where where there is demand benefits and solar, but in the same way as as copper goes into all these applications, it can't be true that, that there aren't a wide range of chemicals that are driving this in a way that I don't think is is sufficiently understood. Yeah, so look, silicone is also, you know, going, going to into a you also see demand benefits in silicones. So it's, it's, they are there, but just, it needs some finding.   Wouter Klijn  26:52 Yeah, is there any application in, say, coolants, or is that just water?   James Richards  26:59 You know, it's very the thing I really like about talking about this area is everybody I talk to gives me ideas, and you've given me something to go and work on.   Wouter Klijn  27:11 Fair enough. So when you look at this area, there's obviously a lot of commodities involved. There's a lot of metals involved. We're sitting here in Australia talking about this topic. And obviously Australia is a very mining heavy commodity heavy economy. To what degree does this strategy correlate with, say, an Australian Equities portfolio,   James Richards  27:30 As far as commodity share demand drivers, and particularly in terms of China, there should be some correlation, particularly with the mining slice, you know, I think over time, you know, copper and commodities that are geared to this thematic, in my view, should, should outperform some of the commodities which are more geared, I think, to the previous Super Cycle rather than the next one. That's my view.   Wouter Klijn  28:01 Yeah. So we have a lot of iron ore here, which obviously is not escorted, but also lithium.   James Richards  28:08 So lithium, lithium obviously sees tremendous demand. You and this, you know, I've talked about supply being as important as demand and inside and understanding the supply side being been utterly critical to this. And you know, lithium is a commodity where the China is supporting on an immense amount of supply. And so economics in that industry have been pretty challenged long term. Assuming that lithium continues to grow at Advanced caga, then you know, we have to keep on bringing on new supply, and so that has to be incentivized somehow. And so, you know, I see the future for lithium has been brighter than it is today, but not necessarily anytime soon, although, you know, things can change so fast. And you know, we've seen a couple of months ago, suddenly everybody was talking about anti involution in China and the need to make industries profitable. And so think things can change pretty fundamentally, very, very quickly, and that's why I think you need an active portfolio manager keeping an eye on on this and reacting as things change, rather than more passive strategies.   Wouter Klijn  29:23 Yeah, do you also keep an eye on, sort of, like, new materials coming out?   James Richards  29:29 I mean, keep an eye on everything. I'll be honest, like it's like, that's why it's insanely exciting and interesting space, because you see these innovations, and the majority of things that you see can't go nowhere. Some of them are uninvestable, but things can, things can change. And you particularly need to keep, at the moment, an eye on what's happening in China, because so much innovation is happening there. And so I. You know, this is a space that's characterised by innovation and change, and so reacting to that and sensing the opportunities as they come and the threats as they come as well is part of the day job.   Wouter Klijn  30:11 Yeah, because there is a lot of innovation in this space. Like, I think a couple of months ago, there was a lot of chatter about superconductors, and they were getting closer to that, that will be a game changer. I've seen to this space   James Richards  30:23 Well, and people only, people talk about game changers in the nuclear area as well. And so in a number of these cases, you know, the world may well get there, but it's whether it's five years, 10 years, 15 years, you know, it's, you can see the world the way the world's heading. It's just, it's when, when we're going to get to that destination is often, is often unclear, and something, and some things, will get there faster and but in many cases, things get pushed out. Yeah, I saw a really interesting stat the other day with great minds predicting innovations, and the innovations they predicted were almost always correct. They just, they just, would, they just their prediction was just too early.   Wouter Klijn  31:09 Yeah, that's, that's the question, when to, you know, jump into a particular material as well. Because so,   James Richards  31:15 I mean, that is really, really important, because you can get, you can lose enormous amounts of money in investing in a great demand story that that is just uninvestable near tan, because that, and that's why, you know, I said again and again and again, you need to think about demand, but you need to think about supply almost as much As demand, because I don't want to lose money for two years and be right in tan, you know, I think it's really important to invest in the long term but with a short term focus,   Wouter Klijn  31:53 Yeah, because we looked a little bit into where we're at with nuclear fusion. And one of the approaches that has been tried here in Australia uses boron, but I presume it's a little bit too early to jump into boron in a moment?   James Richards  32:08 Boron is something I look at every now and again, and I haven't found and I can see work be exciting, but I haven't. I haven't, I haven't got the stage where I'm excited enough, yeah, yeah. But, and, and if I think about the first time I find it exciting, I'm very glad I didn't invest at that point, because it would not have been exciting.   Wouter Klijn  32:32 Fair enough. Fair enough. So I asked you about the correlation with Australian equities, because obviously this can function as a bit of a diversification strategy. When you look at investment styles, where do you think this has overlap? Because you could imagine that some of these commodity plays could potentially be value stocks, a bit of the cyclical companies there. Does that turn out to be true? Is this sort of a value play?   James Richards  33:02 I think, I think if you look at, if you look at the way that we invest, it's very much valuation focused, but with a strong quality overlay in that we want to be in good assets. We don't love leverage on the balance sheet and and so and so. I mean, I think if you look top down portfolio, it screens well for value. And as you say, multiples are different across different commodities. But So yeah, from a top down basis, we screen as value, but if you look under the under the under the lid, it's a little bit more complicated.   Wouter Klijn  33:46 Yeah, so this strategy plays into the energy transition. And of course, the purpose of the energy transition is to basically decarbonize the economy, the global economy. But how does this sit next to, sort of a decarbonization goal or an emissions reductions goal? Because, you know, the production of some of these materials are potentially quite intensive in that perspective. How do you think about that?   James Richards  34:16 I mean, this is the, this is the consistent RNA is that, you know, it's, it's a lot of, on the face of it, the carbon footprint of the portfolio is, is higher than you'd like it to be, because, you know, these, these activities, have a physical footprint. There's, there's heavy processing, and there's trucks and and there is, there's a significant amount of mission emissions involved, but, and you know, those emissions are more for some commodities, and then they offer for others. But these commodities, we think are necessary to unlock the transition. And so, you know, the view we take is that, you know. We are willing to take that footprint in the short term, but in the longer term, we're looking for producers to reduce their emissions and to get and have a realistic pathway to a better point in the future.   Wouter Klijn  35:14 Yeah, it's sort of along the same lines as you know, if you have a portfolio of windmills, it's not necessarily low carbon, but obviously it's going to help with the energy transition,   James Richards  35:25 Yeah, and, but I think direction of travel is also really important in that, you know, there are, in most cases, there are ways to decrease that footprint quite, quite materially. And so you want to see companies working along that path, and and and kind of helping and sponsoring innovation to help with the remaining emissions where it's more difficult to shift, yeah, and that's why, and, you know, so we think about scopes one and two, but we think about scope three as well, because, you Know, supply chain emissions are important, and the extent to which the company, a company, can influence its supply chain emissions, you know, is something that that we think about a lot.   Wouter Klijn  36:10 Your strategy does sometimes get compared to other climate solutions out there in the market. And I think you're quite passionate about the fact that you have a different way to approach what you see as the enablers of the transition. Can you tell me a little bit about that?   James Richards  36:26 Yeah, I mean, I think there are many valid ways to approach this, but I think you need, you need to know what, you need to know what you're doing. And I think it's quite difficult to have the same level of expertise in the commodity space and in the technology space, you know, I think the very different multiples, the risks and the challenges are different across both and so I think a more focused strategy in both areas kind of makes sense. And, you know, the thing that I love about the way that we're doing here is that, if you have the transition developing faster in China and the east, you versus the west from the technology side, I think the winners and losers are different because, you know, Chinese decarbonization is not necessarily going to use Western providers. In fact, it's most unlikely to and vice versa. Whereas, if you're going to consume a unit of commodity, it doesn't really matter where that unit's been. In many cases, it doesn't matter where that unit has been is being consumed.   Wouter Klijn  37:40 Yeah, I think you said in a previous conversation, I don't I don't care where the copper is sold, as long as it's sold.   Speaker 2  37:48 That's probably more brutal than I was intending to be. But in the spirit there, I can understand why I said that.   Wouter Klijn  38:00 Fair enough. We might finish up with a bit of a left field question. We were close here to Martin Place, and there's like 400 people aligned outside of the gold place. Now there's some limited applications of gold in industrial use, but is this a transition material, or is this not in the portfolio?   James Richards  38:18 I mean, there's, there's been many times this year where I wish that that we thought that gold was a transition material, but I've been, I think the the relevance is minimal silver. You know, obviously has some, some some applications in, in in photovoltaics in particular. And you do get, I mean, so there's a fair amount of gold in the portfolio, because, because gold and others, is often produced by silver, by companies who also produce silver and and also companies who also produce copper and so and so there is, there is gold exposure in the portfolio. But do we target pure play gold companies? No, because we don't think that kind of that thematic appear.   Wouter Klijn  39:03 Fair enough. Fair enough. Well, James, thank you very much for this conversation, and thanks for coming to our offices. Well, thank you very much for having me. This podcast was sponsored by fidelity international as such, the sponsor may make suggestions for topics, but final control remains with the investment Innovation Institute.   Wouter Klijn  39:38 Thank you for listening to the i three podcast. For more information, please visit our website at www.i3-invest.com. That's the letter i The number three, Dash invest.com and don't forget to like subscribe and review. Thank you very much. 
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  123: Cbus' Linda Cunningham – Pricing Risk in Debt Investments, Private Credit and the Impact of Retail Investors 17.11.2025 52min

  Note: This episode was recorded before the release of ASIC's Private Credit Surveillance Report 820. The ASIC report mentioned in the podcast relates to the Private Credit in Australia Report 814, released in September 2025. In this episode of The [i3] podcast, I'm speaking with Linda Cunningham, who is the Head of Debt and Alternatives for Cbus Super. We talk about some of Linda's core beliefs when it comes to debt investing, including the banking 101, to be very careful when borrowing short and lending long at the same time. We discuss the importance of cash flows and ensuring the ability of a borrower to pay their interest. We discuss liquidity mortgage funds and private credit funds aimed at retail investors, as well as the occasional funky fee structure. We even talk about how Linda once provided a loan to finance a catamaran called the soggy moggy. Enjoy the show! __________ Follow the Investment Innovation Institute [i3] on  Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights _____________ Overview of podcast with Linda Cunningham, Head of Debt and Alternatives, Cbus   03:00 My father was a bank manager and I wanted to get into banking at an early age 04:00 In year nine, I had a discussion with a teacher about the difference between a bank and a building society 05:30 Late 80s, the property market was booming, but interest rates were high. One of my jobs was to drive to Geelong and go through the credit files. One of the lessons out of that was how important cash flow is for a loan. Where is the interest coming from to pay you? 11:30 Matching liquidity profiles, the case of AXA products marketed to retail clients. "Having daily liquidity is great, until it is not" 17:30 You can finance anything, I've financed a catamaran, but it is about where it sits in the portfolio 18:30 Setting up the internal credit capability for Cbus. "You are coming from a bank and so you don't think about who is going to communicate with the borrower what the interest rate is" 19:30 "I started in 2016, but we didn't write our first loan until 2019" 20:30 Financing a catamaran, the 'Soggy Moggy'. 22:30 Debt is not like equities; you can't just go out and buy a ready-made portfolio 32:00 There is no pressure for us to allocate money [to loans], we can give that money to managers 34:00 On occasion, we are seeing some 'funky [fee] structures'. 36:00 Private credit is not new; there have been mortgage funds operating in Australia for at least 30 years 38:00 What is getting more focus is: where is the private credit sector getting its money from? 40:00 I do worry about the flow-on effect from what is happening in retail products 41:30 The market is very competitive on loan transactions at the moment, are people pricing risk appropriately? 45:00 It takes someone really strong, who gets paid on funds under management, to say no to the funds, whereas at Cbus we don't have that tension. I can look at other credit managers 49:00 On the internal front, we would like to do a little more construction deals. We think there is going to be a little more residential over the next year or so 50:00 We are not sure if in affordable housing equity is the way to go. But we do think that with debt you get an appropriate return for your risk Full Transcript of Episode 123 Wouter Klijn  01:16 In this episode of The [i3] podcast, I'm speaking with Linda Cunningham, who is the head of debt and alternatives for Cbus Super. We talk about some of Linda's core beliefs when it comes to debt investing, including the banking 101, to be very careful when borrowing short and lending long at the same time. We discuss the importance of cash flows and ensuring the ability of a borrower to pay their interest. We discuss liquidity mortgage funds and private credit funds aimed at retail investors, as well as the occasional funky fee structure. And of course, we delve into the state of the private credit market and ASIC's recent comments on the sector. We even talk about how Linda once provided a loan to finance a catamaran called the soggy moggy. Enjoy the show!   Linda Cunningham  02:06 Linda. Welcome to the podcast. Thanks for having me, Wouter.   Wouter Klijn  02:09 So your journey started a bit unusually compared to maybe some of your peers. I believe you started in the industry when you were just 15 years old. How did that happen?   Linda Cunningham  02:20 That's correct look, and I'm going to age myself here, but we are talking, you know, the early 1980s I had grown up. My father was a bank manager, so I had, from a very early age been exposed to banking, and by the time I was finishing year 10, I had a decision to make, which was, you know, Did I did I want to go on to year 12? Did I want to go on to university? I knew I wanted to end up in banking. Superannuation funds didn't really exist at that time, but I knew I wanted to get into the lending side of things, and I had the opportunity to actually start working in the local branch at the bank, a different bank to where my father was, and I enrolled to do a TAFE course. So I did a Gosford Teik, an accounting course three nights a week for four years. So once I finished that, I enrolled in doing my degree by we'll call it remote learning. In those days it was called by a correspondence. Yeah. So by the time I was 23 I had been working for eight years, three years in a branch and five years in the corporate banking area, yeah. And I had my degree.   Wouter Klijn  03:40 Excellent. And I think there was an anecdote where you even on the school playground would discuss monetary policy or something.   Linda Cunningham  03:49 Look, I do remember, in a commerce class in year nine, having a debate with my teacher about the difference between a bank and a building society. And apparently I was, I was quoting the Banking Act of 1959 in those discussions to tell him there was a difference, right?   Wouter Klijn  04:09 Right. Not your average conversation, I think, for a teenager.   