How can superannuation funds invest in innovation?

This week I spoke at the Ausbiotech conference in Melbourne on the role of superannuation investing in life sciences, proposing the establishment of a Superannuation Innovation Forum.

Following are notes from my speech:

Superannuation and Life Sciences Speech
AUSBiotech Conference, Crown Conference Centre, Melbourne
Tuesday 6 October 11.30am – 12.00pm

Today I want to focus on how we can get superannuation funds to invest in innovation.

This question is directly related to life sciences. But it is broader. If we can establish the right environment, then we will see investment flow to technology companies, advanced manufacturing and other entrepreneurial companies benefit.

There is a ground dog day element to this discussion that as a nation we have never been able to quite address.

The fundamental reason why is that government, superannuation and industry talk at each other – not to each other.

One of the perennial problems is that when talking about innovation, government become besotted with the idea of establishing a venture capital culture in Australia. This is backed by Ministerial tours to Silicon Valley and discussions with venture capitalists.

I am afraid that our policy makers have spent far less time talking to the heads of superannuation funds – who are literally next door.
So let’s talk about the obstacles that are preventing capital flowing to innovation.

Government

Part of the problem is that the Governments own rules make it difficult.

Superannuation funds have been required to manage liquidity in order to meet redemption requests and member choice requests.

This is one of the real costs of the choice of fund that we all individually are able to access. My ability to transfer assets within a couple of days anywhere in the system means that superannuation funds can only ever invest a tiny proportion of investments in unlisted assets.

There has been discussion on the need for liquidity facilities and special rules that could enable super funds to invest more in illiquid assets – but unfortunately we have not seen progress on this issue in the recent Financial System Inquiry.

Venture Capital

The second issue is the venture capital model.

Venture capital is at its heart an investment structure. One of the problems with venture capital is that it is not ideal for superannuation funds. The key issues are:

1. Investment volatility
2. Fees
3. Flipping

Again we need to understand the impact of one arm of government policy – which requires disclosure of fees and has established low cost accounts – MySuper. Venture capital is more expensive and for a system that has been designed to be fee sensitive this is an issue.

Returns from VC have also been volatile, which is again not suited to a system where individuals carry investment risk.

Where super funds do invest in VC one of the problems they encounter is the flipping culture. If superannuation funds do take risks on illiquid investments they have no incentive to sell to realise a short term capital gain. They have an interest in holding for the long term.

Superannuation

The third issue is the superannuation industry itself. A key factor that supports investment is knowledge. In the case of infrastructure investment, we have built up knowledge over the last 20 years. The result of this accumulated knowledge is that superannuation funds feel more comfortable allocating to infrastructure. This same level of knowledge does not currently exist in sufficient depth in innovation.
How do move forward?

The first thing I am advocating is the establishment of a Superannuation Innovation Forum – an independent group funded by Government, industry and stakeholders – whose job it would be bring the superannuation industry, government and industry together to develop solutions.

One of the functions of such a group should be to develop investment models that enable superannuation funds to invest. This could involve collaborative models and may require changes to regulation.

The forum should involve all stakeholders, including the ASX – which will remain the major source of capital flow from superannuation funds and which is already a major source of capital flow for small cap stocks.

What kinds of outcomes could we see?

One thing I would like to see is the emergence of a series of Autralian Innovation Companies that are listed on the ASX with the major shareholders being superannuation funds. The purpose of these companies would be to invest in our entrepreneurial companies – including life sciences. When investments succeed the Australian Innovation Company would not sell – it would use the cash-flow to fund future investments with the aim of building a company that in the end has global scale.

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Why long term investors should engage with the Congo

World Humanitarian Day on August 19 is a good time for investors to reflect on the world we live in. The Melbourne Program Committee of Australia for UNHCR is holding its second event, which we hope will become an annual opportunity for the superannuation sector to support UNHCR’s work.
This year we will hear from Sister Angélique Namaika, a nun from the Democratic Republic of the Congo who works to assist women and girls who have been abused by the Lord’s Resistance Army, will present.

Sister Angélique – the 2013 recipient of the United Nations High Commissioner for Refugees’ Nansen Refugee Award for her work with Congolese refugee women – has seen at first hand the impacts of DRC Congo’s tumultuous past, which continues to play out today with news this week that 34 people have been charged with genocide.

It would be easy to conclude that after a decade of conflict that involved nine African countries and led to the deaths of 5.4 million people, mostly through disease and starvation, that DRC Congo is no place for investors.

