Conversations with Institutional Investors is your gateway to in-depth discussions with the masterminds behind leading global investment firms, including key figures from pension funds, insurance companies, and sovereign wealth funds. Our podcast explores the evolving landscape of asset allocation, portfolio construction, and investment strategy, offering you firsthand insights from industry experts to inspire smarter, more innovative investment approaches. For further insights go to i3-invest.com. You can also subscribe to our complimentary newsletter at: i3-invest.com/subscribe/
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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.
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.
128: MLC Asset Management's Dan Farmer – Active Management, Private Equity, AI and the Early Days at Telstra Super
Season 9 · Episode 128
Monday, February 2, 2026 • Duration 47:15
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.
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?
127: Frontier Advisors' Kim Bowater – Consultants in a Changing Industry, AI and Gender Diversity
Season 9 · Episode 127
Monday, January 19, 2026 • Duration 43:03
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.
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!"
126: Professor Scott Donald – Should Trustees Use AI?
Season 9 · Episode 126
Monday, January 5, 2026 • Duration 40:10
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!
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
125: The Devolution of Neoliberalism – UTS Finance Department Roundtable
Season 8 · Episode 125
Wednesday, December 3, 2025 • Duration 01:05:44
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.
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.
124: Fidelity's James Richards – Investing in Energy Transition Materials
Season 8 · Episode 124
Monday, December 1, 2025 • Duration 40:10
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.
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.
123: Cbus' Linda Cunningham – Pricing Risk in Debt Investments, Private Credit and the Impact of Retail Investors
Season 8 · Episode 123
Monday, November 17, 2025 • Duration 52:27
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!
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?
122: Fidelity's Maroun Younes and James Abela – SMIDs in a World of Large Cap Dominance, Are Things About to Change?
Season 8 · Episode 122
Monday, November 3, 2025 • Duration 47:58
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.
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
121: JANA's Mary Power – Offices Market Woes, Liquidity and Blended Approaches to Property
Season 8 · Episode 121
Monday, October 13, 2025 • Duration 32:12
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.
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
120: Stanford University's Ashby Monk - The Future of the Pension Industry
Season 8 · Episode 120
Monday, September 29, 2025 • Duration 48:13
In this episode, I speak with Ashby Monk, who is Executive & Research Director at Stanford Long-term Investing, a part of Stanford University in California. Ashby has been advising most of the large superannuation funds in Australia on governance, organisational efficiency and knowledge management. He is a regular visitor to our country, and has been here 55 times. We discuss the future of the superannuation industry and the role of innovation. Unsurprisingly, this means that we spend a fair amount of time talking about artificial intelligence and the changes it might bring to the industry. Ashby is of the opinion that it will be transformational, while initial problems such as hallucinations are quickly being dealt with. What does AI mean for the super industry? Well, consultants might be in trouble as AI systems will come to play a critical role in providing alternative views or in red teaming. Asset managers, too, will come to feel the heat, and boards might want to add directors with deep technological knowledge. Enjoy the Show!
Overview of Podcast with Asby Monk, Stanford University
03:30 I've never met a pension fund with an R&D unit.
09:00 I've seen Australia as the future of pensions
10:00 People in Australia don't quite know how cool it is, the member first culture
12:00 There is no professional School of Investing in the world; it is an apprenticeship
16:00 The secret sauce for a pension fund is in understanding your own advantages, weakness and goals
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.
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.
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.
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.
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.
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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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.
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.
20:00 You can have a culture of knowledge sharing or a culture of secrecy and I don't think you need to do much more than to say those words to understand what is implied
22:30 What attracted me to the asset owner industry is that it is a mission-driven culture
26:00 The AI boom…, everybody acknowledges that particularly our industry is going to be transformed
28:00 AI for knowledge management; the hallucinations are starting to go away. We are very close
32:00 Red teaming with AI; ask to replicate what your analysts are doing to see if you get a different view
33:00 Consultants might be in trouble, unless they move fast towards AI
34:00 Anybody who provides advice…, even me, you could probably ask an AI: 'How would Ashby respond to this idea?'
36:00 The big asset managers that we can think of right now, their existence is threatened
37:30 There are about eight Australian super funds that can be world role models
39:00 I often ask: 'Who on your board has technological expertise?' and the answer is often 'none'.
Ashby Monk 02:27 Thank you so much. It's an honour to be here. Truly. I think that if I didn't have my job, I would want your job.
Wouter Klijn 02:35 It's pretty fun.
