Governance in a time of chaos

Investor Weekly cover story

By Christine St Anne
Mon, 03 Mar 2008

Page 1 of 3

Market turmoil and profit losses have made investors wary and nervous. Christine St Anne looks at whether the industry has what it takes to safeguard investor returns during what promises to be a volatile year.

In August 2006, corporate mogul James Packer told an audience of superannuation fund executives and fund managers: "All of you in this room are responsible for the retirement savings of Australians. You carry their hopes and dreams."

At that time the Australian equity markets were in the midst of a bull run, global markets remained strong and investors were enjoying double-digit investment returns.

Fast forward to 2008 and the lingering credit crisis of last year has effectively ended the dream run of the local share market. January's market correction wiped 5 per cent off the returns of the median superannuation fund, according to research firm SuperRatings. As a result, all major superannuation fund balanced options are in the red.

For the first time in five years, people are faced with negative returns.

With the spotlight on performance, funds will be scrutinised on how they navigate through this market turmoil. Do they have the skills and proper governance structures in place to protect their members against the falling markets?

The representative trustee model inherent in the board structure of superannuation funds has been the subject of recent debate at industry conferences and in the media.

In fact, it is an area the Australian Institute of Superannuation Trustees (AIST) felt was necessary to explore at this year's conference of major superannuation funds (CMSF).

The trustee representative model of superannuation funds includes an equal representation of union (employee) and business (employer) groups.
 
Representing investor interests
AIST policy and research manager Andrew Barr says: "There has been strong focus on this model for some time. This is because the industry has grown so much and sectors like to take a crack at each other and cement their ground. It's the first time we have commissioned research in this area."

Barr could not provide comprehensive details about the results, but anecdotal findings to date reveal a strong link between the representative trustee model and fund performance.

It is a structure that has made funds resilient to the many challenges they have faced in superannuation since they were established in 1985.

"Industry funds have been around for 20 years or so. During that time trustees have had to face both challenges in the investment and legislative environment," AustralianSuper chief executive Ian Silk says.

The representative model does have its own set of challenges, according to the Australian Institute of Company Directors (AICD) Western Australian president Fiona Harris. 

"As institutional investors, superannuation funds have been very loud when it comes to the governance of the companies they invest in. The structure of what they call for is not necessarily the model they have adopted on their own boards. With a representative board you don't always get the full skills set you need in a company board," Harris says.

Harris has spent time in industry superannuation funds and the commercial sector. She was chair of public sector fund the Government Employees Superannuation Board (GESB) and worked for KPMG. She also helped draft the governance standards for the Association of Superannuation Funds of Australia (ASFA).

An important factor behind board performance is the interpersonal skills, which may not be present in the representative model, she says.

"Board performance is about team building. You need to appoint the right people who have the interpersonal skills that can address a company's challenges in a constructive way," she says.

Silk, however, believes the boards of superannuation funds do have the right mix.

"The calibre of people continues to impress me. We have a range of people who have skills in the commercial, union and academic world," he says.

Governance in a time of chaos

Investor Weekly cover story

By Christine St Anne

Page 2 of 3

AustralianSuper's board includes 12 people, representing employee and employer groups.

Former Reserve Bank of Australia governor Bernie Fraser is the only independent director on the board. The board also seeks advice from the investment committee, which includes Hastings Funds Management former managing director Tim Poole and Leighton Holdings former non-executive chair Geoff Ashton.

Unisuper also believes that stakeholder representation is an important element of a trustee board.

While Unisuper has kept its representative trustee model intact, the fund has appointed a number of prolific and well-respected people in financial services.

Unisuper chief investment officer David St John says this is vital in administering a successful superannuation fund.

"Importantly, their appointments have not disturbed the principle of equal member and employer representation," St John says.

A question of accountability
At an industry function in January, former Perpetual managing director Graham Bradley spoke about the challenges for the investment market at a time of falling markets and corporate collapses.

Bradley called for the industry, including superannuation fund trustees, to be more accountable for their investment decisions.

"Superannuation fund trustees have a responsibility to be more involved, aware of their investments being made, the risk management disciplines in place, and more accountable to members. They cannot delegate their responsibilities to consultants and advisers," he says.

AustralianSuper's 15-person investment team seeks advice from external advisers Frontier Investment Consulting and JANA Investment Advisers.

"We are not over-reliant on our advisers; we do not slavishly following their advice. Our external advisers provide us with niche expertise and support the experience of our investment team," Silk says.

In the case of the $25 billion Unisuper fund, while there are informal relationships with external asset consultants, the fund uses its own 23 internal investment team led by St John. The fund also plans to hire an extra five people to the team.

