Chant West

Master trusts chase outperforming industry funds

Commercial master trusts are making significant yet cautious changes to their strategic asset allocations in a clear attempt to match the performance of their main competitors, industry funds. Master trusts are cautiously investing in alternative assets – among the valuable contributors to the performance of industry funds – and fine-tuning their portfolios. But their exposure to alternative assets is mostly limited to defensive assets and remains much lower than that of industry funds.

Master trusts have been shaken by the out-performance of industry funds over the past six years or so and are very conscious that under-performance on a relative basis can have a crucial effect on contribution inflows. This has forced master trusts to look at what they are doing.

The question is whether the adjustments by the master trusts to their strategic asset allocations – which are responsible for as much as 80% of a fund’s returns – and the changing investment outlook are enough to close the performance gap? We believe the gap has narrowed considerably.

The strategic asset allocations of master trusts should be considered in the context of why industry funds have outperformed them. Looking specifically in this article at growth funds (funds with growth assets of 61% to 80%), the out-performance by industry funds, measured over thefive years to June 2006, is attributable to:

Lower exposure to international shares, which hasbeen the worst performing sector with a negativereturn of 2.3% per annum on an unhedged basis – seeTable 1.
A higher allocation to property. Listed property hasbeen the highest-performing sector over this periodwith a return of 16.2% per annum.
A higher allocation to Australian shares. This sectorreturned 12.3% per annum over the five years toJune.
Significantly more alternative assets such as privateequity, opportunistic property and infrastructure.

SHORT-TERM COMEBACK

Table 2 shows that in the five years to June 2006, industry funds recorded a median return of 8.4% per annum – outperforming the median returns of both the master trusts (6.8% per annum) and the implemented products of the leading asset consultants (6.9%).

However, over the past one, two and three year periods to June 2006, the difference in the performance of master trusts and industry funds has been minor. Investors should understand how much of the improved relative performance of master trusts is attributable to their different asset allocations.

The main contributor was the improved performance of international shares, which recovered to produce a strong 19.9% return on an unhedged basis over the 12 months to June. Their returns were only 4.1% behind Australian shares compared with 14.6% behind over five years.

TABLE 1: INDEX PERFORMANCE TO JUNE 2006 (% PA)
Asset Sector	1 Yr	2 Yrs	3 Yrs	5 Yrs
Aust Shares	24.0	15.0	23.9	12.3
Int’l Shares (UH)	19.9	9.5	12.7	-2.3
Listed Property	18.1	18.2	17.9	16.2
Aust Bonds	3.4	5.6	4.5	5.9

TABLE 2: GROWTH FUNDS MEDIAN PERFORMANCE TO JUNE 2006 (% PA)
Industry Sector	1 Yr	2 Yrs	3 Yrs	5 Yrs
Master Trusts	14.6	13.6	13.7	6.8
Industry Funds	14.5	14.1	13.9	8.4
Public Sector Funds	14.0	13.8	14.1	7.6
Consultants	15.0	13.9	13.9	6.9

SHAKE UP TO MASTER TRUST PORTFOLIOS

The most marked change to the asset allocation of master trusts is their larger exposure to alternative assets - see Table 3 and 4. Master trusts have been making a concerted effort to understand these investments, in light of the performance by industry funds.

However, a couple of key points are worth noting here. First, the average exposure of master trusts to alternative assets remains at just 4% of their portfolios against 11%by industry funds, the pioneers among investors in these assets.

Second, master trusts on average have placed half of their alternative investments in what we classify as defensive holdings such as absolute-return funds compared with growth alternatives such as private equity. Growth alternatives are generally less liquid than listed investments, rely heavily on revaluations, and represent a higher element of risk. Master trusts place much emphasis on liquidity and so have a stronger emphasis on listed assets than industry funds.

LATEST INDUSTRY FUND ASSET ALLOCTIONS

Over the past 12 to 18 months, industry funds have reduced their allocation to Australian shares and correspondingly increased their allocation to international shares. However, the fundamental differences remain between the asset allocations of industry funds and master trusts.

The two most noticeable differences are the much larger exposure of industry funds to alternative assets and their lower allocations to international shares (24% in industry funds against 28% in master trusts).

Industry funds have kept their property bias (11% of their portfolios on average are in property against 8% in master trusts) and are hedging their international shares much more than master trusts. Industry funds hedge some 40% of their global shares against 33% of those held by master trusts.

A central characteristic of industry funds is their continued leaning to Australian assets. This is reflected in their property, infrastructure and share investments.

WHY THE DIFFERENCES

The differences in asset allocations of master trusts and industry funds may be attributable to several factors including their choice of asset consultants, their origins, and their philosophies.

Generally speaking, industry funds have long had an affinity for property because of the stable, attractive returns. Their broad-based membership tends to favour Australian assets, and the tremendous cash flow of contributions from millions of members has enabled significant investments in alternative assets.

WHAT ABOUT THE FUTURE

Based on consultants’ long-term projections for the performance of the various asset classes, industry funds may need to make some adjustments to their strategic asset allocations to maintain their competitive performance advantage. Consultants generally expect Australian and international shares to produce similar (pre-tax) long-term returns, and property to produce lower returns. This suggests that a significant source of outperformance of industry funds over the past six years may not be sustainable.

In a choice of fund environment, the performance of all funds will be closely scrutinised to determine the soundness of investment strategies. Trustees well realise that with the introduction of fund choice members are now free to change funds if they are disappointed with investment performance.

TABLE 3: AVERAGE STRATEGIC ASSET ALLOCATIONS (%)
Asset Sector	Industry Funds	Public Sector	Corporate Funds	Master Trusts	Consultants	Industry Average
Aust Shares	31	33	32	33	34	32
Int’l Shares	24	28	28	28	28	27
Aust Property	9	8	9	6	6	8
Global Property	1	1	0	2	2	1
Alternatives	8	4	3	2	2	4
Total Growth	73	74	72	71	72	72
Cash	5	4	3	4	5	4
Aust Bonds	11	12	12	12	11	12
Int’l Bonds	7	9	12	11	10	10
Aust Property	1	0	0	0	0	0
Alternatives	3	1	1	2	2	2
Total Defensive	27	26	28	29	28	28
TOTAL	100	100	100	100	100	100
STATISTICS
Growth /defensive assets split	73/27	74/26	72/28	71/29	72/28	72/28
Aust/int’l share split	57/43	54/46	54/46	54/46	55/45	55/45
Aust/int’l property split	93/7	86/14	96/4	80/20	78/22	87/13
Listed/unlisted assets	81/19	89/11	91/9	95/5	93/7	90/10
Hedged int’l shares (%)	40	43	38	33	37	38

TABLE 4: BREAKDOWN OF ALTERNATIVE ASSETS
Asset Sector	Industry Funds	Public Sector	Corporate Funds	Master Trusts	Consultants	Industry Average
Private Equity	2	1	1	0	1	1
Property	1	1	0	0	0	0
Infrastructure	4	0	1	1	0	1
Debt	0	2	0	0	1	1
Hedge Funds	4	1	2	3	2	3
TOTAL	11	5	4	4	4	6

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