Ashby Monk 02:39 Yes, you know, because the investment Innovation Institute almost sounds like my life's work, but you've already got it, so I'll have to find something else. But it's, it's a it's a pleasure to be here, in large part because I think you and I are working on very similar things.
Wouter Klijn 02:57 Thank you very much for that. And you also have your own podcast, which has an interesting name of 'Don't get fired'. Why did you choose this title,
Ashby Monk 03:05 Don't get fired Podcast, yeah, so that is meant to celebrate the heroic nature of innovation and institutional investment. Oftentimes, I'm sure you're aware the pathway to doing creative things, especially as it relates to the asset owner side of things, that pathway generally flows through a courageous person that is deciding, I'm going to do things differently, and in the process, generally takes career risk. And so the don't get fired podcast is meant to be somewhat funny, but it's also meant to acknowledge, like, we don't have standard pathways of innovation in this industry. You know, I've never met a pension fund with, like, a well formed R and D unit. Oftentimes, it's just a person who is ready to take on a challenge and and I think we do need R and D units, and so the podcast is all about different pathways to innovation.
Wouter Klijn 04:06 Yeah, yeah. It's interesting because I think that's my cat.
Ashby Monk 04:13 Hello Kitty. That's a perfect that cat wants to talk to us about innovation,
Wouter Klijn 04:16 Exactly, but yeah, no, it's, that's, that's interesting because I listened to your last episode with Mark Delaney, and he made a reference to that where, I think, before he joined the superannuation industry and became CIO, now of Australian super, he worked for an insurance company. And he said, he sort of made his remark that at the beginning, when he worked, there was one of the most innovative companies in Australia, and then over time, they became scared of innovating, and it actually ended up collapsing. And he for part of it was because of a lack of innovation, which is basically goes to the core of your premise with the podcast.
Ashby Monk 04:57 I mean every, every, long-lived organisation faces this challenge around how much to exploit and how much to explore. So you exploit the assets, you have to generate performance, and then you also have to explore in order to, you know, go out and find new things to exploit in the future. And there's a balance, and I think it was the Winner's Curse, or the winner's winner's dilemma, maybe, where those organisations that are very successful often end up in a pattern of exploitation, and then that ultimately sows the seeds of their demise, those organisations that go on for generations. So these family owned companies that you know, go hundreds of years into the future. They build very deliberate innovation practices and and the funds that you and I study, these are funds that have stakeholders rather than shareholders. We know these funds are going to live for centuries. You know, like obviously, many of the super funds are fairly new on that time scale, but University endowments, sovereign funds, etc, they're looking out 100 years into the future. Those organisations are going to have to balance that exploitation, exploration dilemma. And I'm not sure most of them are ready for that.
Wouter Klijn 06:24 Yeah, it's sort of a fine balance between sticking with a winning formula and doing enough innovation to stay relevant, I suppose. And you're right, the super funds are relatively young, so maybe they are a bit scared to, you know, do too much innovation and and mess it up, but, yeah, it's a developing industry, but one of the things that I thought was quite interesting when when you spoke to Mark, is that you mentioned you've known him for 13 or 14 years. And I know you have been advising a number of funds here in Australia, but your interaction with the funds goes back quite some time. How did you first get involved with the Australian funds?
Ashby Monk 07:04 Well, my mentor, my academic mentor, is a guy named Professor, Gordon Clark, who is Australian who, I think you probably know Gordon, I think he still comes down to Melbourne once a year, for a month. He might even teach a class at Monash, one or two classes every year. And really, he was the one who introduced me to the Australian superannuation industry. And as somebody you know, obviously very interested in the future of pensions, you can't help but be blown away by what's happening in Australia. So I would argue the accumulation side of the equation is basically solved in Australia. Now, the de accumulation, the retirement side of things, there's still some challenges, and people are working on those challenges, but the superannuation industry, by and large, feels like the future for the rest of the world defined contribution, so you're not taking that longevity risk pooled, so you're getting the best asset management the lowest cost. And then also there's the regulatory aspects, where you know you have to contribute, so there's that mandate, and so that combination of everybody contributing professional management and really getting this accumulation running puts Australia in a very rare community in the world where it feels like you got your pensions organised. The Canadians seem pretty good, but those are mostly DB plans and so we all wonder what happens when the nanobots get injected and we live for 200 years? How are we going to manage that? They would tell you that they can manage that through maybe renegotiation. But in the Australian case, you won't have to. People are just going to have to work for longer because there won't be as much money there. And so, you know, obviously I'm, I'm talking like a true Stanford engineer. People are going to live forever with nanobots, but, but really, politicians everywhere are trying to figure out how to manage the unfunded liabilities for old age retirement security, and so you have that there. And so I know there's a long winded answer, but going back 14 years, I was introduced to the Australian super folks. And really, as sad as this is to say out loud, I think I've been back 55 times. Wow. I owe a lot of trees to the world. I got to plant some trees, but that's largely because I've seen Australia as the future of pensions.