However DRC’s huge natural resources means that long term asset owners already have some exposure to the country.

DRC is one of the most significant miners of coltan, which is used in a variety of electronics applications including every smart phones. With demand for coltan likely to increase over coming years we can expect to see more investment in the region with DRC already producing 20% of the global supply.

According to KPMG, the DRC is also the largest producer of cobalt globally, accounting for about 55% of the global output in 2012 and the second largest producer of industrial diamonds in 2012, contributing about 21% of global production.

The DRC is not only important for its minerals. DRC Congo is a huge country – the size of Western Europe. The Congo Basin, which spans six countries, consists of 500 million acres of largely undeveloped wilderness that is the companion to the Amazon as the Earth’s lungs.

What then should investors be doing in the DRC?

The first thing is to engage with mining companies to ensure that mining is conducted on a sustainable basis with benefits for the local population.
Investors need to also consider how to support the development of local infrastructure by working with development banks.

There is also a role for investors to engage around building frameworks that will support long term, sustainable economic development including the development of local stock exchanges.

Structures like the UN backed Principles for Responsible Investment provide the logical place for investors to collaborate to develop programs and practices that will support the sustainable development of countries such as the DRC – and indeed any other countries that are recovering from conflict.

World Humanitarian Day is a great place to start this engagement.

Melbourne Program Committee of Australia for UNHCR’s event will take place on Wednesday 19 August 2015, from 5:30pm – 7:30pm at First State Super Melbourne Seminar Room, Level 13, 15 William Street, Melbourne. To attend please rsvp to to Stacey Hynes on 03 8613 9732 or at stacey_hynes@firststatesuper.com.au

The annual performance review is dead – good riddance

News that Accenture is getting rid of its annual performance review for its 330,000 employees is being greeted with announcements by other corporations including Deloitte and NAB to end the practice, which whilst universally unpopular has become a standard dance ritual in many organisations.

The criticism about the effectiveness of annual performance reviews have long been documented. How is it that the practice has continued for so long, for such little positive impact?

Elite sports are a good case study. Would a high performance footballer expect to only have an annual discussion on their performance? Would a coach be satisfied to only sit down with their players once a year to provide feedback on how they are performing?

The heart of the matter is that annual performance reviews are a lazy way of managing employees. Perhaps suited to an industrial world where jobs could be divided into constituent components, they are not fit for purpose for our modern economy.

So, how should an employee be managed?

It is timely to ask this question. One of the things that I have seen over the last twenty years is the disappearance of discussions on management from mainstream business focus.

Many will remember the focus on learning organisations and teams in the late 90’s. But as the economy recovered from the 90’s recession, the focus on management waned. As the economy boomed there didn’t seem time to focus on managing employees, and when the global financial crisis arrived the focus then became survival.

Now the economy has stabilised, and the day to day threat of economic collapse that the GFC threatened has subsided, it is time to focus on management quality. With rates of growth likely to be low over the coming years, good quality management is likely to become a key differentiator of performance.

Quality management requires time. Like a coach managing elite athletes, if a business wants to perform, then it will need to make sure that managers work with their team on a day to day basis. The end of the annual performance review is a recognition that lazy management is no longer acceptable. Good riddance I say.

Exploding the Porthos Retirement Myth

Increasing pension access age to 70 should only happen if we improve health adjusted life expectancy

In Alexandre Dumas’ famous novel, Man in the Iron Mask, Porthos, the musketeer known for his colossal strength passes away after heroically saving his fellow musketeers. Porthos dies, not via the sword of an enemy, but because his body fails him. Dumas writes “All at once, his knees buckled— they felt empty— and his legs softened under him! “Uh-oh!” he muttered in surprise. “My fatigue is tripping me up. I can’t walk. What’s wrong?” Dumas went on to write, “Oh!” replied the giant, making a supreme effort, uselessly tensing all the muscles in his body. “I can’t!” And uttering those words, he fell to his knees…..”

Fantastic fiction, but I am afraid that is just it. Fiction. The reality is that this is not how people live out their final years although we are setting national policy as if it was.

The age at which governments set access to old age pensions has always had an element of politics and guesswork. Germany’s Otto von Bismark, who introduced the first age pension in 1889 did so out of fear of the growth of socialism, introducing bills at the same time as legislation that sought to ban the emerging socialist parties. Bismark set access to the age pension at 70 when life expectancy was 72. The clear policy intent was that the pension would not cost the German government much because people would not live long enough to enjoy it.