Linda Cunningham  04:12 No. But look, it had been something that had always interested me. And look, I still now people have various dreams. One of my dreams is always rolling coins. So yeah, rolling up the 20 cent pieces and 50 Cent pieces into the pieces of paper. I can still do that in my head,   Wouter Klijn  04:31 Very good. There's probably muscle memory comes into play with that one. So having started relatively young, you've seen probably a few financial crisises. I think the 1990 collapse of the Geelong based pyramid building society was one of them. Can you share some of your learnings from some of these downturns with us in terms of how it shaped your outlook on investing?   Linda Cunningham  04:56 And look, that was absolutely a very interesting time to be in the lending space. I had moved from New South Wales to Victoria with my work. And, you know, late 80s, everything was booming in property, everything was booming everywhere. But you also had interest rates pretty high. And, you know, the market was, was, was very hot, and the bank I was working for had exposure to all of the pyramid associated companies. So there were actually four building societies there. And we were actually doing what these days would be called a warehouse loan. So we're effectively providing them, you know, with the loan, 80 cents in the dollar, based on a, on a on a pool of mortgages, and those loans, the underlying loans, would be some commercial property. They'd be residential. It'd be a whole mix of things. And one of my jobs I got to do was to get on the freeway and head to Geelong every few months and actually sit there and look through the credit files. There was you couldn't get them on Excel. You couldn't log into a data room. You'd actually go in and sit there in the premises and look through those credit files. And I think for me, one of those, the sort of lessons out of that was, was really how important cash flow is for a loan. You know, if you are, you know, in our case, we're expecting, you know, the borrower being, say, pyramid building society, to still pay our interest. But you know, if you've got a pool of loans that are in there, that are just secured against a vacant block of land or a non income producing property, where is the where's the income coming from, where's the interest coming from, to actually be able to pay you? And I think that was, that was probably one of the strongest sort of lessons that I actually had, was really how critical income is. And I would say that was even important. If you looked across, you know, the banks books at that time, and a couple of other names you've got to mention from that era. You can't not mention the state mortgages tri Continental, all of the state banks, like I work for State Bank of New South Wales, which actually was in a pretty good state, but we're probably still in that time whereby we actually had a large proportion of our property based loans, which were from an LVR perspective, we had breaches, right? And it was one of those situations where you we actually did okay, like those loans were were pretty good, because the income was still solid on them. The borrowers were still earning enough income from these assets to actually be able to pay the interest. But, you know, they suddenly went from having a loan to valuation of, you know, 60% to 80 or 90% breaching covenants, etc, just really because of the rapid change in interest rates in the market and the impact on on property values,   Wouter Klijn  08:02 yeah, and I think that importance of knowing where the income come from and the underlying assets that sort of carries through through time. Because I think we recently spoken about a loan, and we won't name any names, but it basically looked like a term deposit. But when you looked under the hood, it was something very different, with very different liquidity profile,   Linda Cunningham  08:24 Absolutely. And look, that's, that's not a new thing. You know, it has its place. It is just understanding how you're matching what you're what you're doing. I mean, we, we do do construction loans, and generally most construction loans, particularly you, if you're building, say, an apartment complex or something like that, your your only income, your only earnings that come in is when your pre sales of those residential apartments settle. So you are capitalising interest on on your loans. Now I think that's absolutely fine if you're understanding what you're investing in and understanding what you're expecting out of that investment,   Wouter Klijn  09:09 Yeah, and as long as you understand the risk profile, because you know, if you expect the term deposit, then you find underlying assets that have maybe seven, eight, sometimes 30 year maturity rates, then that's quite a mismatch, of course, and it sort of comes back to what I think I've heard you talk about, this sort of banking 101, where you basically have said you never borrow short and lend long at the same time. Can you explain a little bit that philosophy and how that comes back today in your approach.   Linda Cunningham  09:42 I mean, when you think about banks or or any form of money lender, you know the reality is you, you need to raise your funds from somewhere, and then you're lending it out. And most organisations, or most of those structures, banks, in particular, I mean, banks run raise funds for. From long term capital markets. They have equity in place. They have subordinated debt in place. They have term deposits from from people. But they're, they're consciously thinking about the overall asset liability matching. And I think that's, you know, that classic thing I worked at AXA, so I moved to AXA once I left banking. So I moved there in in 2000 or 2001 I was there for over 12 years. So that obviously covered the GFC as well. Yeah, and look, you know, AXA had what they referred to as an income the mortgage funds were income funds, Australian mortgage Income Fund. Those funds were providing commercial loans to small corporates. So you know, they were traditionally the sort of four to $20 million sort of size loans. Really good book, really good quality book. There are a few others in the market, like perpetual, very similar. I mean, probably 40% of the assets in that portfolio were actually your neighbourhood shopping centres. You know, the ones where you've got Coles, Woolworth, your chemist, your butcher, those sort of things. So good income producing assets. But those products were to retail and wholesale investors, and as part of the characteristics of those funds, they did have the ability to have daily liquidity, and that's great, until it's not. I mean, there was nothing wrong with those loans that were in that book. And for you know, the entire life of of that particular fund, it had been in net inflows every single month, up until September 2008 and then by 2008 you had the Australian Government introduced the deposit the deposit guarantee, straight away, that really reinforced for people, the difference between something like a mortgage fund or a private credit fund or any other sort of funds. And you've got to remember, these things have been around for decades. You started off with debenture funds and so on, suddenly realised that it's very different to being with the bank. And look, you know that that fund was, was frozen in October 2008 we at that stage, we had one problem loan across the whole period of time, one problem loan, but our investors had to wait, you know, three to four years to actually get their money back, because we had commitments in place for loans. And often loans will repay you early, but you can remember it's it's also GFC, it's hard to refinance. So borrowers weren't going to repay you back early unless they, you know, unless they wanted to. So, you know, I think that for me, really highlighted that aspect of, you know, borrowing short daily liquidity and offering a product or that, or investing in something at the back of that that is a longer term investment.   Wouter Klijn  13:24 Yeah, yeah. Because, essentially, to provide that liquidity, then you either have to build in a cash cash pool, which will have a drag on returns, or you rely on new investors coming in, which is, you know, of course, not guaranteed, but, but those structures are still around, right?   Linda Cunningham  13:44 Look Absolutely and we already use the word pyramid, but it is. It's one of those things I mean loans, private credit is good. Loans are good. You've got to remember, we're still talking generally at the top of the capital stack. So the asset class, I like, it's, you know, just making sure that investors understand what what they're getting in assets. These assets will produce income coming off them, so there's always a little bit of income coming out. But unless you're actually getting loans that are repaying during that period, or, as you said, new investors coming in to pay out the old investors. It works until, as I said, until it doesn't.   Wouter Klijn  14:34 Yeah, no, that's, that's very true. I can remember that period. Actually, I was just starting at Morningstar, and suddenly all these funds started to lock up. And there was plenty to write about to tell you that, but it was a very interesting period, for sure.   Linda Cunningham  14:50 Look, I remember it quite vividly. I mean, I was, I was involved in actually looking at some of the hardship requests that came through. And. That is absolutely devastating to see that, you know, there were people who had sold their home, and the advisor had told them to put it in this account because it was, you know, it's like a term deposit, or it's a cash account. Don't worry about it. And then they go to buy a new home and they don't have their money anymore. Situations where people who had saved a deposit had been saving it because the interest rate was that little bit higher, they'd been saving their deposit there they couldn't access their deposit. There were situations where people had been putting aside money for their wedding, money set aside for funerals, other family events that were taking place. And when you read the the hardships, provisions, I mean, that's, you know, it's very tough, and you feel for people who just haven't understood or haven't realised that this situation could happen, that when they do want their money back, they won't get their money back. So it is about, you know, is it right for the person and how much, how much they should have in those kind of structures?   Wouter Klijn  16:11 Yeah, and that brings a very sort of practical face to liquidity. Because I can also remember, you know, this, you know, the famous book, The Big Short, where they're talking about these investments in subprime loans, and basically they put this trader forward as this genius trader, but his funds locked up. And you sort of justify that by Well, if you go out now, then you lose all your money, but if you stay for a while, then you make a lot of money, but the investors might have different liquidity requirements, so you can't just tell people like you're not getting your money back, right?   Linda Cunningham  16:46 No, look, it is. It is just challenging. I, as I said, I think loans is great. I'm I'm too conservative. You know, it is about I like loans. I love looking at them, you get to see so many different asset classes across my career, working in banks. Look, I've done things from hotels to hospitals. I've done seed lots, I've done abattoirs, I've done a catamaran. There's some really interesting things that you can finance. Because the reality is you can finance anything but, but it is about where it fits into a portfolio.   Wouter Klijn  17:32 Yeah. And that brings us sort of to the direct lending business, because you originally joined Cbus in 2016 to set up the direct lending business for the fund. What were some of the main challenges to get this off the ground?   Linda Cunningham  17:49 Look, I would say it was, it was very much at the beginning of sea buses, internalisation journey, I probably thought that there would be, when I arrived that there would be more processes and procedures and things like that in place. The operational background that Brett Chatfield is is is very determined and very clear on what he wanted to achieve. So when I arrived, I spent quite a lot of time working with him in terms of, you know, just setting up the whole, the whole processes, the procedures, the Credit Framework, you know, the delegations, the whole process for a credit cycle. I mean, we do have, you know, a credit process and framework, which is, you know, 4050, page document that gets updated each year in terms of making sure that everyone in the team is consistent in how we think about, you know, the debt side of things, and what we look for, what you've got to address in your credit manuals or in your credit papers and things like that. So there was a lot of work that was was done in putting that in place. But also, you come from a bank, you don't even think about who is going to produce the interest statement for the borrower, who is going to communicate with the borrower and what their interest rate is. So there was a lot of work with our operations team to make sure that we could actually put those, those things in place. And of course, don't forget your regulatory things. You know, all of a sudden you're going okay. So do we have lending as a designated service on our AML KYC policy? Where are we on the regulatory side of things? So I started in the end of 2016 we didn't write our first loan until the beginning of 2019 Wow.   Wouter Klijn  19:43 Okay, that's how long it took to set up all the processes.   Linda Cunningham  19:46 Exactly. Look at the same time. And you know, that was, I was looking after the rest of the global credit sector at that stage. And so, you know, we you still had your day to day, you know, with your managers and things like that going on. But it was very much we need to take our time in setting this up, thinking about where we want to play in the market, and how and and when we want to play. I think, yeah, important aspect of it.   Wouter Klijn  20:15 Do you still remember some of those early loans that you made in 2019 I presume the catamaran that you just mentioned was not until later.   Linda Cunningham  20:24 The catamaran was back in my banking days. Okay, I'll confess this thing ended up being called the Soggy Moggy it was. It was a catamaran that was supposed to sail from Victoria to Tasmania, and it was a deal that State Bank of New South Wales did with, think, at the Bank of Tasmania, or whatever it was, a state government sort of initiative, let's say it was fine. We got our money back, because we actually had a put option on that catamaran for it to be sold to a European company that was actually going to sell it across the English Channel. So it was fine, but yes, that was that would not be something that Brett or Christian or even Lee now would be very comfortable in in us putting in the book.   Wouter Klijn  21:18 That's That's unfortunate, because I've just got a plumber around who I talked to and is in sea bus, but so I can't tell me on a miniscule part of catamaran. So, but what were some of those early direct loans that you got involved in, in 2019   Linda Cunningham  21:38 Things that we got involved in those early days were things like mainly syndicated transactions. We were very clear that if we were going to do bilateral loans with people in the market, that's really labour intensive. So for us, this is an institutional loan portfolio where we're looking to participate alongside banks in the syndicated loan market. So we've been in, we're in shopping centres, office buildings, a couple of transactions that we didn't end up doing, that we bid on and then were under priced in. So a couple of those loans are still in our book. Yep, been good performers. Very happy with what they've done. They've performed the way that they were supposed to to go, but it was, it was slow, but that's what the organisation was really clear. It wasn't about. You know, debt is especially this type of loans. Is not like equities. You can't just go out and buy a ready made portfolio. And aim was to think carefully about what, what we put on the book. Because when you write a loan, you you are in the situation that Australia is not a big trading market. You can buy and sell loan, but not a lot of that takes place. So if you invest in a loan, you have, you have to live with that loan. So it was about making sure that we were cautious about what we got invested in and at the same time. And the thing that, I guess continues to this day, is we don't have to write a loan. We would like to grow our loan book. It's an important, and we think, a valuable part of, sort of the global credit sector. But the same time, if we actually don't see that we're getting good opportunities or good deals to do, the team's not given dollar targets. The team's given a return target, and you know, a long term objective as to where we see that as a manager weight so if they're not seeing good deals, and you even, recent times, we've seen that we've knocked back deals not because they're not good borrowers, but because, really they have the structure hasn't been right, and the pricing is not reflected the risk.   Wouter Klijn  24:04 You did make some some loans during the covid pandemic, which you know probably wasn't that long after you actually started first investing. What gave you the confidence to do that,?   