Wouter Klijn 09:42 Yeah, yeah, it's an interesting system, because my background is Dutch, so I grew up in defined benefits schemes as well, and I know that my dad retired in his late 50s with 70% of his last earned wage for the rest of his life. So that's that's not really working, if you and is he still going? Lift to 100 he's still going. He's still there.
Ashby Monk 10:04 Yeah, pretty great if you can get it,
Wouter Klijn 10:07 yeah, although it did require along the way some adjustments, like they did realise at one stage it wasn't affordable, so they had to make some adjustments as well to the benefit formula.
Ashby Monk 10:17 But you thought just one thought, well, we're on the Australian uniqueness. Because I think, you know, people in Australia don't quite understand how cool it is the member first culture. The it may frustrate you as a superannuation fund that your members can stand up and leave and go to a different superannuation fund, but it also means, when you're talking to your board of directors and you're saying, we need to do this innovative thing, it's for the member the board listens. When you go to a fund that has a monopoly over their asset base, over their membership, they don't necessarily have to listen to that. And so, you know, the Australian superannuation industry is not only the future, but it's the most innovative. It's in competition with each other, and there's been some deviations recently where there's the my super, there's the you know, the different benchmarks that feel like maybe they are making the innovation less palatable, but compared to the rest of the world, the Australian industry feels dynamic and in constant renewal.
Wouter Klijn 11:28 Yeah, yeah. It's interesting to see where that will go with the especially the performance test, because I think the main reason behind it was to force some of the smaller funds to merge. But we're almost getting there. So is that still going to be relevant going forward? Because, as you said, there are some, there are some restrictions to what it put in place with tracking error and peer awareness. So yeah, that will be interesting to see whether that gets solved or not.
Ashby Monk 11:57 And if it's solved, does it just put you like, let's say pure awareness becomes a, in quotes, problem. Doesn't that just make you the same as the American endowments that stare at each other all day long, or the Canadian pensions, you know, like, by the way, like this right now in the rest of the world is an industry that 100% herds the way best practices are communicated in this industry. I'll remind you, like there is no professional school of investing in the world. It's an apprenticeship. The way best practice gets communicated is by peer imitation. Follow the leader. And so right now, Australia is becoming the leader in many domains. And then the question I think you and I are asking is, how do we keep that innovation going so that you're not just exploiting the assets you've developed over the last 10 years, you're continuing to explore, but most of the other funds are are exploiting, you know, like the Yale models everywhere,
Wouter Klijn 13:00 yeah, but especially as well going into retirement, because, as you said, I think accumulation has probably been more or less solved. Retirement hasn't, and it almost seems that some of the solutions that are also palatable to members almost have an element of defined benefit to it, where funds can pull again and an income stream is being formed, and one that is not relying on, you know, an insurance type of arrangement.
Ashby Monk 13:30 But even there, you know, you've got organisations in Australia that are really taking retirement seriously, whether they're hiring a chief retirement officer, or they're naming their new fund with the word retirement in the title, right? And so in that sense, like I'm really excited about this future of mass customised deaccumulation. I know that's a mouthful, but you can imagine technology enabling people to communicate scenarios, goals, you know, health status, things like that, and start to build portfolios that meet your retirees where they are well, of course, managing the you know, the downside risks that Come with living much longer than you expected, but I am really excited about moving beyond just annuities or the simple defined benefit structures. And I think in Australia, where you have so much data on your members, you might actually be able to use this innovation mindset to build the future of retirement, the accumulation
Wouter Klijn 14:41 And that sort of ties in with what I wanted to talk to you about as well with long term investing. Because, you know, these are problems that have a very long term horizon, and sometimes, you know, we do get a little bit stuck in, you know, what's the next quarter of earnings? You know, is this manager under or out? Performing, but there's some fundamental questions that lie beneath a successful pension system. And basically I was talking in a previous podcast to Eduard van Sheldon, who has been sometimes your collaborator on some papers, and he's now involved with fclt Focusing capital on the long term. And so for this might be a nice extension of that concept, because…
Ashby Monk 15:25 Are we in competition with FCLT at i3, you know, if I, if I'm here as your representative, do you see that as you know your your competition, or are they part of the family?