But the current debate on increasing the Age Pension access age to 70 should not be based on politics and guesswork, but data.

Evidence from the Institute for Health Metrics and Evaluation (IHME) at the University of Washington is demonstrating that whilst we may be living longer, we are not healthy as we age.

IHME coordinated the Global Burden of Disease Study 2013 which estimates the burden of diseases, injuries, and risk factors globally for 188 countries. The study’s data on Years Lived with Disability (YLD) is particularly important. For Australia, whilst life expectancy at birth has increased from 76.9 years in 1990 to 81.5 in 2010, health-adjusted life expectancy at birth has increased from 66.4 years in 1990 to 70.1 in 2010.

Health adjusted life expectancy is of particular relevance to the current debate on access to the old age pension. It represents the age at which an individual is able to work productively. Unlike Dumas’ Porthos who worked like a titan until the moment his body collapsed, the evidence suggests that working up to 70 is simply not going to be an option for many.

The Global Burden of Disease Study reveal that the major causes of Years Lived with Disability (YLDs) in Australia are heart disease, low back pain, and pulmonary disease with diet and tobacco smoking the two major contributors. The key issue for policy makers to consider is that increasing the access to the Age Pension to 70, will not increase workforce participation. We will either see people moving onto disability support pensions, or accessing their superannuation to fund their exit from the workforce – which ill-health means will not be a choice.

If as a nation we do want to increase the nation’s productivity by getting people to work longer, then our key focus must be on the factors that are leading to ill health. Reducing smoking and improving diet should be seen as a major levers in enhancing national productivity. The good news is that Australia ranks well on health adjusted life expectancy. We should view this as a competitive advantage and focus on ways to increase this advantage.

We do need a debate on increasing the age pension but it must be focused on improving productivity not on delivering short term Budget savings. At the moment our debate would make Dumas, regarded as one of the fathers of modern fiction, proud.

LINKS
Global Burden of Disease Study
http://www.healthdata.org/gbd

ACKNOWLEDGEMENTS
Alexandre Dumas, The Man in the Iron Mask (Penguin Classics) (p. 387). Penguin Publishing Group. Kindle Edition.

Did asset allocation models lead to the Greek financial crisis?

As Greece continues to negotiate with the European Union, a significant question is whether asset allocation models contribute to financial instability?

An excellent case study is the German insurance market. As at the end of 2012, German life insurers held investments to the value of EURO 768.9 billion. Of this, 90% of total assets were held in fixed-income securities.

The current low-yield environment has led Germany’s Reserve Bank, Deutsche Bundesbank to raise questions about the potential for German insurers to become insolvent if low yields persist.

In a discussion paper issued in October 2014, Deutsche Bundesbank researchers Anke Kablau and Matthias Weiß analysed the impact of protracted low yields on solvency. According to Kablau and Weiß one option was for insurers to take on additional risk. “They could try to increase the net return in order to enlarge the allocations to the bonus and rebate provisions, part of which is recognised as own funds. Increased risk-taking would have to be viewed critically in terms of financial stability. Insurers’ risk management systems would certainly need to be progressively adapted.”

The German insurance dilemma raises the broader question of the macro-economic impacts of asset allocation. At a micro-economic level it makes complete sense for an insurer to adopt an asset allocation model where 90% of assets are invested in fixed-income securities. But when a whole system, which in this case is not just German insurers but pension funds globally, adopts the same asset allocation model we create problems.

What we need to see is differentiation, not herding, in investment strategy. Regulators have a role to play in supporting this. Rather than frowning upon risk, which the language of the Deutsche Bundesbank discussion paper implicitly does, regulators need to understand that by encouraging herding behaviour of investors we actually increase systemic risk.

The German insurance model, and others like it, created a platform where government bonds would be purchased, even where risks were deteriorating. We may be facing a Greek crisis today, but the makings of future crises exist in the sustainability of US debt.

The core message for investors is that whether we like it or not we have to step up and recognise that what we do contributes to the health of the global economy. Adopting investment strategies that look cost effective from a micro perspective, does not mean we don’t have responsibility at a macro level for their outcomes.