Linda Cunningham  24:17 Really, that was, I would have to say, Kristian was, was really strong leadership across that period of time? And you can't you've got to forget. You've got to remember that what was happening in the superannuation industry at the time we had early release happening, and my team also manages the cash for the fund. So front of mind, we were seeing all of the requests coming in for early release. That Kristian was, you know, this is a time of challenge, but it's a time of opportunity as well. And he was very clear that he wanted us to be that's the entire investment team thinking about what the opportunities were. So I think from the. You know, around about the 20 months from April 2020, we did probably about $1.2 billion worth of investing in the direct debt strategy. Okay, we did a couple of residential construction projects where we sort of, you know, we had definitely had one transaction, which had been knocked back by a bank because of the covid pandemic and the uncertainty about what was going to happen on construction sites and so on. But we didn't couple of others as well whereby, you know, we just knew that you needed to get these things built. They were good opportunities. They were, were comfortable with pre sales, were comfortable with the builders. It was great opportunities to do transactions and provide good, solid returns for the members. And look, it wasn't just loans. We're also our portfolio is quite has a really broad remit. So we're buying corporate bonds as well at that at that particular time, and getting some fantastic opportunities to get funds invested for the members. So you've got to remember them. Yes, you had members leaving, and you had to make sure you're meeting those but you also had managed members who were staying, and you needed to take care of the returns for them as well.   Wouter Klijn  26:22 Yeah, yeah, I can imagine, with Cbus being, you know, for the construction industry, that there's a fair few sole traders as well that probably made use of access to the early release and hardship rules, maybe because they wouldn't be able to get out and perform their jobs.   Linda Cunningham  26:40 Look absolutely, I think that was consistent across the whole sector. You know, those early days you were stopping and trying to work out, well, how many of our members may be eligible for this? And if you remember, some of those rules were really just a self certify structure. And you know, a lot of people who were nervous about what was going to happen, and it's about, I need this opportunity is in front of me. I need to take advantage of it. While is there Cbus, as well as other funds, have also done the numbers to see what that has impacted on the long run for people from their superannuation balance perspective. But at the time, I guess you know, that was the right thing for people to do.   Wouter Klijn  27:29 Yeah, so Kristian Fok was driving some of these initiatives saying, like, let's look for opportunities as well. Was it hard to sell that to the IC and the board? Because it was a very, sort of nerve wracking time.   Linda Cunningham  27:41 I think Kristian was had the support of the board. This is, this is a numbers game. You know, you need to understand your members. You need to understand that book, but it was very important that you don't forget what you're here for. And I think, you know, there was very much that steady state, obviously the returns in March, April, May, etc. Thing. If you look at the numbers and you see there is the recovery, you'll see that it was it happened quite quickly. And if you were too nervous, you would have missed out. So it is about being confident. Kristian and Brett were very good in terms of driving that staying invested.   Wouter Klijn  28:29 And you mentioned during the time there were just certain assets that needed to be built. Can you tell me a little bit about your approach to funding construction projects?   Linda Cunningham  28:38 Sure. And look, there were some of the other fun things I've, I've done across my career in banking. You know, in the early days, I ended up in the property team in Sydney, which was quite interesting, and then down here in Victoria as well. So I just as background, I've been involved in things like construction of crown in Melbourne, 333, Collins Street, Dockland stadium, Park, Hyatt. So I've always loved the construction side of things. And I think that was another that was another carrot for me in terms of joining sea bus, the fact that I knew that Brett was very keen that we do participate in the construction space, but I'm an old banker, so we are quite conservative in terms of how we approach construction. And here at the at present, we've got sort of three construction deals on our book. One of those is a residential construction and you that has pre sales in place that that cover our debt. So we will do some construct residential construction deals that don't have 100% pre sale coverage. And that's a really that's a real testament to the the internal knowledge that we have within. Sea bus, because you need to have confidence that you can get this building, that this building can be built, and that people will buy the product. And so it's really important from the internal conversations we do have about any of our construction deals, but just coming back, the other two deals that we've got are actually industrial properties, and they're both ones which are operating businesses running really well, and they're expanding, and so they've actually got pre commitments in place to take that additional space. So it's construction that is not speculative, that that's not where we're playing, but it's a good, you know, component of of our book, we've done construction for social and affordable housing. And that was another one that was done in the in the depths of covid. Again, looking at it, we actually had a takeout from our community housing provider to buy that on completion. So we knew that if we could get that finished, we actually had the takeout from community housing provider who had their debt locked in to be able to buy it.   Wouter Klijn  31:10 Yeah, yeah. And that's how you manage your risk. So you have this internal portfolio, but you also make still use of external fund managers. How do you think about that mix? Is there sort of an optimal balance between internal and external investments from a debt side of things?   Linda Cunningham  31:29 I mean, the overriding statement is, is what's in the best interest for the members? So we do have a longer term manager, weight, which sees that our internal strategy growing over time, but that's always asterisked with if we can see appropriate opportunities for that portfolio. So we do think having the mix of internal management and world class external managers is ideal. It enables us that flexibility to make sure we're getting the right return for risk all time. So we're seeing what our external managers are doing. We're talking to our external managers on a regular basis, and some here in Australia, some are offshore. So we actually have that global approach to how we're investing. So if we were looking at transactions here in Australia, and we're saying that just doesn't make sense, we can't see things that make sense. There's no pressure for us to write a deal. We can allocate the money to managers. And I think that's, you know, that I see that as really is the sweet spot. There is no it is not that we have to internalisation for the sake of internalisation. It is about getting that right return for the members, but, but I'll say, we do. We do benchmark ourselves. So in other words, we run, what are the costs of running an internal strategy compared to what it costs us to get external managers in place? And you know, we're always conscious of of that. We talked about some private credit managers before we get a lot of people who would like us to, you know, allocate to them rather than having an internal strategy. And we've seen some really competitive pricing. But it's interesting, when you read the the asset report in terms of fee structures and where things get hidden and all of those, we're very much about transparency. I mean, none of the managers in our credit space are on any form of performance fees or anything like that. It is give us your rate, and we will pay that all of the income on our loans come to the members. There is no, there's, there's nothing funny, and we've seen some, let's call it, funky structures offered to us, which we sit there and go, This doesn't fit in with RG, 97   Wouter Klijn  34:19 What sort of funky structures?   Speaker 1  34:22 Oh, you know, where they'll take part of the upfront fee, or they will offset fees with other charges and other things that come in place. Yep, that's not we're not comfortable with that. And and the other thing you have to think of with, with, with some of those is we might pay a bit more to somebody else, but I'd prefer to be paying a bit more to have confidence in a manager than other managers, who won't charge you very much, but they give you rubbish. You know, that's an easy. easy decision.   Wouter Klijn  35:01 Rubbish is still rubbish.   Speaker 1  35:03 Rubbish is still rubbish. And the cost of buying that rubbish and having it in your portfolio, you know, the losses that you might incur, in no way can you justify having a slightly cheaper fee but picking up rubbish?   Wouter Klijn  35:19 Yeah, no, for sure. So let's delve a little bit deeper into sort of the private credit sector, because it has been very popular. We've just seen the release of that ASIC report that highlighted some questionable practices. I mean, overall, they were relatively positive, but I did see some issues there, and often heard criticism or comment around profit credit is, well, it's still relatively new. It hasn't gone through a business cycle, and you don't know, you know what the level of defaults will be. And I think when we sort of prepared for this podcast, you said it's not that new at all. It's been around forever. Can you explain it a little bit?   Linda Cunningham  35:58 Absolutely, we're already talking about a pyramid building society and those in estate mortgages. If you think about it, there's been debenture funds or mortgage funds operating in Australia for at least 30 years. I mean, even if you you look at IFM who've got their specialised credit funds. I mean, that's been operating since 1999 that has been playing in a mix of public and private credit for a very long period of time. You're talking about 26 years now that that's actually been operating. So I think private credit has always been around, and what's my definition of private credit, very similar to assets, and it's basically anything that's not done within a bank, and I actually think there's a need for funding outside of the banks. And you think about why this occurred, and you think about the asset report also talks about Australia having about 50% of the private credit is real estate based. And I think that does come back to you know, the difference between how a housing loan on a bank balance sheet, what capital you require for a housing loan compared to what capital you require to do, you know, commercial property loan. Yeah, I think that has been a big driver in provide or in in there been an appetite for for people outside of banks to provide the funding. And I think that's a good thing for the market. It's a good thing for the stability of the banks and so on. It is just probably what's become more of focus is, where are the where it's the private credit sector itself getting its money from. There's obviously institutional investors   Wouter Klijn  38:01 From you?   Speaker 1  38:07 And look, we prefer, we prefer in in that space to choose our own, be selective, and tune us our own assets, and do it directly when we're not interested in having a manager really in that space for us, but I think it has been around for a long time. But yes, there's not been as much oversight of the sector. There hasn't needed to be the GSC, there was quite a lot. I mean, you had funds at that particular time, you know lm finance up in Queensland. Always think of the Queensland gold chains, white shoe brigade. If you look at LM finance, you, you look at Storm Financial, you look at any of those names, you, you'll see these same patterns repeating themselves.   Wouter Klijn  39:01 Yeah, I remember Storm Financial was, I think we wrote about that for years. That was, that was a big one. But it also at this time. I think part of the reason why the report also came out is what we talked about earlier. There is now participation from retail investors into the private credit space, and so new vehicles have been constructed that live on advisor platforms, and they tend to have daily liquidity and back to the old mortgage funds like there's only a couple of ways to provide that liquidity, and it doesn't come from the underlying assets. So do you worry about seeing sort of this increased retail participation in the private credit space.   Linda Cunningham  39:45 So I guess where I sit. I'm I am slightly like removed from it. I I worry about the retail investors that mentioned the days with AXA. But it probably even goes back to my days been on the counter and seeing people come in every second Thursday to cash their pension checks. You There are a lot of people who are relying upon income and want their return. And I just, I worry about that side of things. I worry about the flow, potential flow on effects. You know, there are good lenders out there, but it is about, you know, is the product matching it? Are the way they funding it appropriate? Yeah, that would be sort of that biggest question   Wouter Klijn 40:31   What are some of the other concerns you have about private credit funds. I understand that some of them might have some leverage in them?   Linda Cunningham 40:39   That's a good question. That is certainly a trend that we are seeing. There is a lot of debt that's been put into these funds, also known as a NAV loan. On the positive side, it can help the manager to smooth the cash flows and possibly boost the returns to in the investors. But on the downside, that debt ranks in front of the investor. So I worry that's not fully understood by wholesale investors. There could also be some risks for institutional investors who support a manager that offers a wholesale product. In this scenario, you're likely to see loans being shared across the platform, across the wholesale and the institutional investors. So how are decisions being made on those underlying loans in a scenario where the fund manager is needing to get loans or part of the loan repaid as quickly as possible to meet redemptions, yet the institutional investor might have a more patient timeframe.   Where we are in the in the current environment, is often the products are not paying a lot more than, say, a term deposit or something. So people are looking at them and going, well, that's only a little bit more. That's obviously not much riskier. Or, you know, it must be okay. And I think that distorts the fact that some of these structures are there's a level of fees and expenses and things like that that are coming out before the investor actually sees their return. So they're not seeing that. In reality, say we're getting a pass through of all of those things, their return would be a lot higher. Alternatively, and this is where the market is very, very competitive on loan transaction at the moment is, Are people pricing risk properly? And that's, that's where it starts impacting, say, on us and the transactions that that we're doing, you know, at the moment, there's a lot of competition in the in the Australian space. You've got foreign investors, institutional investors here. You've got a lot of the foreign banks here, and you've obviously got your private credit funds, your Australian banks. Australia's a small market, there's not a lot of transactions, so you are actually seeing people competing to do transactions.   Wouter Klijn  43:22 Yeah. Does that have sort of a flow-on effect, in the sense that underwriting standards might drop a little bit Martin's coming in, does that have sort of that cascading effect?   Linda Cunningham  43:34 It absolutely does. And so that's why, that's where it does impact us. We do see that, you're, we're in syndicated deals. So we, we're seeing who's in those deals and who's in those transactions. There's been a number recently, you know, in the last few months, where, by we've knocked that participation in a transaction, not, you know, it's, it'd be a good borrower, but the pricing for the way it's been structured, and when I, when I'm in structured, the covenants that are in place looser than They should be, and that might be okay, the borrower might not do the bad, the wrong thing, but they're very loose covenants, and the pricing is low, and we can look at that and we just say, look, thanks, we won't participate in that transaction. So the team's really quite disciplined. You know, we've got a broad group of people in that team now with broad experiences and things like that. But no one feels the pressure to they just want to do, you know, good transactions and that are appropriately priced.   Wouter Klijn  44:46 Yeah. So do you see more of that happening? Do you see more loans, where you think like: 'I'm going to skip on this one' ?   Linda Cunningham  44:53 Some of those are easy decisions. Where it gets where it gets harder is where Look, you're always going to want the loan to pay you a little bit more than what it does. I mean, that's, that's your borrowers always want to pay less, and lenders always want to charge more. So there's, there's, there's a space where that is really a clear decision. And there's borrowers whereby you know, you're prepared to give them a little bit of a leeway because they're good operators and things like that. But there's other transactions where you just say that that doesn't make sense for for where we see that risk, or the potential risk of that transaction, we will just walk away and again, because we're not we don't have to play in one space. I always think back to the days when I worked in the bank, if you're in the property section of the bank, and the bank says we've got enough property and not doing any more, what are you going to be doing if you're in a credit fund and credit returns are not looking good, what are you going to do? You've got investors that have given you money that want to get invested. You know, it's it's quite challenging. It takes someone very strong who is earning their money on funds under management. Say no thanks to the funds. Whereas that's not, that's not a challenge that we we have at sea bus, because I can look at other I can look at credit managers and allocate to them, or I can sit down with, you know, Justin Pascoe and the asset allocation team. We can talk about credit markets generally, what we're seeing the themes, and we just think about, well, you know, should we do we want to do, go underweight credit at this particular time. How do we want to position ourselves? You just got to maintain your discipline.   