Wouter Klijn 15:41 We're all friends, aren't we?
But, but I thought it was interesting because it ties back into some of your ideas that you put in a paper around investor identity, which I think has also been part of your work with some of the Australian funds here on basically, not so much identity as you know, what do we stand for? But more? What can we do? What is our operational capabilities? What is our skill? And I sort of was amused by the fact that you describe it in the sense of how you put a chocolate chip cookie together, yeah, which my daughters love. So I see a lot of that. And sort of this, this idea of, how do you cook up your own risk adjusted return? Yeah, to stay with that analogy is that where you think the secret sauce is?
Ashby Monk 16:29 So the secret sauce is in understanding your own advantages, weaknesses and goals. So that's the first thing to just throw out there. The identity was meant to say, after travelling the world for 20 years and consulting, but then also writing books and papers, this realisation that, first, most of academia is not paying attention. So we've got 10,000 business schools. The last I checked, there's no professional schools of investing in the world, but to understand how CalPERS or ADIA or Future Fund or New Zealand superannuation fund, how they make decisions and operate and optimise for their stakeholders, it's not necessarily the kind of thing you learn in A Business School. Singapore's GIC. The G stands for government. And so in many cases, you really need to understand how you operate inside government. And so all of this is to say we didn't have models of Investment Management. And I mean that isn't from an academic model perspective, to allow people to understand, hey, this is how I should run my fund again, the role of models like the Canadian model, the Yale Model, the Australian model, the Norwegian model, the Dutch model. These were ways to be inspired, but there's nothing that says the Canadian model should or needs to be implemented in Australia, right? The Canadian model is a defined benefit model, a Crown Corporation model, the Australian model might be an industry fund model and a defined contribution model. And so understanding those details are critically important. And so we wrote this paper about the investor identity, which has a thumbprint in the middle, fingerprint, ultimately, to say, Yeah, we may produce returns with the same core ingredients, but there is no, you know, there is no chocolate chip cookie that is the same, perfectly, the same from kitchen to kitchen, from batch to batch. Frankly, no chocolate chip cookie is the same. And so acknowledging that broad differentiation and that your people are going to be different. If you're in Juneau, Alaska, or if you're in Abu Dhabi, your culture will be different. If you're a member driven fund sitting in Melbourne, or your public pension plan in Iowa, your technology will be profoundly different if you're sitting in Silicon Valley versus sitting, I don't know, in Oslo. You know, the thing we wanted to at least acknowledge. And so the identity is meant to be an irreducible model of the inputs and enablers that long term investors use to drive return, and I can talk you through them. But ultimately, it was really meant to be a model that allowed boards of directors, CEOs, heads of strategy, heads of asset allocation, to begin to think about this is our organisation. These are the inputs we have. Here's what's good, here's what's bad. Here's an asset allocation or an implementation we can pursue and have high conviction that will outperform.
Wouter Klijn 19:47 Yeah, I'll put a link for the paper so people can go really in the weeds. But I thought what was quite interesting as well that you gave some practical examples of how this model can be applied to investors and. To their long term strategy, and one of them looked at private markets, and they decided that maybe they needed to have more exposure to private markets. And then when they actually went through the exercise of what is our capability, what what is the expertise of the people we have, that they found some gaps in technology and expertise that they realised they had to pluck first before they could, you know, spend the money. And that's, I quite like, the fact that it's a very practical framework as well, where it's not just, you know, people in boardroom talking about great thoughts, but actually still doing the same thing that it always done. There are some practical implications of this. And you also describe that within the core ingredients, there are ways to improve it. And you give three high level elements, there governance, culture, technology. And I wanted to pick out one of them, because I think culture is sometimes not always well defined, but you say at one point it is Shadow governance. What do you mean by that?
Ashby Monk 21:09 Culture are the norms and procedures, often unwritten governance protocols. So it's our expectations of each other. It's our routines. You can have a culture of knowledge sharing, or you can have a culture of secrecy, and I think you don't need to do much more than say those words for you to understand what's implied. You know, you can have a radical candour culture, like a certain hedge fund in Connecticut, or, you know, you can have a, you know, a collaborative culture. All of these things imply something about process, information, flows, recruiting and retention of talent, and so it sits atop the key inputs and helps you drive better investment decisions. I mean, that's assuming you have a good culture, effective culture, I've seen many times where the culture is not effective, and understanding that you need to improve your culture is actually really important, calling it out for people and saying, Look, this isn't a constructive culture that you're creating here. You know that's also actually a valuable part of the process and understanding your identity and your strengths and weaknesses.