LINKS

Anke Kablau and Matthias Weiß, Deutsche Bundesbank, How is the low-interest-rate environment affecting the solvency of German life insurers?
https://www.bundesbank.de/Redaktion/EN/Downloads/Publications/Discussion_Paper_1/2014/2014_10_27_dkp_27.pdf?__blob=publicationFile

Vale Phil Spathis

I first met Phil Spathis when we were at the Finance Sector Union of Australia. For a number of years I worked for Unite in the UK. I remember making a call from a phone box in Spain to talk to the FSU about my return to Australia. I got the time zones wrong and ended up calling at some un-godly hour in the morning. The phone was answered by Phil, the only one in the office. This was typical of Phil. His studying for his law degree whilst working full time and looking after a family were the stuff of legend.

Years later when we both found ourselves working in the industry fund movement, Phil’s commitment to the trade union movement had not wavered. He continued for many years to serve on the state executive of the FSU, and continued to be passionate about working issues.

When I began consulting in the responsible investment space it was Phil that gave me my first assignment, which was to establish a Sustainability Reporting framework that benchmarked the progress that the ASX was marking improving reporting around sustainability. Phil was the quiet force for investors on the ASX Corporate Governance Council, working in a collaborative, yet determined manner to incrementally improve governance stances of the Australian market.

Phil’s best known contribution to corporate governance is the battle that he led with Michael O’Sullivan against News Corp’s transfer of listing from Australia to US that would have undermined minority shareholders rights and entrench the power of the Murdoch family.

When ACSI stood up on behalf of Australian investors, Murdoch initially thought that he could brush them aside. But ACSI started organising – skills learned in the trade union movement – and established a global coalition that in the end forced Murdoch to the negotiating table.

Eleven years later the importance of corporate governance is universally recognised. But it wasn’t always like this. ACSI’s News Corp campaign was not just important for Australian investors. It gave legitimacy for others to stand up. That in the end describes Phil.

My deepest sympathy to Phil’s family.

Links

ACSI’s News Corp story:
http://www.theage.com.au/articles/2004/10/08/1097089571715.html?from=storylhs
http://www.acsi.org.au/sustainability-reporting.html

How to manage house price increases caused by foreign investment

This week I had a good chat with a London cabbie who besides bemoaning England’s cricket team, said that one of the results of the property boom in London is that he rarely gets fares to Chelsea, which has emptied out as properties are bought by foreigners who do not reside in them. The story of foreign investors driving up property prices is the same in other global cities including New York, Toronto and Paris.

Returning to Australia, the subject of rising house prices is reaching fever pitch. With the real economy declining as a result of the fading of the resources boom, and with banks curtailing their investment lending, the finger is being squarely pointed at foreign investors.

The demand by foreign investors for property is a global phenomenon. And much of the investment is from emerging markets where individuals are seeking to transfer wealth to countries where the rule of law means provides long term security.

The desire to transfer assets from the developing world to the developed world is likely to be a permanent feature of the new global economy. But what are the implications?

In the short term governments may be happy to see housing markets buoyant and local construction stimulated, but in the long term are we creating economic imbalances?

The danger is that rising property prices in global cities will ultimately make these cities uncompetitive as higher wages and higher rents makes the cost of running a business unaffordable. The increasing cost of operating in the world’s global cities, may in turn cement the divide between the developing and developed world where business costs will be lower. The cycle of property investing is therefore likely to continue as wealth will continue to be built in developing countries and transferred to property investments in global cities.

What should governments and investors do?

The first thing is that there is a need to establish sensible constraints on the flow of capital.

Singapore took an early lead in this direction in 2011, introducing a foreign buyers’ sales tax, which is now 18%, after property prices boomed by 20-30% in 2008-09. Singapore provides exemptions from the sales tax for certain countries, the result of which has been to stabilise property prices.

We may also need legislation to prevent hoarding of housing. Requiring investors who do not rent out a property to pay a special levy may be one option that could ensure that increased housing supply actually results in an increase in availability of rental properties.

By structuring foreign sales taxes at a rate that allows for sensible investment there is the potential to raise revenue that could be used in ways that are in the long term interest of cities. Taxes on empty households and foreign buyer sales taxes are a good way of financing infrastructure, urban development and affordable housing.

The final area of focus needs to be on governance of emerging markets. We need to create a global environment where private wealth feels secure investing for long term in the economies where they create wealth. With growth in emerging markets likely to be higher than growth in developed countries it is also in the interest of institutional investors to focus on improving governance, which would allow greater flows of pension capital to be allocated to growth regions. This means that institutional investors should actively support measures to crack down on corruption wherever it may occur.

Foreign capital has the potential to be a source of development that can stimulate local economies, but like fire it is a good friend, but bad master, and must be managed.