Why super funds, big and small, shouldn’t borrow

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UniSuper’s John Pearce… ‘when you are dealing with people’s life savings, they would prefer you to be prudent rather than clever’

After five years as chief investment officer of UniSuper, John Pearce describes it as ”the best job I’ve ever had.” That may partly reflect the fact that Pearce’s investment beliefs look to offer a neat match with UniSuper’s members who hold 465,000 accounts. Pearce spoke to BARRIE DUNSTAN about those beliefs and more.

With more than three decades of hands-on experience in the local funds management business, John Pearce says he is unimpressed with parts of the initial report from David Murray’s panel. But he does agree with the criticism of borrowings by self-managed super funds. He worries about people with small balances using leverage in super funds. To use borrowings is completely against the spirit of superannuation, and he thinks it would be a great outcome if the Murray report saw regulations to ban borrowings.

Leverage has been at the centre of past collapses, Pearce says. The global financial crisis wasn’t that long ago and yet, with interest rates low, people again seem to be much more comfortable using leverage. This apparent amnesia is worrying, he says.

The use of borrowings also offends one of his key investment beliefs – that superannuation investments represent life savings and should be invested safely. His other two core beliefs are that valuation is the key and that investment is more art than science.

Because super savings are non-discretionary, for Pearce this means retirement investing should focus on quality companies with strong balance sheets and profitability. While UniSuper may miss out on early investment gains in stocks like Facebook or Twitter, it should also avoid disasters. Similarly, it avoids risky geographical areas like Eastern Europe, Africa and parts of South America. “When you are dealing with people’s life savings,” says Pearce, “they would prefer you to be prudent rather than clever.”

Valuation may seem an obvious belief, he says, but it is the single biggest determinant of investment performance and it goes beyond valuing individual stocks. Pearce has established an approach in the investment team which looks at relative valuations among asset classes and seeks to avoid turf wars between different his sections.

Reflecting his belief that investment is more art than science, Pearce   thinks there has been too much past emphasis on derivatives and the use of quantitative techniques. “There is more to investing than using an Excel spread sheet,” he says and quotes Warren Buffett that if the secret of success is mathematics, the Forbes Rich List would be dominated by actuaries. Rather, he says, the only thing on Buffett’s desk is a calculator with large, easy-to-read keys. Buffett is saying, says Pearce, that if you need more than a calculator you are trying to solve the wrong questions.

Using the qualitative, rather than quantitative, approach means thinking first about the about the logic of an investment and only then about the maths. Quant analysis, for example, might suggest investing some money in Pakistan to move the portfolio a little higher on the efficient frontier but, says, Pearce, investing in such a country is, first and foremost, a bad deal.

Pearce, 51, was born in Madras, India, and his parents came to Australia when he was a baby.  He grew up in the rough and tumble of Sydney’s western suburbs and went to high school in Parramatta. His ability saw him go to the University of Sydney, develop a passion for all things financial and earn an economics degree. He joined Westpac’s graduate program in 1983 after leaving university but his big change came three years later when he joined the State Bank of NSW as a trainee dealer.

Pre electronic dealing, trading rooms were crowded with people smoking and screaming into telephones. This was meat and drink for a western suburbs boy.  “That was it. [I said] this is what I want to do.” He moved up the ranks, running the dealing room then becoming head of financial markets. (Later, he was mentored to take a year off and attend Macquarie University for a Masters in Applied Finance.).

When CBA took the over Colonial State Bank, he was treasurer. Though he had really been involved in the asset management side, Chris Cuffe offered him the job as head of investments from 2000 to 2003 and when Cuffe later left, he took over as CEO of Colonial First State for three years until 2006.  Then came what he acknowledges was a brief, two-year, failed experiment when he was head hunted to China’s second largest insurance group, Ping An. He returned to Australia and went back to his investing roots, becoming chief investment officer of UniSuper in 2009  — and also re-connecting with Chris Cuffe, now chairman of UniSuper.

Pearce and the $45 billion fund recently made headlines over opposition to the Westfield group’s reorganisation but Pearce denies UniSuper is an activist shareholder; it simply took a stand on principle when it disagreed with policy by a  company in which it had a significant stake. (UniSuper regarded the previous holding in Westfield Retail Trust as an ideal investment in shopping centres, with low gearing, harvesting the rents and paying a regular income with a 7 per cent yield). It was not the start of an activist trend, he says. Going public is usually the last resort of asset managers in Australia and, after the incident, relations with Westfield are still cordial. UniSuper remains in the top three shareholders.

UniSuper was a pioneer in direct investments and infrastructure but has been standing back from direct property and some infrastructure projects recently. Pearce says it does not have a separate bucket for physical assets; rather it applies its comparative valuations approach – rejecting direct property when it is too expensive compared with listed shares. Pearce also thinks the idea of having exposure to unlisted assets is creating irrational behaviour and pricing – as in some of the bidding wars for ports and other assets.

UniSuper has been buying listed REITs rather than direct property; once again it’s that valuation questions with listed shares cheaper. “Until we are being paid a premium for the risk of illiquidity, we’ll stick to the listed market,” he says

Pearce is not excited about the Murray report. He thinks the debate about longevity is ill-informed. He says the brutal truth about solving the longevity problem is either people have to save more money or die earlier. “The bigger your lump sum, the bigger your annuity can be.” Using new products can merely share the risks around.

Pearce sidesteps a question of the recent freezing of the super guarantee contribution rate as “political machinations” but he is puzzled and annoyed at negative talk about dividend imputation. He can’t see that scrapping it would change the demand for corporate bonds; rather he thinks it would just increase the cost of capital for local companies. “I don’t know why the report is getting into these things, quite frankly,” he says.

In funds management, the big problem is the quality of advice, Pearce says, and the need for higher standards and education. He doesn’t see any short-term solution and thinks attacking the vertically integrated institutions is the wrong approach. Yes, he admits his time with the largest retail group but says that, where clients need restitution, the large bank-backed groups can handle this better than smaller groups.

He is conscious that UniSuper is different to other large funds. It is more an industry fund than, say, a corporate fund like Telstra, while it has a narrower membership target – specifically higher education employees – than, say, Australian Super.

And he doesn’t think UniSuper needs to join the battle  with SMSFs, saying this is a part of the market it is not going to service and he won’t  try to be all things to all people.

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