Wouter Klijn 22:24 And how do you think how malleable is that culture? Because we talked a little bit about the nature of a large part of the Australian pension system, where, you know, they come from a background of not for profit or profit, to members. That's already like a vastly different starting point than when you look at commercial asset management firms. Can you change a bad culture, or is it just tinkering at the edges?
Ashby Monk 22:53 I think first thing to say is, I think part of what attracted me to this industry, so that is, let's call it the asset owner industry, whether it's Dutch, Canadian, American or Australian, is that it is a mission driven culture. Most of the people inside these funds are there because they believe in the mission, and they are willing to forsake some compensation, usually, but some corporate benefit in pursuit of this higher purpose. What a cool job. And, oh, by the way, like, you can be paid pretty well and like, it's a really fascinating job where you're constantly learning on and on and on. But at the core, we're mission driven in this industry. We're trying to protect nation states through sovereign funds, retirement security through pension funds, on and on and on. So I love that aspect to it, and it does take a huge amount of time and effort to build that type of mission driven culture inside a commercial enterprise, and they're constantly trying right like this is partly why here in Silicon Valley, people are always changing the world. You know, with their search algorithm or their, you know, whatever is the new cryptocurrency they're going to change the world. They're trying to tap into that mission driven culture. And in our industry, we have it and so, protecting it, nurturing it, using it for the recruitment and retention of people, using it to guide that decision making. You know, beyond our own tenure at an organisation is really important and valuable, like think about making decisions for the benefit of members long after you've stopped working there, if you're buying a real estate asset or an infrastructure asset or a timber asset. You're thinking about the members benefit decades from that, or you should be. So I think that's a very powerful meta layer inside these organisations.
Wouter Klijn 24:55 And the other element of it is technology, and we've spoken in the past a little bit about. At knowledge management and the interaction with technology and how to retain, you know, core information and the knowledge build up over, you know, decades of doing transactions and issuing mandates, but that's only one part of it. Of course, now we're looking at integrating artificial intelligence. Do you think that it's more important these days to get a technology right? Is it playing a more important role?
Ashby Monk 25:27 Tech is the crack in the door for innovation. So if you know, you're down in Australia, which means you think innovation is probably a little bit easier than it is elsewhere. Now you may work at a superannuation fund and think to yourself, gosh, it's so hard to do innovation, but you're better off than you are if you're in an American public pension plan. And in part that is that competition that all those things, but wherever you are, okay, technology is changing so quickly that boards of directors are asking their C level executives, what are we doing about this? It's becoming a crisis, and I know that most big organisations wait for crises to drive huge change, whether it's moving from a product based asset allocation to a risk based asset allocation, or, you know, strategic asset allocation to dynamic asset allocation. These are usually in response to crises. Well, the AI boom, and it may have a bust, because we're seeing some pretty wild valuations and a lot of capital flowing into the space right now. I saw today some wild news, but everybody acknowledges that our industry is is in particular, our industry is going to be transformed now, people, anybody that's using a spreadsheet listening to this, if you have a spreadsheet as part of your core day to day, that's probably going to go away in the Next 10 years, yeah, okay. Like, that's a crazy thought. How many people see spreadsheets as a critical piece of their day to day in the investment industry? Fine, maybe it's 20 years. But 20 years from now, if you're writing in spreadsheets, you're doing so, you know, because you're ironic, like people typing on typewriters today, you know you're doing it because you think it's cool, like listening to record players.
Wouter Klijn 27:25 You know that is cool. Vinyl.
Ashby Monk 27:26 That is cool. I agree with you. It is cool. I love the vinyl, but, but you know you're doing it because it's like fun. It's old timey. AI will connect to your PDFs, your email, your Word documents, extract the data you need, clean it, ingest it, and, even better, overlay it on top of other data sets, so you start to get a rich sense of what you own. And then this is just getting the data organised. Now that the data is organised, and in a dashboard, you're having these epiphanies about it. Oh, I didn't think I owned that there in that structure. Can you model it, modelling into the future, new knowledge, new intelligence, and then you start opening up new markets, investing in nature as an asset class, investing in compute as an asset class. And you know, there's new things that will start to emerge out of this that are really excited, exciting outer space people are going to be investing in.
