Australia's hunt for alpha resembles one of those legendary medieval quests for the Holy Grail.
Australia's hunt for alpha resembles one of those legendary medieval quests for the Holy Grail. In fact, Australia's pension funds make the Knights Templar look like positive amateurs when it comes to seeking out golden assets.
There is, however, another way to optimise members' balances that doesn't involve endless digging for quality managers. Nor is it particularly expensive.
Unfortunately, however, it is not as sexy as 'the search for alpha' so we are unlikely to read too much about it in the media.
Centralised portfolio management (CPM) doesn't quite have the same ring to it as chasing alpha, and you can't use striking verbs like 'hunt' or 'chase' when you refer to it.
CPM is actually rather dull and, unlike its flashier active cousin, it's all about optimising member balances by reducing internal costs, not by hiring external managers.
The process aims to cut the costs caused by inefficient and unnecessary trading among different fund managers within an institutional investor's multi-manager line-up.
Index manager Vanguard Investments is the only firm to offer this service in Australia and it currently has two clients: MLC, which signed up three years ago, and Victorian Funds Management Corporation (VFMC), which signed up last week.
Vanguard looks at the universe of fund managers within a client's multi-manager line-up and then creates a shadow portfolio that aims to aggregate the holdings of every different manager.
Australia has a concentrated equities market so it is inevitable domestic shares managers will have considerable overlap in their portfolios.
By creating a shadow portfolio that is an aggregate of all the various managers' holdings within a pension fund, transaction costs should in theory be driven down.
Vanguard head of investment and research Scott Lawrence said compared with a traditional multi-manager Australian equity portfolio, the gains that could be earned from CPM were about 60 basis points annually across the portfolio.
"By using a central portfolio, turnover rates generally reduce by 50-75 per cent of the weighted average of the underlying managers, which can have a huge impact in reducing the portfolio's costs and therefore increase net returns," Lawrence said.
Vanguard, however, has yet to convince the rest of Australia's institutional market. One barrier that could stand in the way is the underlying managers themselves. It might be the case they do not want to share portfolio information with a third party, especially one that could in future become a competitor.
VFMC has taken a cautious approach and initiated a pilot CPM program with just three of its underlying managers.
CPM is a different animal to alpha altogether, but in an equity market as concentrated as Australia's it is yet another means to optimise member returns.
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