Wouter Klijn  46:45 Yeah, for sure. And you do come at it from a different angle than, I think, a fund manager as well, because you're investing for members in sort of a context of a multi asset portfolio, and I think you've stipulated that the credit part of the portfolio, the fixed income part of the portfolio, it's not a standalone option, it's part of the multi asset portfolio. Does that make you look different at how you invest in credit and in certain transactions? With that idea that maybe more a diversification lens rather than a pure credit lens.   Linda Cunningham  47:22 Look, absolutely it is when our manager, when our members invest, majority of our members go with one of the pre mixed options. Okay, and so all of your pre mixed options, most of them, will have some exposure to credit, but as part of that overall portfolio, you know, our total credit component might be six or 7% of it, so it's not a significant component in in the first place, they have exposure to equities, infrastructure, private markets and so on. Where, where credit does cross over is the fact that, if we are in public credit, it's tradable. Sometimes it's not tradable when you want it to be tradable, but, but generally it's tradable. It's like equities. It trades like equities, but on the private side, you have to be conscious that you're actually using some of the funds illiquidity budget. So when we do do private credit, whether we do it in house, ourselves or via a manager, we are conscious that we are making that long term commitment. We're allocating money to something that may not pay us back for three to five or seven years time. And so we actually treat that as an illiquid asset, so we expect it to give us a premium over a liquid asset. We also when we look at the overall sort of risk side of the fund, we do, we do take into account that is illiquid. So you always sit down with the Private Markets team. We're having discussions all the time about how we think about our illiquid component of the portfolio. So it's got to compete, to an extent, with other illiquid assets, whether it is the property, the infrastructure, private equity,   Wouter Klijn  49:15 yeah, yeah, that makes sense. So last question, what is on the calendar for the rest of the year? Do you have any research projects coming up? Any reviews of sectors?   Linda Cunningham  49:26 Look it's really a business as usual time the sectors we think are well set up, and we talked before about the fixed income sector, our fixed interest sector is just govies, so that's where we make our duration call. Our credit sector is just credit, and it is predominantly floating rate credit. But those sectors are set up well, we're happy with the managers in it, but it's a matter of monitoring and just and just continuing to make sure that they're, they're fit for purpose and set up the way that we want. On the internal side of things, we're keen to do some more construction deals. We like to think that there's going to be a bit more movement on in particular, residential construction over the next year or so. So there's a focus there, and the team, obviously has been we've been working on the social and affordable housing side of things. We'd be keen to be involved in that space that's been particularly challenging, but it's a continual head down and see what we can do and see if we can make it stack up.   Wouter Klijn  50:35 Yeah, yeah. What's the interest in affordable housing? Is that from a credit perspective, or is there that element of ESG to it   Linda Cunningham  50:44 Look, it's predominantly from a credit perspective, but we do think about a sort of if we can make it work, it's a win, win, win. So we need to get fundamentally returns for the members, and we think that's why debt makes sense. We're not sure that equity, especially in social and affordable housing, is the way that we want to play. But for debt, you can get an appropriate return for you. Or risk, we'll look at doing it, but also the construction side of things. If we can create jobs for the members, that's also a win. And the third point really is that societal, there is a need for some more housing across the board, but in particular in that social and affordable space. So if we can support that, we're very keen to do.   Wouter Klijn  50:21 So, yeah, absolutely, yeah. Well, Linda, thank you very much. That was a fascinating conversation. So thank you very much for your time.   Linda Cunningham  50:29 Thank you. I appreciate the opportunity to talk to you.  
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  122: Fidelity's Maroun Younes and James Abela – SMIDs in a World of Large Cap Dominance, Are Things About to Change? 03.11.2025 47min

  In Episode 122 of the [i3] Podcast, Conversations with Institutional Investors, we speak with Maroun Younes and James Abela, co-portfolio managers of the Fidelity Global Future Leaders strategy, about the attractiveness of small and mid-cap investments, a $12 trillion market with significant growth potential.  They acknowledge the recent underperformance of small caps due to market concentration in large caps, particularly in US tech, but point out that people are starting to wake up to the risks associated with those concentrations. Are we in an AI bubble, driven by these large caps? The conversation starts at a high level, discussing the importance of quality, value, transition, and momentum, and then we do a deep dive into specific investments, such as Arista and FICO-score provider Fair Isaac Corporation.  We also come back to AI and see how it can be used by asset managers. ________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights ________ Disclaimer: The content in this podcast is for institutional and wholesale investors and is not for distribution to retail investors.  This podcast has been prepared without taking into account any person's objectives, financial situation or needs. It is provided for general information purposes only and is not intended to constitute advice of any kind. References to specific stocks is for illustrative purposes and is not a recommendation to buy, sell or hold those stocks. You should consider the relevant PDS and TMD for any Fidelity Australia product mentioned before making any investment decisions, available at www.fidelity.com.au. Podcast Overview 04:00 Large caps outperforming small caps in the US is unusual; historically small caps have outperformed over time. But people are waking up to the risk of concentration, both at a stock level and sector level 07:00 We are not too concerned about US exceptionalism, because we don't see a huge break point going forward 07:30 It is always hard to tell whether we are in a bubble, but there are early signs of a formation (of an AI bubble). There is a lot of spending in this area and at this stage we don't see that return on capex coming through 09:00 Fidelity webinar on AI 10:30 We have four focus areas: quality, which is the love quadrant, value is a neglected quadrant, transition is the quadrant of hope and momentum is the hot quadrant 13:30 We have guardrails for allocating to the different areas: 40 per cent quality, plus or minus 10, value 30 per cent, transition 20 per cent and momentum 10 per cent, 17:00 The case of Arista, looking for a catalyst to unlock value 20:00 Another case study, Fico credit scores 23:00 On selling discipline 28:00 We are not looking to make a big market call, but are looking to participate in the continued rally 31:30 We mainly have exposure to China in the healthcare sector. Most Chinese tech companies are too large for us 32:30 Getting compared to the QSML exchange traded fund 37:00 Looking but not buying; the case of Deckers and the Hoka shoe 44:00 White paper on Lessons Learned over the years 45:00 Using AI in our work; you can get to a working knowledge of a company in a matter of minutes For the Fidelity webinar, 'Navigating the AI boom: A framework for investing', please see here. For the Fidelity white paper, 'Discovering tomorrow's global future leaders, today', please see here. Full Transcript of Episode Wouter Klijn  00:00 Welcome to the show.  James and Maroun Thank you, Hi.  Wouter Klijn  So why small and mid caps? What got you started in this particular space of investing. James  00:21 Well, for me, I started in the Australian market, in Aussie mins and smalls, but we were asked by clients to move into the global space. That's where Marouns joined me to attack this global market, which is huge. The tractions are significant. There is a very, very big market. The size of the market is 9 trillion US, which is huge. So 12 trillion Australian so it's 5x the size of the Australian market. So the opportunity set is significant. The breadth and depth of stocks is very significant. So the number of stocks you can own in the universe, in each sector or in each theme, is quite broad and diverse. Valuations are very attractive, and one of the other key things is that they are still under researched, and in many cases, under appreciated for what they actually have in terms of quality. So that allows moon and I to find ideas that are often 15 to 20% EPS growth on 15 to 20% roes trading on very reasonable multiples, compared to things that are more discovered in large caps and the size we can now go up to is about 60 billion US, which is our universe scope, which gives us quite a long runway in terms of years of holding stocks before they are large caps. They're all the key attractions. So it is a very attractive space. Wouter Klijn  01:32 So we've seen a lot of concentration, in particular US equity markets. And we did see that earlier this year's small and mid caps have underperformed a bit. Are the two linked? Is the concentration in the market affecting the smaller mid cap space? Maroun  01:47 Yeah, absolutely. So they're two sides of the same coin. So you've basically had in the US market a concentration of maybe half a dozen stocks, predominantly in the technology sector, and they've been doing incredibly well. So they've propelled the market a lot higher, and they've they've allowed large caps to outperform small caps. That's quite unusual. Small caps historically, if you look back 25 - 30, years, small caps historically, have outperformed large caps. They're smaller. They're growing off a smaller revenue base. It's much easier for them to double and triple in size over time, but certainly over the last maybe five or six years, that's not been the case. So it has tempered some enthusiasm, I guess, in the past, for smaller mid caps. But I think you're also starting to see people now waking up to the risks associated with the concentration levels, both at a stock level as well as a sector level, and people actively now looking to diversify away from that. Wouter Klijn  02:44 Yeah. So you don't see it as a structural change. This, the small cap premium is still out there. It might be just a temporary dislocation. Maroun  02:51 I think so. If you look back in history, there has been periods in time where, where large caps have done quite well. If you look back to the nifty 50, back in the early 70s, there was that there was a handful of stocks that did incredibly well, predominantly at the top end. So we do go through periods every so often. I think this is another one of those episodes. Wouter Klijn  03:09 Yeah. So might be a nice buying opportunity then?  Maroun Absolutely, yeah, we definitely think so, yeah.  Wouter So we've looked a lot at US exceptionalism, a lot of talk around that, especially the Magnificent Seven. But you know, is it the broader market, or is it just the Magnificent Seven that are exceptional? Or do you see that also extended to the to the smaller mid cap space? James  03:35 Yeah, with US exceptionalism, it's a very big topic area. So what we focus on, I guess, in our world is returns, and the return profile of the mega caps is quite high. Still, during that 20% level, in terms of roa's or Reich's return on investor capitals, our index is still around a 15 to 16% level, which is quite high, and also the US in aggregate compared to the rest of the world, is very high. So 15 to 20% returns on capital, compared to the world average of around nines to 10s, whatever you want to call it like, the US, is 50% better on average, in terms of returns on capital to the rest of the world. So we are still, you know, half of our fund, at least, is in the US. There's a lot of talk about the US builds great businesses. The Chinese build great manufacturing, and European builds great regulation. It's a well known kind of cliche, but the fact is that the US does have great businesses, whether they're whether whatever you is you want to say, the cause of that is, and that's expected to continue, especially for the next few years. Yeah, so we don't think it is a one off, and it's not just the mag seven either. Mag seven are symptomatic of the US being a leadership marketplace, and we find that's why we find it very attractive, because in global mids and smalls, we've built a portfolio which has returns on capital of in the 20% range as well, and still a very reason. Or valuations. So, you know, we aren't too concerned about that concept of us exceptionalism, because we don't think it's there's a huge break point that's obvious coming forward.  Wouter Klijn  05:10 So there has been a lot of talk around whether we are in an AI bubble or not, and whether the Mag Seven isn't a symptom of that. What's your take on it? Do you have any views on whether we're in a bubble, just in an expensive period. Maroun  05:22 Yeah, it's always hard to know whether you're actually in a bubble or not, but certainly there, there are signs, early signs of formation. There's a lot of spending going into this area, and at this stage, we're not seeing the return on that, that increased capex come through now it may still Come, come come further down the track, and in which case, all this spending is justified. And you know, things continue as they are, but when you're seeing an increasing level of CapEx, I mean, some of these companies in the mag seven are spending 10x the amount of CapEx they were 10 years ago. So they were capital like businesses, and now they're quite capital intensive. Businesses spending a lot more money, that money needs to earn an attractive rate of return, because one of the things these businesses have done historically is deliver very high rates of return. So when you're investing a whole lot more money and you're large and you're dominant, the hurdle rate for you to keep on growing becomes it becomes incredibly high. So I guess we'll see over time where this ends up being a bubble or not. But certainly there are some early signs that, you know this could head down that path. Wouter Klijn  06:31 Yeah, yeah. So most people talk about the mech seven when they think about AI and AI development. Are there any opportunities in the smaller myth gap space that stand out? Maroun  06:40 Yeah, so we're seeing quite a few of those, and we have a few of those in the fund itself. They don't dominate the headlines that they're not household names, but a lot of them are in what we call the enabler space right now. They're either doing things like advanced packaging and hybrid bonding or certain techniques such as power efficiency in industrial end markets. We go through this in quite a bit of detail. Recently, we did a webinar probably about half an hour. We went through AI in detail and what it means for our universe. And we even had our sector lead, that technology sector lead, dialling from Hong Kong through the webinar as well. So if people are interested, I'd encourage them to have a look at the webinar for quite a bit more detail, Wouter Klijn  07:23 Yep, and we'll put a link in the description. So let's have a look at your process, your investment process. There's four areas that you focus on, quality, value, transition and momentum. Why these four elements? James  07:38 They really allow you to keep a balance style through the whole sort of movements of the market. So markets can be like what I call quality momentum cheerleading. It can be a bear market, where value and transition kind of works much better. They can be very thematic elements of the market. So this allows us to be basically balanced, but also have guard rails that makes sure we're not too extreme in one particular style factor, specifically like quality, is quality compound. It's a high return businesses that are long duration value. Businesses are typically lower valuation, but at least the balance sheets are good, and they're not in some strategically declining marketplace. We're happy to hold those if they're just out of favour. Transition names can be turnarounds. They can be cyclicals on the recovery. Or they can be innovators, and then momentum can be top of cycle, cyclicals top of cycle, thematics or or things that are just like in in a hot sort of thematic as well. So that those four elements is how we think about it, that we think about it in terms of risk as well. So that allows us to think that your blind spots and your winning spots tend to be governed by where the stocks are on that journey. So we have different sort of funny names, like qualities a love quadrant Valley is a neglected quadrant transitions. The quadrant of hope and momentum is like all like the night club quadrant or the hot quadrant. It's where things are. Yeah, lots of fun and things are going up. Wouter Klijn  09:03 Is that how you label stocks as well? These are the hot stocks, and these are, James  09:07 well, they get labelled in qvtm, so they get labelled by that, but it's your brain definitely is wired to where that is. So for example, the quality quadrant is love quadrant. Like a long term marriage or a long relationship, you get very comfortable. You get very complacent. So the risk is in, this is business. So this is, you know, competition, capex, complacency, arrogance is what can set in when you're a high quality stock. If you've got something that's unique, and we've found things that are unique have 20% returns for, say, 10 to 20 years. That can happen if you are offering something very unique, but you have to work very hard for that to work for 20 years. Wouter Klijn  09:43 So does that help you in managing, sort of, also the risk of, like, you know, falling in love with a stock or, yes, developing bias? James  09:48 Exactly. So at the individual stock level, yes, you are trying to manage the stock, individual stock risk. And then at the portfolio level, you're trying to manage factor exposure risk, and you're not. Trying to, for example, in 23 and 24 Those years were very much quality momentum markets where a lot of it was generating alpha from PE expansion or earnings upgrades. So what you end up having, you're managing risk at the stock level and the portfolio level, and what you also then have is a spread of businesses that are like four sort of types as well. So quality compounders, which are those beautiful compounder stories, cyclicals. So your value transition, momentum, kind of triangle, cyclical, mid cycle, top cycle. Then you have your innovators, which go from transition to momentum when they're going from generally low returns to high returns. And sometimes they can move over into quality if they can sustain that for many years, and you've got your thematics, which are generally momentum. So there's these four types of stocks that you can can own, and they they're on very different journeys. What they're doing in terms of share prices and returns and multiple expansion is very, very different, but that we've made alpha in all of those categories, those four stocks types that I mentioned. So we do it for stock picking, for risk, to make sure our heads in the right space, but then also to make sure the portfolio is generally balanced all the time in a market that can do well in up markets and down markets.  