Wouter Klijn 28:30 Yeah, I think I've seen some startups on mining in outer space, which is quite, yeah, yeah, but, but coming back to sort of the AI bit, and we've spoken a little bit before about the role that AI can play in knowledge management, and I think this was around the time that GPT three came out, and was this example with Morgan Stanley that applied it in his wealth management. And I asked you whether this was the tool that we all had been waiting for to now, you know, probably manage our knowledge. And I remember you gave this illustration of well, almost because you asked it to write your resume based on information that you gave it, and then it came up with a resume that basically said, included universities that you never went through, papers, you never written, but all sounded possible. Yeah. And do you think we've moved on from that? Is it more reliable to for organisations to actually the outcomes,
Ashby Monk 29:33 The hallucinations are really going away. I still spot hallucinations, but it's so good. So if, if Google is what chat GPT truly has the how. Okay, so, so, like that, just that's a very simple way of thinking about what the gpts are going to deliver you out and like right now. Yeah, and so in that sense, I think we're in this map quest moment. For those of you that are old like me, you grew up with paper maps, and then once paper maps were going away, you ended up with this platform called Map Quest where you would literally go in and you would prompt the system to say, imagine I was here, and I needed to go there write me directions. And it would write them point by point, and you would print these things out, and you would literally get in your car with printouts from MapQuest, and you would go point by point. And occasionally it would be wrong. You'd be like, Oh crap, there's construction here. What do we do? And you'd have to figure it out. Chat. GPT, to me, feels like an incredible Mapquest style prompt. Hey, my neck hurts. Can you teach me how to diagnose my thing and it will give you point by point diagnostics. You still need to do it yourself. And so in that sense, we haven't quite taken that intelligence layer, we're kind of at the artificial knowledge layer, where it's delivering you the knowledge, but then it's up to you to decide how you apply it. AI will be when you say, you know, I need to figure out if I have a, you know, a bulging disc in my neck, or if I just have a sore tendon, as an example. And the AI goes into your watch, and it can see your gait, and it can, you know, pull the readings off your phone and immediately tell you that you know, based on your ear bud readings from your ear that it's a disc that's AI, a k is, here's how you go and figure it out on your own. So I think we're close to, like, the true AI moment, but, but not quite there, but like, it's, it's around the corner,
Wouter Klijn 31:51
Yeah,it feels very close.
Ashby Monk 31:51 Like it's very close. And like, I, I think, like a an easy way to see the power is to use AI as a red team. So you've got, you're making your decision, you've got your own process, your own people, your own information, your own risk management, and you've got this AI system, and everybody should have a budget for whatever system. This is where you're experimenting and learning, and you're asking it to replicate what your current analysts are doing and just see, like, what are you missing? You know, run ask the AI to run this memo through your system and point out what's missing. What are the things that we should be asking? And then have your investment committee ask that when the person is presenting the memo, those are the easy ways to start to use AI, and in doing that, you'll start to understand where it's hallucinating, where it you know is going wrong, and how to apply this artificial knowledge, which is what we're getting. You will also start to prep yourself for the era of A i, not just the a k, where it is now able to turn the plane for you, you know, like a true copilot, where the pilot is sitting there and the plane is flying itself,
Wouter Klijn 33:09 Sounds a bit like an asset consultant. Are they in trouble?
Ashby Monk 33:17 Oh, boy, I think so.
Wouter Klijn 33:20 Well, maybe this is just a third voice,
Ashby Monk 33:22 Or maybe, or maybe they're gonna be there. They're going fast towards AI. Who knows? But? But, I mean, you know, if you think about, like the headlines about McKinsey or any of these consulting businesses, like they're in trouble, you know the the moat here is the data, the information, the knowledge. And so if you have these walled gardens of data, then you're probably safe for a little while. And I do think that's where the consultants have a moat. They have the historical data, they have the fund performance. They haven't really made use of it in the way that I think we're talking about. So they themselves will need to use AI to ingest every single report they've ever done, every transcript, every call, and they'll begin to formulate their own llms slash ontologies, you know, gpts that are providing these insights. But, yeah, I think anybody that's in the business of advice, even me as an academic, you know, you could probably go into chat GPT to say, and say, How would Ashby respond to this idea? And you probably get a pretty decent response, because I've written eight books and 180 papers, which are definitely in there.