"Unisuper has a significant depth of investment staff in its own right. It does look to the wider market for specialist and tailored advice. This expertise tends to reside across a number of organisations," St John says.

To ensure greater accountability and engagement with its members, Harris believes superannuation funds can learn from some of the practices adopted by company boards in the commercial world. She has also called for the big superannuation funds to arrange annual general meetings, something AustralianSuper already does.

"That way members have the opportunity to quiz their boards about the direction and the way their fund is performing," she says.

"Company directors and superannuation trustees are the most aligned group of people. They are delivering wealth to members and shareholders and both want the same outcomes."

At the end of the day, Silk says industry funds have achieved what they have set out to do.

"Funds are virtually proven investment vehicles and the kudos goes back to both the management of the fund and its board," he says.

With industry superannuation funds consistently dominating the SuperRatings performance tables, AIST chief executive Fiona Reynolds says there is no reason to change the model.

"The fact that top performing superannuation funds in Australia are not-for-profit funds supports our position that the representative system provides the best outcome for fund members," Reynolds says.

"Representative boards of trustee directors come from a range of diverse background. There have been no major disasters or mismanagement of representative super funds. The same cannot be said for some corporate boards as we have seen with the likes of HIH and Enron."

Governance in a time of chaos

Investor Weekly cover story

By Christine St Anne

Page 3 of 3

Lessons from Centro
Indeed, the credit crisis has already claimed a few scalps. In the US, massive losses have hit the investment banks; the giants of Wall St.

Closer to home, Basis Capital and Absolute Capital have dissolved while Centro, Allco and MFS are struggling to pay off debt.

For Bradley these "market corrections may well expose inadequacies in the system, particularly in the area of investor protection".
He believes there are lessons to be learnt from Centro.

"It will be interesting to compare the published governance statements of Centro on its risk management and contrast these with Centro's board and management's actual procedures and decisions," he says.

Centro's vision statement notes: "To maximise risk management returns to Centro investors, Centro's customer-focused value-adding team philosophy is seen as the best way to deliver profitable and risk-managed growth."

Bradley says: "How carefully, one wonders, were these words considered when Centro's board in October 2007 decided not to refinance its short-term debts because it thought that interest rates had gone too high and that it could get better rates if it risked waiting a few months.

"No doubt all of this will be examined in excruciating detail in the inevitable class action over coming months."

There are also lessons for investors, including fund managers and research firms, he says.

"Do better analysis and ask boards and management harder questions," he says.

It is a view shared by Maxim Property Securities Fund managing director Winston Sammut.

Unlike Australia's two large listed property funds run by UBS Asset Management and Colonial First State Global Asset Management, Sammut did not take a stake in Centro.

As a result, his fund topped the Morningstar performance table. The Maxim Property Securities Fund was marginally down at negative 0.90 per cent for the year to December 2007. The Colonial First State Wholesale Property Securities Fund and UBS Property Securities Fund posted negative returns of 19.47 per cent and 20.14 per cent respectively.

Sammut did not invest in Centro for governance reasons.

The Centro group is made up of Centro Property and Centro Retail, both listed companies. For Sammut, the issues of governance were inherent in the fact that both listed companies had identical boards.

"There were quite a number of transactions between the two entities - where is the independence?" he says.

Although Centro's difficulties were related to the current credit squeeze, he says that with gearing levels at 70 per cent, the company was extremely vulnerable to any interest rate hike.

While on paper Centro chief executive Andrew Scott had a personal stake in the business, this investment, however, was based on non-recourse loans.

"When a company goes under, these non-recourse loans don't have to be repaid, and the responsibility goes back to the shareholders. They are the ones that have to pay for it," Sammut says.

Sammut also takes a swipe at rating agencies that have kept their positive ratings on these fund mangers.

"No-one questions these consultants. At the end of the day it's the mum and dad investor that have lost 30 per cent of their return. Yet financial advisers will see that the Colonials and UBSs of this world are recommended by the rating agencies. People are getting paid for being a failure," he says.

Morningstar head of research Anthony Serhan says: "Any such assertions fail to grasp an understanding about the way we use our quantitative and qualitative processes."

For Morningstar, a fund manager's capabilities are also about "confidence in the people, processes and resources", Serhan says.

"We are not about to turn our processes into a one-call show," he says.

Despite the turbulent start to the year, Bradley remains confident this "new situation will challenge the corporate and financial sectors to develop and refine their skills".

"If we do this well, our retirements will be happy and our children's inheritance secure," he says.