Wouter Klijn  11:16 Yeah. And do you have certain ranges that you move in between quality and value and momentum, or do we try to get a style neutral type of… James  11:24 Yeah, we have a guardrails. It's based on a 25 year back test. It's 40/30, 20/10 actually. So quality, 30 plus or minus 10. Value, sorry, 40 plus or minus 10. Value, 30 plus or minus 10. Transition, 20 plus or minus and a momentum, 10 plus or minus 10. And as long as we're within those ranges where then our rolling three year out performance, you know, should always be positive. That is the goal. And that was based on a 25 year back test using the UBS HOLT system. Wouter Klijn  11:52 So value has been sort of unloved for quite a while, until, sort of the Ukraine war happened. How do you hold on to that allocation? Because it can be quite painful, I think sometimes during the cycle, Maroun  12:07 yeah, yeah, it's, it's different types of value, so a lot of it is cyclical. So you can have energy going through a different cycle that's not tied to the broader, you know, value versus growth. We've made money in energy. We've made money in insurance, getting in and out again. Insurance has its own cycle, depending on when there's catastrophes and when you have a hardening or an increasing in premiums and a softening that's taking place. A lot of these things are really related to demand, supply dynamics within their tight little within their tight little industry, because supply is quite lumpy. It comes on in chunks. And so you might get periods where a lot of supply comes on and you get an oversupply, and the respective prices for the industry drop, and then you get a period of no new money coming in, because returns are quite low and lots of companies are losing money, and then you get a demand spike, and that actually pushes up pricing, and supply has got a lag response. So we're not looking to play the quality versus value macro cycle. You know, when we're looking at cyclicals and value names, we are looking at them at a stock by stock or industry level basis, Wouter Klijn  13:22 so quality, value and momentum are probably, you know, well known style factors, style approaches. Transition is a bit different, though, and when you talk about transition, you're not talking about the energy transition. What do you mean exactly by transition? Yeah, Maroun  13:38 Look, I think James alluded to a little bit in one of his earlier responses, but transition really is we're talking about a change in the business model. So it could be a turnaround. You could have had a business that's been underperforming for a long period of time. You get a new CEO come in place, there's a cost cutting programme. Potentially there's divestment of non core assets. The business is going to refocus on areas that it competes well in, and forget everything else. So that would be a transition name. You could also be a biotech stock or an early stage technology name. And you're going through that journey of you're still loss making now, but you're building up scale, and in another six to 12 months, you're going to hit that profitability mark, and you're going to be break even self funding, and then, you know, on that path to increasing margins and returns over time. So when we're talking about transition, it's not the energy transition, it's a fundamental transition, or a fundamental shift in the business itself, either the business model, or just moving through that life cycle. Wouter Klijn  14:46 So you recently wrote a piece on a case study that you invested in Arista, which is a networking equipment company. Now there was sort of an interesting situation there where there were concerns around whether there would keep. Their main client, or whether they were potentially cut out of that ecosystem. And you went there, you talked to management, and you got a clear picture. But is that the type of transition you're talking about, or is it? Is that just a catalyst that you're looking for when investing in particular companies? Maroun  15:16 Yeah, so Arista itself, we actually classified it as a quality name, not a transition name. It was a high quality business that had been doing incredible margins and returns over a long period of time, and it had been outgrowing the broader market. So for us, it was a long term quality compound. But you're absolutely right, the opportunity was caused by this location, and that this location was so Arista, at that point in time had, and still does have, two large clients, being Microsoft and meta. And this is back to 2020. Meta had basically come out and said that they're delaying their capex spending, and a lot of the market participants thought that that was meta's way of saying that they're going to be spending less with Arista and a few other people now, myself and the technology team went to Silicon Valley. We met with both Arista and Facebook at the time, and it was very clear to us that the issue why meta was actually postponing its spending was to do with the Intel chips that it wanted access to, rather than anything else, and that they were not looking to move away from Arista in the network switches department. So for us, ideally, yes, you want it. You want to look for a dislocation. You want the market to be concerned about something, and then for you to have a differentiated point of view, because that really is where the mispricing occurs, and we're looking to take advantage of those situations. So even though Arista wasn't a transition, per se, there was a temporary dislocation for about a year or so, until the market gained comfort that actually Arista is not losing any share from from from Facebook, and Facebook remains a loyal customer. But it was that temporary dislocation in price that we took advantage of and ended up being quite profitable for us. Wouter Klijn  16:56 Yeah, I presume that it doesn't happen all the time. Do you stumble upon these occasions regularly, where you find that the market is interpreting certain data in a certain way, but when you actually talk to the company, it turns out to be another way? Maroun  17:11 Yeah, I can give you a recent example. One that we're looking at for a long period of time is called Fair Isaac Corporation. So you may or not know, but in the US, there's a thing called the FICO score, which is effectively your credit score. You need that to get you needed to get home loans, auto loans, you know, lots of different things and and it's called FICO because it's Fair Isaac Corporation. So this company has effectively had a monopoly on credit scores for decades. Anytime you need to get a loan, you go to a bank, they request your FICO score from FICO, it comes back, if your credit is worthy enough, then you sort of get the loan. And you know, and off you go. Now, recently, what happened was the head of the Federal Housing Authority, the FHFA, in the US. Bill Pulte, who was appointed by President Trump, came out and tweeted that FICO have been raising their prices quite aggressively, and they have FICO score back in 2019 or 2020, cost cost you 50 cents, and now it cost you $4.50 so it's gone up nine fold in five years. But $4.50 in terms of the cost of buying a home, when you think about things like land taxes, when you think think about insurance and all sorts of different fees that you paid to real estate agents, it's actually a tiny part of the entire thing. But in percentage terms, these guys have been increasing pricing, 5060, 70% year on year for the past four or five years. So, you know, the share price in FICO corrected quite aggressively. Was sort of 22 $2,300 a share. And it sort of came down to about 14, $1,500 a share. And for us, you know, speaking to the company, understanding how reliant the lenders are on a FICO score. And there is a competing product called Vantage score, but it's not, it's not anywhere near used as much as FICO and a lot of the systems in terms of lenders, the mortgage, you know, the guys that securitize loans and sell it as MBS products to end investors, all of their systems are all set up on FICO score, so the incentive to switch is not really there. And then, when we spoke to the company, they still had views about, you know, creative ways in terms of they can increase pricing going forward. So for him, it wasn't deterring them whatsoever. And so we took advantage of that. And then, you know, recently, within within the last couple of months, we've actually seen them come out with a unique way of changing their pricing and still getting, effectively, 100% year on year price increase, but just doing it in a way that is quite innovative, cutting out the middleman, so the end customer is still paying the same but they get twice, Christ twice. The revenues for themselves, and the FHFA came out and said, we're actually supportive of it. So this is a business with pricing power. But again, a temporary dislocation. The shares were down sort of 30, 40% and you could sort of get in there, do the do the research, and walk away with a differentiated point of view and take advantage of that dislocation. Wouter Klijn  20:18 Yeah, yeah, for sure. So you're keeping a close eye on Trump's tweets as well, then to see if it's any opportunities there.  Maroun  20:25 His tweets are always creating opportunities. It's basically creating opportunities on a daily basis. Wouter Klijn  20:32 Either that or chaos. So if you look a little bit at your selling discipline. So I saw that last year there was a time that you you trimmed some of the stocks because you were looking at the PE ratios that were quite high. Can you tell me a little bit about how you how you stick to that selling discipline, even in markets like today, where it still seems to be going up all the time, but obviously you have to take profit at some stage, yeah. Maroun  21:01 So we've got different reasons for sell, for selling, and one of them could be the thesis is broken, right? So we assumed something was going to play out with this company. It's not looking like it. Our initial assessment is incorrect, and we need to get out, because it's not what we thought it was. That's a bit different to what you were alluding to, and you're absolutely right. Another reason why we would sell is where the valuations are no longer representing a mispriced opportunity, and we are relatively sensitive to valuations. Even though we do like quality names, we're not going to go out and pay crazy multiples for it. So if I go back to last year, the middle of last year were overweight the US, and towards the end of the year, we found a lot of names in the predominantly in the US had run, had run up so much and well ahead of their fundamentals that we were taking profits in some of these names, and when we were recycling them, we were just finding more relative value opportunities in places like Europe, for example. So we went from the middle of last year being overweight the US towards the end of the year being underweight the US. And that was really just because of risk management, right? We just wanted to make sure that the valuation of the portfolio level was manageable, because you don't want to be susceptible to large drawdowns if you get a bear market, if you get rates moving up, if you get value sort of having a strong style rally, so we manage that as well at the portfolio risk level. So what we were doing last year was more around the valuation side, and ended up being predominantly moving away from the US in other areas, into other areas. James  22:37 Yeah. Also, for last year, was particular the timing question you asked, because 23' – 24' Maroun and I four Maroun and I noticed a lot of the performance of the stocks was from PE expansion, so that's fine if there's earnings underneath that. So yeah, we haven't had to chase stocks on 40 or 50 times PES, for example, to try to get alpha. A lot of the times they're buying stocks on 20 to 30 times PES that are good quality businesses. But we've also held stocks that have, like, held on to stocks that have gone up four to 500% because the earnings are actually moving up in that quantum, that magnitude. So Apple oven, for example, we still own today, that is up four or five times from our original purchase. But the earn, the earnings numbers are actually a lot higher, 404 500% higher. But then also, if you look out one, two and three years, the earnings continue to grow at, you know, very high levels. So that also makes sense. But if it doesn't make sense and why we did trim a lot, a lot of the stocks, like, for example, in US industrials, the stocks normally traded at 10 to 20 times. Multiples, no trading at 3530 or 30, a button above PES and the earnings growth was Five 6% so the analysts getting nervous. We're like, this is getting a bit and so that's when it's a bit more dangerous, in our views, that the multiples have expanded, but the earnings are not there. And then, if you roll out year one, year two, year three, the multiples are still high relative to history, high for the growth and high in absolute terms relative to the market. So that's why you got to Yeah, that context is what we constantly think about. And if Yeah, like Marin said that if the thesis is broken, that's definitely a sale. But then also the valuations just start to make less sense to us, then the mispricing is not there, and then we will trim or exit. Wouter Klijn  24:26 And how do you look at the individual companies placed in sort of the broader market environment? Because we are in sort of an unusual period where it just seems that equities just keep going up. I mean, we've seen a lot of super funds that basically said market is expensive. We're taking risk off lower equities and then just continue for another three years. Yes, and might continue for another five years. How does that change your thinking in terms of portfolio construction?  Maroun  24:53 Yeah, I mean we our view is that we're hired to solve the investment piece, so we're not really trying to make a big call from. It is to cash. So we have a bit of flexibility in terms of cash, but realistically, cash for us, most of the time, is sort of five or 6% or below. We're not going to sort of go out and say we're really negative on the market. We're making a big market core, and we're going to go to 20% cash, for example. That's just not what we do. Because ultimately, what our clients are hiring us for is we want you to solve the equity piece, and we assume that you know, if they're getting nervous about valuations or equities, they can make a move themselves at their portfolio level, whether it's an individual, whether it's an institution, they can shift some money out of equities into cash, but that's sort of not, not for us to make for them, having said that, we do keep an eye on the market levels. We're looking at sentiment. We're looking at euphoria. And so within equity, sometimes we can sort of move a little bit more defensively, out of higher beta names, out of names that are more exposed to the economic cycle. If we feel as though we are going more towards top of cycle, we might go into things like a bit more defensive health care, consumer staples, where we think they're going to be relatively unaffected, even if you go through a recession or anything like that. So So we're making those sorts of decisions, but we're not going to be sort of moving the portfolio from 100% equities to 80% equities and the rest in cash. Wouter Klijn  26:16 So how are you positioned at the moment in terms of those that balance between defensive sectors and more growth he wants. Maroun  26:22 So right now we are, we do have a little bit more beta than the market. Our view is this, you know, the euphoria that we're in continues. We don't want to be super exposed to it, but we want to participate in it. So I think our beta at the portfolio level is probably about 1.05 Yeah, so slightly above market. We don't have a huge amount of defensives in there right now, and cash is probably running at about 5% so relatively neutral ish for us. So we're not looking to make a big market call, but we're looking to participate in the continued sort of rally.  