Wouter Klijn 34:40 Yeah, yeah, yeah. That's interesting because I was recently talking to sue brake, former CIO future highlights. She's now involved with an AI company called dragonfly oh and and, but part of what they do there is basically creating. In expert personalities using AI, feeding all the data in it, and then almost question it like an interview. So the example that I gave is that they they try to understand the perspective of a mega Trump person. So to build this model, and then try to ask it questions in how somebody like that would look at economic, financial questions. That's one example. But I can build a whole bunch of personalities, but it sounds a bit like that, maybe they can build an Ashby personality, or maybe I should.
Ashby Monk 35:33 Won't people be shocked when we tell them that this isn't actually Ashby? This is Ashby's robot on this podcast,
Wouter Klijn 35:41 I would be in trouble then.
Ashby Monk 35:43 No, you know, this is really me but, but I do hear stories of investors wearing, you know, lapel mics, and they're they're trying to capture as much of their audio, because they've got this in their mind, magic that they want to bottle. And it is super wild the moment we're in. I mean, I just marvel that we get to live in this moment where, yeah, this industry is about to be transformed. It is interesting. And if you're an asset owner, you have a mandate to be there for it. If you're an asset manager, you don't know, interesting. Nothing says the companies are going to stay forever, you know, like the big asset managers we can all think of right now, their existence is threatened right now. Australian super A R T aware, like they're going to be there. They're, you know, they have stakeholders. They're not shareholders. And so it is. It is a really wild moment for me to think about what is this entire industry look like 24 years from now. Just put, like a, sometimes I put a very precise number on these things to help clarify. Like, okay, my kids are this my kids are in their, you know, late 30s. And what is the world like? Well, pension funds. Do they have global offices anymore? I don't know. Do they?
Wouter Klijn 37:13 It seems that most Australian funds are building global offices.
Ashby Monk 37:16 Well, I know, and I might have even helped with some of that.
Wouter Klijn 37:21 To go into that, I think you advised most of the top eight Australian pension funds, if you look at sort of those high level areas, governance, technology, culture, what do they need the most help with? Where they pull you in?
Ashby Monk 37:38 Oh, they need so little help compared to, like, the typical county pension plan in America. I mean, it's all it's like, you know how, like, coaches pay, you know, they coach the people who are the best the most. Have you heard like this? You know the it's like, I'm trying to create global role models. And it happens that in Australia, you have about eight that could be global role models truly like in the way that the Canadians were in the knots. You know, every one of those funds that you're thinking about right now, they're taking a slightly different perspective. Some care more about impact. Some care about insourcing. Some care about being the world's best partner to the world's best managers. Some have the built environment. So, you know, on and on and on, there's really interesting things happening in that geography. And so when they come to me, usually it's, it's about, hey, we're trying to reach we're trying to do something better. We'd like to do X, and then where I can offer some information is, here's the organisational gaps you have today that might inhibit your ability to be successful at that thing. And so do you need to change a delegation framework? Where should we get inspired for that. Do you need to change a compensation policy? How much, how far you know, is it going to change your culture? Do you need Board education? Do you need to pay a lot of money for data? Do you need to hire somebody on your board that has a background in data analytics? You know, one of the things I find myself saying a lot to people is like, who on your board is an expert in technology? It's like, none like, we've just spent all this time getting investors on the board just in time for the investors to be less valuable than the software engineers or the, you know, AI architects, you know, and some of these funds are spending meaningful dollars on their tech stack, and so, you know, that's an area where I might help
Wouter Klijn 39:49 That's quite interesting, because getting tech savvy people on board might be not as easy as just, you know, finding somebody with the right background. On because highly trained, highly technical people do not necessarily other people that you know. Take a step back. Look at a broader picture as a board member. Have you? Have you seen it done?
Ashby Monk 40:13 Well, that's it's a challenging question, my friend,
Wouter Klijn 40:18 That's what we're here for.
