Q: What’s your view on private credit?
A: It's the flavor of the month. Everybody's into it. If someone told you that private credit was unlisted, illiquid and unrated, you wouldn't be as enthusiastic, but a lot of private credit, that's what it is. It's not officially rated, it's not listed, and it's illiquid, and you get paid for that.
And for certain, it is disintermediating some of banking activity.
We've got some in the portfolio. We think it plays a good role in the portfolio, but it's not like buying an investment-grade listed government bond, it’s something completely different. It's a good place to invest, particularly because they’re floating-rate investments. Part of the interest has been that base rates have gone up from zero to 4% or 5% and so 300 or 400 above that goes from being 5% to 9%, so at 5% no one's got an interest; at 9% everybody's got an interest. So the benefit for being floating rate and being lifted by the higher base rate, so they're both good reasons to own it, but for the reasons I identified it's not without risk. In the credit cycles, when conditions become adverse, the credit investments become very illiquid, which is significant; even leveraged loans are relatively illiquid.
Q: What does that mean for you? Looking at managers that have been through multiple cycles?
A: There's some very good managers who do it, very good management. Churchill is very good. There's others I've seen who are very good. They've got long-term track records in it, they've got really structured ways they build their portfolio to limit this diversified issue, or diversified security, diversify industry. All those things matter, but it's only a very small part our portfolio, 3% or something. It's probably one of the smallest asset classes.
Q: You hit on private equity a bit. In remarks you made to the Australian Financial Review on Pluralsight, you talk about being burned by that investment. It's a space right now where we hear a lot of mixed things from other allocators, CIOs, especially on distributions. What's your outlook? Are you still planning to allocate more?
A: We're looking to increase our allocation materially, to probably double our allocation to private equity. We had that plan to do that in 2021 but the pricing got so expensive ... we just couldn't come at it, and so now things have settled a bit.
The pricing hasn't come back that far, but markets by and large, certainly the leverage has come down as it's a bit less risky than what it was. We're looking to start increasing our allocation.
It's been a great long-term returning asset class. We'll continue to do something into the future. As long as you get high-quality managers. Our team is very good at selecting managers, and we're supplementing that by doing co-investments now. Because we're so strongly cash flow positive, we don't feel the need to have capital returned so we don't have to recycle capital. Our challenge is to deploy capital, which is different to other investors.
Of course, I'd like entry multiples to be two or three points lower than what they are... Unfortunately, I'm not the only one in the market, and so you have to accept the terms.
I've seen three managers this week, PE managers. The industry is getting bigger. I've been doing private equity since 2000, the industry is getting bigger, but they're still really solid people that go about it the practical way, almost like old school. So I think that's pretty good. And always the essence of private equity returns is the ability of the managers of that company to generate the improvement in operational earnings, basically by growing revenues, scaling up, growing revenues, and that's not a given that most of the time they can deliver like that. So I still think that it's got a pretty good place in the portfolio.
Q: Do you do any hedge fund investing?
A: We sold all of our hedge funds in 2006, got rid of them all because when I looked at them and I picked them, we had a few of them, all they were doing was equity selection strategies or bond market selection strategies. And we've already got a bond manager and equity manager, so I'm just buying alphas, which I've already got alpha streams.
In effect, you’re buying alpha streams that could be better than your existing ones in a different container. And typically when you put a portfolio together, what a hedge fund portfolio is is a series of different alpha and beta streams structured together, and maybe they net out the beta. And in effect, a balanced plan is exactly what that is. So what you really ended up with was a balanced plan within a balanced plan. I thought, well, I might as well get the big one right than get the small one right.
We've had them off and on over the journey, they've come back into favor again because they're floating rate-based investments ... Then it's back in fashion. Interestingly, both private credit and hedge funds are back in fashion at higher interest rates. So I think that's a commonality there.
So we've had some global macro ones, but not really... We're very big, they're hard to scale and they're expensive. So they're not a natural place for us to deploy capital.
Q: About ESG, we've written so much the last 12 months about what's been happening in this country, how political it's become. What is your plan? How are you looking at it?
A: The straight answer is that we've always had what people might now call a narrow view of ESG.
In 2003 I developed some corporate governance principles for our portfolio. We went for a principles-based approach as there were different views from different quarters.
We deliberately developed some principles, not policy, so we could get some broader agreement and then solve it in practice. Then I was involved in the founding of ACSI (the Australian Council of Superannuation Investors), and hired years before that the external advisers. But it always started from the premise that, what can we do with this to enhance investment returns for members?
In 2000, just after Enron, we were worried about fraud, governance. We're worried about financial misstatements.
Then after that, climate became an issue. For example, I spoke to a conference of security analysts, from fund managers, and most had no interest in 2004. But it was coming, you know, it was coming. And so that was a real example of an issue which is a non-financial issue, which was going to become a financial issue in 2004. So there's lots of cases whereby you need to be forward-looking doing it and so our focus has always been (that) with our team, which is 18 people.
We hired our own ESG person who was probably the most experienced in the Australian marketplace who actually was an ex-company analyst before that, which is a different background to where a lot of them come from now. We just focus on, what do we think are the material risks at the company level? Kind of what you might call non-financial now, which will have a material impact in the future. So as long as we link our ESG efforts really solidly to creating shareholder value, we think we stand on good grounds. You can have your hand on your heart and say, "we're doing this for returns." So we haven't swayed from that at all. And I think the world started there, moved away from that, and is now moving back to that position.
Q: On investing in other markets, you've made a £10 billion commitment to invest in the U.K. Tell us about that and if you have similar plans for anywhere else?
A: Yes, £10 billion. The U.K. Government, like the U.S. government, is keen on foreign capital. Australia, since it was established until about five or 10 years ago, was always a capital importer, is now a capital exporter across the superannuation system.
For a 100 years, we were capital importer, because we were a developing country which needed capital. Now we're by in large a capital exporter or close to it.
Q: Australia thought of itself as developing?
A: Yeah, we needed foreign capital. So when I was in the government, we didn't import foreign capital to grow.
So the U.S. has a big current account deficit it has to import foreign capital to keep the place operating. And governments always prefer equity capital to debt capital. Long term, it creates economic growth, etc., etc.
And the U.K. government's got the same perspective on foreign capital. So we, we think the U.K. is a good long-term place to invest. It's got a lot of unique characteristics. When you're in London, I think it's probably the only truly global city in the world. New York has got a lot of global people, but it's a U.S. city, while London really is a global city, and that is a unique competitive advantage, which I don't think is easily replicable.
Now, how they maximize that benefit varies over time, but I think that's their sustainable competitive advantage, and participating in that in a long run will give us good returns.
Q: What's your view on China? Do you invest in listed equities there?
A: No, not much. We do emerging markets through managers.
My bigger picture view is that it's a bit like Japan, in a sense they're at the demographic pivot point. So the population grows really quickly, and urbanization grows really quickly and building enough housing struggles to keep up.
And so they're chasing this rise in urbanization, working population. And as that starts to peak and go like this (points up), the housing industry is still geared up to keep on building like this. And so over a period of 12 months, or something, two years, you get a situation whereby the underlying demand levels off and starts to decline, but the industry is still geared up to keep on producing. You get this excess supply gap. And that's what sort of happens in Japan. And China's got some of the same characteristics.