James  27:00 Sector positions are mainly technology, consumer, financials. They're our main sort of positions that are like and industrials, industrials, that those four sectors make up probably 70% of the portfolio today. But also on your question, it's also the market level. So that the market, I know it, is quite euphoric, and people say like the market, and we were aware of it, the market's gone up nearly 20% has gone up nearly 20% for three years in a row, and it's looking like the construct doesn't look scary yet, like it looks quite good. It the breadth and depth of the market is still quite wide. The valuation parameters of the market is still quite attractive. It's on like an 18 times per year, growing at double digit returns. The ROA is still about 15% ROE of the market in our mids and smalls universe, our portfolio is around 20 times, with over 20% ROA growing at double digit as well. So there's nothing that's like screaming red flags in terms of valuation parameters of the market or our position relative to the market, but we do track that every single quarter quite religiously, and try to make sure that the PE to G, pe to growth ratio, makes sense, the Pe to the roe also makes sense. That gives you an idea of where the market, you know, is extrapolating, and that's where you can get extended. But yeah, there's nothing that's a massive red flag at the moment that's yeah, concerning us.  Maroun  28:22 Yeah. I think it's probably at this point worth highlighting the bifurcation between large caps and smaller mid caps. So everything James said is absolutely true. Our small and mid cap universe today's is trading on valuation levels broadly consistent with its 20 year history on free cash flow. Yield, yeah, free cash flow, yield, PE A lot of those different valuation metrics where you're seeing valuations looking very stretches in large cap land. So if you look the MSCI World, it's trading at valuation levels that are in the top decile of its long term historical averages. So that valuation euphoria, you're seeing it predominantly concentrated in large caps, in our segment of the universe, our valuation levels are broadly in line with the history, and so is the growth rate. So for us, relatively speaking, it's quite attractive. And hence why we're more invested in small and mid caps? If we were running a broad cap or a large cap mandate, then we probably might have a different answer for you in terms of valuations running too far ahead.  Wouter Klijn  29:21 So we talked a little bit about the sector balance. What about in terms of geography? I think in the recent webinar that you did, you talked a little bit about China, there's some ideas around, I think, the tech ecosystem that might get a bit of a wake up call. What is your exposure there? Maroun  29:38 We have a little bit of exposure to China, but not in the technology sector. Right now, we have exposure to China in the healthcare sector. Most tech, yeah, most of the technology names in China that are doing quite well are too large for us, so we're not really participating in the Chinese tech space, per se, but we published another small cap. So. Unfortunately, not a smaller mid cap, yeah. So we are slightly overweight China. Our benchmark is developed markets, so any position in China is an overweight so we are slightly overweight China. We are overweight Europe, and then we're a little bit underweight the Wouter Klijn  30:16 US, yeah. So you just brought up benchmarks, and as I was preparing for this podcast, I asked some of the asset owners what I should ask a small and mid cap manager. And they said, What about performance comparison to ETF? Do you benchmark yourself to an ETF? Because there's, these days, there's an ETF for everything. So there is a quality value ETF. How do you look at that? James  30:41 Yeah, qsml is definitely one that a lot of clients raise, and a lot of clients have that exposure in our universe, qsml has done quite well. We've done quite similarly to it. I guess the difference is that we are more balanced than the pure quality factor style, but mids and smalls has had a quite a good rally, like overall, especially small caps. So that's, I guess, what you want to participate in longer term. But we definitely do look at it, qsml, Van Eyck product, Maroun  31:14 Yeah, I think for us, a single style factor is not really who we're looking necessarily at, because, remember, we're a blend of four different styles in there, right? So what we're ultimately trying to do is deliver a smoother return outcome for clients, and we've done that. So if you look back at calendar year 21 it was a very quality growth in momentum a year, same as 23 and 24 but 22 was was the exact opposite of that. You know, it was anti quality. Quality sold off quite aggressively. It was pro value. We outperformed in calendar year 21 we outformed the calendar year 22 we outformed the calendar year 23 very different markets, and we delivered consistent alpha in very different markets. So if we were tilted to one style or another, whether it be quality or value or anything else, we would have had some periods where we did incredibly well, and would have had some periods where we underperformed the broader market. And so you ride that volatility up and down if you're excessively exposed to one style. What we're trying to do is just sort of deliver consistent Alpha year on year, independent of what the broader market is doing, independent of what style is doing well, or what style is not doing well, independent of what rates are doing, what inflation is doing, what the Fed is doing, all those sorts of things. Our process is really more designed to give you that smoothness of return profile. Yeah. Wouter Klijn  32:32 Fair enough. If we delve a little bit into your your process, one question that I always like to ask, because it gives a little bit of a sense of how you think about companies is, can you think of a company that you've done due diligence on? It looked initially attractive, but as you dug deeper, it actually turned out now we're going to stay away from this talk. Maroun  32:51 Yes, someone we looked at earlier, probably towards the end of last year into early this year, was was Decker's outdoor. They own a bunch of different shoe brands, the two most prominent ones which account for over 90% of their sales, would be the Ugg boots, which we all know, and the other one is the Hoka shoes, which are those thick cushioned running shoes? Lightweight. Yeah, lightweight. Thick cushioned running shoes and Deckers has been on an incredible growth profile. The last four or five years, sales have been increasing double digits and accelerating. For a number of years, margins have been going up, returns have been going up. So everything kind of looked quite attractive, but when you sort of dug in a little bit below the surface, you realised it was the growth was predominantly driven by increasing penetration of Hoka there, you know, and they were first mover. Effectively, there was competition coming in, because you can't really copyright shoe design, you know, there might be certain elements of it, like, you know, Air Max or something like that. But, you know, anyone can sort of come out with their own version of it. So competition was picking up. It wasn't an area that you could have long term, sustainable competitive advantages in and and it was predominantly, you know, single product risk and trading on very high valuation levels, because the market had woken up to that growth profile.  James  34:14 So we kept looking at it, because it's all people running out of the gym, running down the street, running through the park, everyone's wearing Hoka you get into a lift, someone's wearing Hoka, like Maroun. We got to look at this Hoka again. But we did it like, for like, a year, and we spoke to the analysts probably five times about it, Maroun  34:30 And then, and then, you know, we decided to stay away from it. And then earlier this year, they guided to, you know, they they missed their numbers by a few percent and guided to a slightly weaker than expected quarter, still growing, but not 20% growth. It's going to be more like 10, 11, 12% growth when you when you're a stock on, you know, 50 times PE that's a very sharp draw down, right? So the stock basically halved in the space of two months, even though. It's still growing, but just not growing as quickly as what it was. And so for us, it was having the discipline to not get caught up in the euphoria and just just look at it objectively and ask yourself whether the fundamentals justified the valuation levels and our view they weren't.  Wouter Klijn  35:18 So was that a buy moment when it halved? Maroun  35:22 So we have looked at it again, but you know, at this point in time, we're still sort of staying on the sidelines. James  35:28 And symptomatic of our process too, like we meet with all the analysts around the world. So the shoe market is big, so Puma is listed, Nike's listed, Adidas is listed. So we've got analysts in Japan, sorry, and that's yeah, so Japan and Europe. And in this one, America, so Maroun, and I like saw what the Hoka brand was doing in our eyes, with people in the lift, in the gym, in the parks, and the valuation was at incredibly high levels. So, but the context of shoes was very competitive. So Nike was having a tough time. All of them having a quite a tough time. So yeah, it wasn't an easy marketplace as well. So you had this Hoka brand that was doing something very different to the rest of the market. But then eventually the market weight, or the market anchor, basically brought it down. So yeah, it was a very interesting one for our process and conversations that we have between ourselves and the analysts. So it is quite an interesting example. Wouter Klijn  36:28 Yeah, yeah, sounds a bit like I had a recent conversation where we're talking about the nature of cyclicality. And the comment was there around well, some companies might not look cyclical, where their clients are, so maybe everybody that wanted that shoe bought that shoe? Maroun  36:44 Well, it's fashion risk, right? And fashion can be fickle. You know, what we used to wear 20 years ago and what we wear today? You know, very, very different, yeah. Wouter Klijn  36:55 So just asked you about what would potentially be a dud investment. What is your most your favourite investment? Maroun  37:01 Yes, well, certainly the most profitable, memorable one for us would be AppLovin, which is a very unique business that does ad tech. Basically, it's historically surfaced ads for you in the video game world. So if you're playing a mobile video game and you're getting ads within the video game. They're sort of the matchmaker that sit between the advertisers and the suppliers of ads, and historically, they've only surfaced you ads for other video games. So you're playing a video game, and then you see an ad and how you might be interested in this video game. Do you want to download it? What they realised is they were that they had the technology and the information to be able to also serve you ads for different verticals. And a vertical they got into, they opened it up in beta form in q4 of last year, but it was e commerce. So now all of a sudden, you can be playing a video game, and you might see an ad for you. Might you might be interested in this shirt or this shoe or something like that, right? And and it was, they opened it up in beta form in q4 of last year, and all the feedback from the advertisers was that the return on advertising spend is very, very high. It's second probably only to meta, ahead of ahead of tick tock, ahead of Snapchat, Pinterest, Google, even so, you're opening up a new segment of the market all these e commerce advertisers who previously wouldn't advertise with you. You're delivering them very high return on advertising spend. It's incremental new customers. It's not sort of customers that that you're getting in different parts of the funnel, and this year, they've gone from beta to now opening it out more broadly. And so we're seeing rapid adoption in that and so the stock almost went up tenfold over the course of 18 months. So it has definitely been very profitable for our investors. Wouter Klijn  39:00 So how would you classify stock like that? Is that traditional marketing is it like AI that uses the algorithm to predict what you want to buy? Maroun  39:09 It's got AI in it, so the engine that powers is AI. So say it learns they're not obviously going to reveal their secrets in terms of what they do. But you know, if you're on social media, it's relatively easy to know what you're interested in, right? Because you click on a bunch of different links you might be following you know certain people. So if you follow, for example, a lot of different food bloggers on Instagram, Instagram quickly works out that you're interested in food, right? And if you click on different articles about celebrity chefs and all those sorts of things, it works out pretty quickly you're interested in food, so it can service you ads related to food, whether it's cookbooks, whether it's a new new restaurant is opening up, you might be interested in going to it. It quickly works it out. When you're playing a mobile video game, it's a lot harder to figure out what you know or what you're interested in, right? So they've got an AI system that sits underneath there. Yeah, and it has been able to sort of figure out quite effectively, things that you're interested in, how they do it. It's a bit of a black box, but that beauty of the AI model, so it's very hard to replicate. They're sitting on a huge amount of data. There's no one effectively, with the exception of a very distant player called Unity, which is a very, very distant number two that has the data or the capabilities that they do. And like I said, they've just opened themselves up to a whole new customer base that can now, that can now sort of spend with them. So it's it's doing a lot of things. It's leveraging AI, it's giving customers who, over the last three or four years or five years have only really been able to spend money with Google, Facebook and Tiktok. In terms of advertising, now you're getting a, you know, another avenue for you to place ad dollars in, and you're getting incremental sales, you know. So it's, it's definitely doing a lot of good for its customers, yeah. Wouter Klijn  40:54 So in terms of the process, is it a quality, value transition or momentum stock? James  40:58 We call that an innovator. So basically, I'm from transition to momentum. But remembering now, like normally, quality we have as a multi year high roe business, this business, roe has gone from 10 to 60 but it's held that 60% Roe, which is in the top one to 2% of the world's ROA, or return on investor capitals for now two years. So, as I say, and I know, in my experience in the Australian market, if you find a stock that goes from like transition to momentum into quality, that's up 10x so it's happened with aristocrat, you know, going back many years in the Australian market. It's happened with Apple oven in this marketplace. And it's happened with other stocks that we've had that were, you think their momentum, they cyclicals, but then they managed to sustain that ROA for a very long period of time, and that's when stocks can go up, you know, 510, x as these ones do so. They are innovators that go from your transition and momentum to quality, which is a very powerful structure. And even now, like you asked the question, now, the EPS growth of that business is more than 50% like this year, and then the year after, and they just did 300% return in the last two years. These stocks that have the earnings growth can go up a lot, but it's because, like Maroun's described, it is very innovative. What it is doing, he's doing something very different, but it is solving a problem for its clients and the world. So when you do that, you create a lot of value, which is what we're trying to find every day. Wouter Klijn  42:24 Yeah, for sure. So to finish up with the if any research projects on the boil, I believe you recently published a white paper. What was that looking at? James  42:34 Yeah, it's a bit of detail. The white paper really looks at lessons learned that we've had over the years, the process, the asset class, and just takes, yeah, takes readers through, I guess, the journey of what we try to do in the Fund, and the data to support that, that process. Ultimately, that's what I'll be coming out soon. And then recently, Maroun and I led the AI webinar, which is, which is significant. AI revolution is a massive they call it the fourth industrial revolution of the world. So that was a really interesting thing that we've done just recently. Wouter Klijn  43:06 Have you used AI in your own sort of research or your processes rather investing? Maroun  43:12 I use it almost every day. I've got perplexity Google, Gemini, use a little bit of chat, GPT and grok as well, but perplexity is my favourite of all them. I've actually got a paid subscription with perplexity that I use, and it's amazing. I mean, the amount of things you can leverage it for, it's just amazing. Wouter Klijn  43:32 Can you give one example of what you use it for?  Maroun  43:34 Yeah, so I've got, like, a prompt, for example. Let's say it's a stock. I want to get up to speed on it very, very quickly. We've obviously got internal analyst notes, so we can read a lot of that. But even for private companies that we might not have notes on internally, I type in what I want it to do, and it goes down. It searches information for me, market shares, how those things have trended over time. It does a huge amount. Basically, it can do a relatively decent report on a business that would get you from A zero working knowledge to at least a respectable level of working knowledge. And it can do that for you in minutes. And so you can get up to relative good speed in 10 minutes, 15 minutes on a company after you've read it. And then from there, you can go and say, right, these are the key areas I need to look into. These are the key areas I need to dive into a bit, you know, because these seem to be the key value drivers. And then you can spend the next two or three weeks diving into just those key areas and making sure you have comfort around that. But it basically saves you that upfront work of about a week, you know, a week's worth of work, and does it for you in literally minutes. Wouter Klijn  44:43 So there's definitely some productivity gains. Maroun  44:46 There huge amount. Yeah, a huge amount.  Wouter Klijn  44:49 Fair enough. Well, Maroun, James, thank you very much for coming to our offices and for doing this podcast.  Maroun and James Thank you very much. My pleasure.