Ashby Monk 40:21 I know, I know it's like, if I know, if I say no to that, I've just threw everybody I know under the bus. Look, I think people are trying really hard to get this right, and and part of like, what we do in this industry is like, we are doing our best with scarce resources, and so most of the time, the boards are struggling to understand the complexity of what we're doing, whether you're in Australia or you're in Riyadh, you know, these organisations are investing huge quantities of money through very sophisticated vehicles with a huge tech overlay. It's all changing right now, and so it's hard. I do think these pension funds need safe spaces to learn from each other, which is why I think what you're doing is so important. Again, like, just, I mean, obviously, like, I'm here talking but, but other people here talking about what they're experiencing and doing and learning. This is the pathway to avoiding big problems, mistakes, but it's also about CO opting each other's legitimacy. So just me saying right now, hey, every board of directors on a pension fund really needs at least one person with a skill set around data tech and not just like it. You know, this isn't about putting Norton Antivirus onto an iPad. This is about making a plan for data governance, you know, data management, data cleaning, all of this stuff. I think just saying that on a podcast, people like, oh, gosh, maybe we do need that. And what was the question? I know I had to dodge it, but
Wouter Klijn 42:03 I'll let you dodge it. So coming back to the interview you did with Mark Delaney, he spoke a little bit about resistance to change and the obstacle that can form to innovation when you go into these funds. Do you find a lot of resistance to your IDs? What are sort of the main things that I push back on?
Ashby Monk 42:28 Oh my gosh. Every single time my friend, in fact, I would say my job is there some person in an organisation, pension fund, sovereign fund, endowment, that knows they want to do something, and they're looking, they're looking to catalyse that change. And so they go out and they're like, who can I bring in to talk to my board, or talk to my staff, or or, you know, write a report? And inevitably, they tumble around and somebody asks them to talk to me, and they say, you know, will you, you know, fly to this city. I can cover coach, airfare and a night at the Motel Six, and nobody is as crazy as me. I'll say yes, and I'll go and I'll do it. You know, fly to Juneau, but, but usually, my purpose in those places is to stretch the imagination of what they can do, but also, like what they should be doing. Some of that is, this is what your peers are doing, because there aren't great resources explaining everything that your peers are doing. First of all, telling you who your proper peer group is. That's like, incredibly valuable. Like, oh, you're doing this, this, and you have this implementation, you should talk to these three plans, yeah, you know, that's incredibly valuable. So, you know, I am the person stretching the imagination. And then generally, there's some CIO or CEO who comes in and is, like, That guy, Ashby, like, I'm glad he's out of the room. He's crazy, but let me tell you, like, I just want to, I want 22% of what he just asked for. And I knew that. I mean, I'm probably giving away now, but like, I know that I'm asking for the stars, and then ideally, you go land on the moon, yeah.
Wouter Klijn 44:18 Well, every organisation changes with just like one idea at a time, right? It's like an old brand new framework. We might just end up with a last question, and I'm going to steal this from your podcast just for this episode. All right, you have a section in your podcast. It's called deep thoughts, and so if I put you on the spot once again, what deep thoughts should pension funds have in Australia by the current state of the industry?
Ashby Monk 44:49 The Deep Thought I have is just that good decisions compound. I find myself thinking this lately, and I think there's. The first time I've said those words. So I think it's not a new thought in our industry, like compounding of returns, but I do think, if you just take a second and think, hey, every decision we make, whether it's to internalise an asset, hire a great lawyer, bring in a new data provider, if they're well executed decisions, those decisions compound on each other. Hey, we've got a great lawyer and we've got a great data set. Can we bring in a new analytics provider and that lawyer will think creatively about AI on top of that data set, and now you've got aI on top of a data set, you might say, do we still need to pay that overlay manager, all that we're paying maybe not. Whoa. There's another good decision. All of a sudden, you're bringing some of this internally, these decisions about your organisation, your portfolio, and its implementation, when done with, call it self knowledge, self awareness, and in a deliberate process of trying to generate the best ideas and pursue them, I think you end up in a really great place 1020, years from now, too often, our decisions in this industry are about t equals zero. Should we do this? Manager, that manager or in house? And so you choose the manager that offers you the fee discount without necessarily realising that that decision to fund that manager, it it means you won't have that internal expertise. Alternatively, you decide to bring that expertise internally, and you decide to set up an office in Singapore or wherever. Maybe that wasn't the right decision either, right? So these are all of the things that like feel obvious, but I think when you start thinking around as an organisation, where are the opportunities to compound good decisions and do so within our organisation over time? I think that's my deep thought. Fair enough, may have been shallow, it may have been shallow, but it's, it's still, I'm still refining my deep thought.
Wouter Klijn 47:10 I think there's a lot of areas where we can have deep thoughts about but we will have to wrap it up at some stage. So Ashby, thank you very much for coming on the podcast. Much appreciated.
Ashby Monk 47:20 Oh, I love coming on here. Thank you for having me anytime.