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  121: JANA's Mary Power – Offices Market Woes, Liquidity and Blended Approaches to Property 13.10.2025 32min

  In this episode of the [i3] podcast, I'm speaking with Mary Power, who is the Head of Property Research at asset consultant Jana. We cover the struggles of the property market in the early 90s, when Mary started out in the industry, and the learnings from that time. We take a look at how investors have dealt with 13 consecutive rate rises, starting in 2022 and we cover portfolio construction issues, including blending listed and unlisted property assets, the convergence of real estate and infrastructure, while Mary also predicts that up to 50% of Australian property money might be reallocated to international assets as super funds grow bigger. ________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights __________ Overview of podcast with Mary Power, JANA 03:00 Getting into the industry 04:30 The early 1990s was a dramatic period in the office market and as a young person in the industry that experience was fascinating 07:00 I think we have turned a corner in terms of unlisted property 8:00 In June 2022, we headed into 13 interest rate rises, which was a significant head wind for the property sector. 10:00 The REIT sector is very sensitive to interest rates 11:00 Are REITs equities or properties? 12:30 Property people don't price off the cash rate; they price off the 10-year bond rate 14:00 The Melbourne property market is still a little bit difficult 16:00 People aren't getting their forward projections of labour seating in offices right 19:00 I think it is very hard to promise quarterly, ongoing liquidity in a portfolio with large assets 25:00 There is a big push for the build-to-rent sector to mature in Australia 31:00 Super funds could move up to 50 per cent of Australian property money offshore Full Transcript of Episode 121 Wouter Klijn 02:01 Mary, welcome to the podcast. Mary Power 02:04 Thank you very much, pleasure to be here. Wouter Klijn 02:07 So you've been with Jana for more than 15 years. What got you into property investing or property research in the first place? Mary Power 02:16 Oh, I might have to let you in on a little secret. I I've actually had two stints at Jana. I was actually at Jana in the between '94 and 2000 as well. So yes, I was how did I get into property? It's a great question. I had a friend whose father was a valuer, and I commenced the property valuations course at RMIT, and he got me a cadetship at Urbis, known as at Cox then, and I was hooked. I was enjoyed it immensely. And love the idea of the commerce and the built form coming together. Yeah. So I, I really enjoyed it. And I, I joined at a time when the property market was exuberant in the late 80s, and then it went into the early 90s, which was the recession we had to have. So I saw the best and the worst at the time. And I always say I learned all my skills over those eight or nine years. Wouter Klijn 03:12 Yeah, and apart from the environment at a time, has the investment side changed much? I mean, do do the valuation practices change the deals, change the structures. What's that like? Mary Power 03:26 It's a great question. In fact, a lot of it's changed, and a lot of the fundamentals remain the same. So lots of change, lots of so if you went into the early if you went into the early 90s and we had that recession, which absolutely impacted the office sector. In Melbourne alone, there were six office buildings that were built, and they would have been built on, not with pre commitments that you would have today, so built by developers who then had to entice tenants in. So a mill, we say, a million square feet, or square metres of Office became was built, and then the rest became vacant. So vacancy rose to about 25% and in fact, rents halved. So it was a really dramatic period in the office market. And it was, you know, as a very young person learning it was, it was, it was fascinating. What had happened over that period. We didn't have a Funds Management basis. Then the I think, as we headed into the 90s, I think amp and national mutual were about the only funds managers that were available. Most of property was held within a Balanced fund. And of course, over the course of the next few years. If you fast forward to 2025 the Mercer survey is, in fact, about 94 billion. That's without Goodman, I think that adds another 18 billion on. So, you know, you're a very substantially funds management platform has emerged over that period, over that last 30 years. And you know, it. It now consists of specialist sector managers plus diversified managers. So it's been amazing. Wouter Klijn 05:05 Yeah, sounds like the office sector has gone through a few problematic periods and more exuberant ones, because we've seen, of course, with covid and as well that it got strongly impacted we were working from home. Did that experience earlier on help you going through the covid period? Mary Power 05:26 I think covid, I always say covid was a black swan event. No one had, noone had predicted it, but the balance sheets and corporates and and employment data was all in good shape. It wasn't the same. In the early 90s, we had very high unemployment, up to 11% most people I knew had someone had lost their jobs, and these were very smart people, and we had a lot of corporate issues going on in the early 90s. That wasn't the case in covid. We were in pretty good shape going into the into the covid. So I think whilst it was annoying, and we hadn't seen it before, it was nothing like what I'd seen in the in the early 90s. So that gave me some comfort at the time, yeah. And of course, we had, you know, the new phenomena of working from home, which was something we hadn't had before. And of course, you know, various states had different lockdown periods. Melbourne had a very severe lockdown period. And of course, it's taken some time for people to return to the office. Yeah. Wouter Klijn 06:28 Fair enough. So if we fast forward to today's environment, I looked recently in sort of the superannuation returns for the full financial year, and spread out by the different asset classes. And what sort of struck me is that unless that has been relatively poor performer in recent years, last two years, negative, this year, low, single digit, but at the other side, first time it's single digits again with positive results, have we turned the corner there? Mary Power 07:01 I think we have, and I think you know what happened in 2020? Was covid occurred, and there was this, you know, significant lockdown over quite a long period of time. Never good for the built form that have leases in place. They have contractual leases in place, but you still need people to buy things at shopping centres and office buildings to be occupied for those leases to be sustainable and and of benefit to the tenant. So I think that was very difficult period. I mean, I'm would, I would call the Property Council at the time, they had to negotiate with tenants, 1000s of and come up with a code of conduct of how to interact with a tenant during this, you know, significant period of disruption. And to their credit, they did do that within a reasonably short period of time. On the other hand, infrastructure asset had one contract with talking about 1000s of contracts through the property sector. So it was, it was very, a very difficult period, but I think they did a great job. And then, of course, we headed into in June 22 the start of 13 interest rate rises, which, of course, was a significant headwind to the property sector, because it had performed quite well, even through covert up until the mid, mid 2022 and then we started facing into to higher interest rates. And the higher interest rates, in fact, had been quite difficult for cap rates at the time as a differential. So we know what happened. Cap rates expanded, capital values went down in most cases, the income line, the leasing line was was not too bad that that sort of stood up. You know, it was really the rapid interest rate rises 13 right? Interest rate rises in a short period of time. That really was the problem for the property industry, yeah. Wouter Klijn 08:50 And then if you look at the listed side of the property sector, somehow they did much better. So I looked at Australia's property that increased by 13.8% and then I think international listed property went more than 9% why is there such a strong difference between the listed space and the unlisted space over that period? Mary Power 09:12 So I think, you know, the listed is highly correlated to equities, so you have a big influence. You know, I go back to March 2020, and the a rate sector fell by 46% so that was a very, you know, that was a very stark fall compared to what the unlisted property index was doing at the time. So the A rates are, you know, they've got some interesting characteristics. For instance, the Goodman group makes up about 39 40% of the a rate index. So that will rise and fall depending on on how government have performed over over a period of time. So I think the other thing is that, you know, the a the rate sector, while it is very much correlated to to equities, it's very interest rate sensitive. So you get interest rate, you know, interest rate. Cuts like we've had attractive, very attractive for for the rate sectors, you know, good for repricing of debt. Good indicate, lead indicator. And I think, yeah, the rates can be a good lead indicator for unlisted property. Yeah. Wouter Klijn 10:15 So do you subscribe to the idea that REITs are equities in the short term and property in the long term, or are they just always equities? Mary Power 10:24 Yeah, I think that's a great question. I think over the long, long term, you'd think that they do. You do have a quite a strong correlation, you know, to property over the long term. I think though, you need to be able to withstand having them in the portfolio. You do need to be able to be aware of the volatility. So if you're sitting there in March 2020 you have to ask a trustee or a fund how you know how comfortable you are with a 46% drop in your rate portfolio over that period. Because I think the way we structure a diversified portfolio is we try to buffer, we try to include asset classes like property and infrastructure and private equity that actually buffer equity market risk, so it actually allows you to have strong equity market exposure, but realise that in a downturn in equity markets that you've got these other unlisted assets that actually provide a buffer and should not decline as far As your equities do Wouter Klijn 11:21 Yeah, so we've just seen a quite controversial cut in interest rates from the RBA. And then I think there was a lot of comments that I didn't cut the time before that, but now we just seen that inflation figures came out, and they are sort of, I don't know if spiked is the right word, but it went from 1.8 to, I think, 2.9 What are your thoughts around that? Is that an indication that that won't be cut for a while? And how does that affect the property sector? Mary Power 11:52 Yes, always cautious on commenting on interest rate cuts. But look, I'd like to think that there, you know, are some more coming. I think the benefit of of the cash rate being cut is obviously in the debt markets, so very attractive for pricing of debt. So that's a that's a big positive property. People don't generally price off the cash rate. They obviously price off the 10 year bond rate. So the 10 year bond rate at, you know, 4.29 4.3 has been reasonably sticky above that 4% mark. There was some excitement when it got under under four, you know, you know, more than 12 months ago now 18 months. But I think you know, to get true increases, it would be great for that 10 year bond rate to come down. The only other benefit, of course, is, of course, the cash rate with with gearing and debt, allows you to be accretive, especially when the markets have bottomed. So you know that that is an attractive feature if you add gearing onto your base, base return. Wouter Klijn 13:01 So we've seen a lot of volatility in recent years, and I think you've spoken in the past about the importance of cell evidence stabilising to get a better sense of where the sector is. Is that happening? Are we getting to a more stable environment? Mary Power 13:19 Your short answer is yes, the MSCI Mercer unlisted survey for property is indicating that this is a third quarter of positive returns. So that's fantastic. So yes, we are. I think there's pockets, there's sub markets. Now it's not everything. Not everything is on the, on the on the rise, and I think our one call out at this moment would be the Melbourne office market at this stage, again, back to covid, longer to come out. You know, had severe lockdowns, longer time returning to work. And there has been some punitive tax, taxes that have been introduced into Victoria around the foreign owners surcharge, and that has deterred offshore investors from coming into into Victoria. So we've seen lot less sales in Victoria than anywhere else. So the sales evidence allows the valuers to actually have some some sort of basis for undertaking evaluations. Melbourne is still a little bit difficult. Yeah. Wouter Klijn 14:21 So those numbers that we mentioned earlier about this that they're not unless Should we take them with a grain of salt then in the unlisted space, or have there been enough transactions that we can get a good sense of what happened there? Mary Power 14:34 I think we're in a reasonable place with with where we're at with valuations now and going forward, and the other the real green shoots for property are the fact that there's a lack of supply. So what kills property supply in a recession like the early 90s? Now, we haven't, we're not. Hopefully we're not gonna have a recession. And supply is is very muted. Is muted? Yeah. Yeah. So that's really positive, and so is the sustainability the tenants are requiring that. That's very important. So not every building is the same. So the universe of, you know, desirable buildings has actually shrunk on the basis of sustainability. And that, again, you want to be in those buildings. That's a good thing, yeah. Wouter Klijn 15:21 So you mentioned that the Melbourne office market, and it seems that there's more and more companies that sort of either referring the working from home or reducing the number of days that you can do that is that supporting the office market. Are we seeing some more positive numbers coming out there? Mary Power 15:40 Yes, yes. I believe so yes. And I think, you know, again, with this lack of supply, people are actually got their forward projections a bit wrong. You know, I was over in the UK, there was a big investment house over there that had been in Canary Wharf was coming back to London, and they miscalculated by some enormous amount of seating, whether it was 3000 seats or something. And instead of being able to go into one location back in the city, they actually had to spread it out across a number. So people aren't necessarily getting the getting the forward looking Labour Employment seating arrangements, right? So it's putting more pressure on, on building, on certain buildings, within certain sub locations, yeah, so that's a positive thing, because it'll drive rents. It will drive rents, and that will drive returns. Wouter Klijn 16:32 Yeah, yeah, yeah, that's interesting. So we talked a little bit about, you know, the unlisted and the listed space, but some of the recent developments we've seen as well, that fund has started sort of blending both listed and unlisted exposures. And partly that seems to be, you know, where they have the relationship and the expertise, they tend to go direct, but then in other markets where they might be less familiar with or don't have the relationships, they might have more listed holdings. What is your opinion on that sort of blended approach, and how do you implement it? Mary Power 17:07 Well, well, it often circles around two things. One, liquidity, they need some level of liquidity. And the second is that there has been a pushover a few years now for where funds have had an unlisted exposure that may have some gaps in it, and they call it a completion portfolio. They may complete the overall exposure on the exposure side with supplementing with some listed so let's say they're underweight industrial they may have gone across the globe and bought industrial stocks and use that as their proxy to build up that that exposure. I think that can work. It depends on your time frame. And back to your earlier question about, you know, is property is, is listed rates more like property on a longer term basis? Yes? I think the answer is yes. And I think if, but then you've got to marry that up with a fund's ability to absorb the risk of volatility in, you know, periods of stress, like we saw in covid. So it really comes down to the perception of risk and return and that level of bullet tolerance to volatility. Wouter Klijn 18:17 What does it mean for the liquidity profile? Is that harder to manage, because, obviously listed space is much more liquid. How do you manage that? Mary Power 18:24 Well, that is a very topical question at the moment, because there are, you know, funds that are looking to change their liquidity mechanisms, rather than one long Cliff event, they're looking for quarterly liquidity, or allowing investors potentially quarterly liquidity with a cap, not just, you know, they can get at any stage. I think it's very hard to promise liquidity ongoing quarterly with large assets in a portfolio, because I don't know practically how that works. I think people that need liquidity should almost be sticking with REITs. Yeah, the only other areas that I've seen is where they've actually buttressed some debt exposure alongside the unlisted that allows some runoff characteristics as as loans are realised, and that will give some some level of liquidity going forward. Wouter Klijn 19:18 Another development that we've been looking at is, is there starting to become an overlap between infrastructure and real estate assets? And for examples, we've seen situations where there's empty land on at airports or at ports, and perhaps that can be developed for property purposes. What do you see there? Mary Power 19:45 Yeah, definitely, definitely. I think going forward, there will be a blurring between property and infrastructure, and I think it will be possibly, sort of viewed through the lens of the cash flow. Because I think one of the things that. Uh, even this last period of the last five years has demonstrated is that, you know, the cash flow needs to be able to withstand things like capital expenditure, and that's a dint to the cash flow. So if you look at infrastructure, mainly it's contracts, and they're pretty stable, and you can actually increase the gearing quite substantially. Property you need to be able to allow for these capex requirements, whether it's incentives or actual expenditure on the on the building. So I think where you start to get some purity in the cash flow, like you do almost with infrastructure, that'll be very interesting area of interest Wouter Klijn 20:39 in the past, infrastructure property either set in separate asset classes or were an alternative asset class. But we see these days more the rise of sort of mid risk in these assets being labelled as mid risk. Is that sort of an indication of that trend that I coming closer together? Mary Power 20:57 Yeah, I think that's that's really important, because I think what's happening is that, you know, illiquid assets now, particularly in property infrastructure, almost need to compete for a place in the portfolio on a whole of portfolio perspective. So if you've got an infrastructure investment and a property investment, you need to look at those on a risk and return basis. So, you know, I think that blurring and that competition between the two asset classes will continue going forward. Wouter Klijn 21:27 Might it also be heightened the competition for these assets by if we get to a stage where there's more and more people retiring looking for income streams, portfolios probably being more geared towards income streams. Do you think that that will contribute to the competition for assets? Mary Power 21:43 Yes, definitely, definitely, and that stability of income. Wouter Klijn 21:47 So maybe we don't need annuity products, just more property assets? Mary Power 21:51 Yeah. And some of the annuity providers had had the basis of the annuity has been, has been property assets, yeah, at all a part of it, anyway. So yes, I think that's, that's, that's quite possible. Wouter Klijn 22:04 Yeah, very true. So if we look at the environment again today, what are you finding? Where do you find more interesting opportunities? What sectors look attractive at the moment? Mary Power 22:16 So yes, we have been looking across the globe at all various sectors. And I was going to say, 18 months ago, we went to Europe. We were very excited in Europe. In 23 mid 23 Australia had had fallen by minus 1.6 the UK was down minus 17, and the US was down minus 10. So I thought this looks very interesting in the UK. Not always. The UK is not always interesting, but it was certainly interesting at that time. And we identified an opportunity. Was an opportunistic opportunity, where they where we invested, where our clients invested, on a, on a, on a multitude of different sectors. But the attractive feature was the discount and the ability for interest rates to fall over time, which was, which was pretty, which was pretty compelling on both fronts, and it's going to be a great vintage for investment over that period. Yeah, yeah. Closer to home, we've looked at and in, and funds have invested in convenience retail, which is a smaller retail, and the attraction of that is its necessity. You've got to buy there, you know, you need to get your usual everyday goods there as a as opposed to expenditure, you know, experience based retail. And I think that that's going to be very solid performer, particularly in a falling interest rate environment. So that's that's been very attractive. We also like the idea of the of the being smaller assets. You know, more assets, smaller assets. You know, big assets can have big problems from time to time. So smaller assets can be quite attractive. And we found that to be quite, quite a good way. You know, area to be looking in. Wouter Klijn 23:59 Yeah, last year there seemed to be a lot of, I call it hype around, sort of the bill to rent in the US, but in Australia, it seems to be still a relatively immature market. Is that starting to change, or are we still at the beginning of it? Mary Power 24:15 Look, I think we're still at the beginning. I mean, I was at Ann Rove and spoke at a on a panel last about last week. And I sort of had to remind myself and sort of others that, you know, we've had sort of five years taken out of the investment timeline over the last five years. So I think we've got to remember where we've been, to think about where we're going. And I think, you know, the US has got a 30 or more than probably 40 year history in multi family. The UK is probably 1015, years into it, and Australia is very immature at this stage. And I think there's a few reasons. I think we've had this period of disruption of five years or more. We've. Had, you know, such negative returns that people aren't allocating. And I think that building costs have escalated so much as well, and development sites have gone down as well in price. So I think, you know, there's a whole lot of things, but I would think if you look forward over years, it will start to mature. I mean, it has to mature. You know, the housing Australia Future Fund is very prominent. We've looked at half deals which are an interesting structure, they're more they're a debt structure, so a blurring of two asset classes, property and debt. So I think that over time, it will mature, and it's certainly a big government push for it to mature? Wouter Klijn 25:41 Yeah. So we talked about a number of opportunities in the different sectors, and I think if you look at property versus sort of other asset classes like equity or bonds, it tends to be a little bit more transactional focused. How do you look at opportunities in terms of a portfolio, and the construction of the portfolio. Do you just have to wait for certain deals to come up? Or do you really think, okay, we can't this might be an interesting deal, but from a portfolio perspective, it doesn't make sense to add this at this stage. How do you deal with sort of those tensions? Mary Power 26:17 Well, the usually the first question that's asked is, what's the deployment capability over five years? So if you've got a lot of deployment if you've got a lot of deployment capacity, that's a great thing, because you can actually plot out where you want to be over time. If you haven't got any deployment capability, you're actually waiting on redemptions to come back. That's a that's a very hard it's a much harder game because you gotta wait. Gotta make sure the timing is right. You know, there's not a there's not a defined, actually a defined date that you know you're going to get your money back. So matching deals and and flows is is very difficult. So if you've got big deployment capabilities, I think we've been very keen to be students of the rate markets and the debt markets, to look where where things are moving to. And in fact, we've done a lot of work in the US. Where we've gone into, went to single family housing, medical office, senior housing, storage. So we've gone into a lot of areas where the rates were lead indicators for those, for those sectors. So the emergence of the alternate sectors, which is what they're called, really has has been expressed through the rates, which has been interesting. Wouter Klijn 27:32 And how do you look at the tension between sort of large funds and smaller funds, in terms of this, this portfolio construction question, because sometimes it seems that small funds have less ability to take on a lot of illiquidity. Is that true? Or how do you look at that question? Mary Power 27:47 Well, I think you've really got to start. I like to start at the basics. What's the investment objective for the fund, what's their tolerance for volatility, and then how many, how much equities and bonds do they have in the portfolio, and then how much illiquid assets do they have? Do you know, if they're running in liquid exposure of 40% that's very high, and that could be across property, infrastructure, private credit and private equity. So you need to sort of start with the basics of each fund and how they're the composition is at the at the time, look at their investment objective. If they've got a CPI plus two, it's very different to a CPI plus seven. Yep. You know expectation. So, so you need to be able to construct your portfolio based on what their expectations are for risk and return. Wouter Klijn 28:33 And another trend we've seen recently is there's a lot of talk about total portfolio approach, or the joint up investing, and sort of the conversations I had around that is one sort of hurdle that I need to overcome is to speak the same language around investments, and that can be quite different, whether you talk about property or you talk about equities or fixed income. How do you see that conversation taking place with sort of China's clients? Is it hard to make the translation exercise? Mary Power 29:03 I don't think we've had a problem with that. I mean, you know, we look at discount rates across infrastructure and property, you know, forward looking PES in private equity. So I don't think that we've had much of a problem with the language going forward. So I think we understand, you know, discount rates, cap rates, growth rates, I mean, yeah, discount rates, cagers, leverage all really important parts of, you know, of the investment subset across every, every asset class, really? Wouter Klijn 29:41 Yeah, yeah, for sure, if we sort of look a little bit ahead, how do you think that the blend between sort of super funds, exposure to Australian property and international property will develop over time? Are we seeing less investment in Australian and more in international like we see? Probably more money shifting into international equities, or what is sort of your view there? Mary Power 30:06 Well, I think the I think it is inevitable money will go offshore, and it has the bigger fund, the big, big funds with lots of deployment capacity are likely to take up exposures in areas that they can't get here in domestically. So that's some of the areas that I spoke about earlier, single family housing, medical office. So so those that have developed up and have a, you know, some level of track record investment, you know, you know, the markets are quite deep, so I think money will definitely go offshore. What percentage of a total property allocation would go off? I'd say up to 50% could okay. It could be anywhere between 30 and 50 Yeah. Wouter Klijn 30:51 And do you expect to see a shift as well in the mix between unlisted and listed? Or is that more up to the individual fund? Mary Power 30:59 It's very much an individual fund, fund basis, very much an individual fund. Again, you know, perhaps if there's a reason they need liquidity for within the portfolio, they might elect to have an allocation to rates. Wouter Klijn 31:14 Yeah, yeah, for sure. Well, Mary, thank you very much for participating in this podcast. It was great to have you on the show. Mary Power 31:20 Oh, thank you very much for having me. Thank you.