CIO commentary on the DBD portfolio

unisuper-john-pearce

UniSuper’s Chief Investment Officer, John Pearce, provides a snapshot on how the Defined Benefit Division (DBD) investment strategy operates, and a comparison of DBD performance and a typical Balanced Fund.

The DBD investment objective

The central objective of the DBD investment strategy is to maximise the probability of generating sufficient returns to meet its future commitments.

To achieve a sufficient rate of return, the DBD has to have exposure to growth assets (such as equities), and cannot invest solely in defensive assets (such as cash).

To achieve this objective the optimal mix of assets may change based on a number of point-in-time factors. Some of these include expected returns on the various asset classes, changes to salary inflation rates and mortality.

Important definitions
Vested Benefits Index (VBI): the ratio of assets to benefits payable should all members withdraw from the DBD immediately.

Accrued Benefits Index (ABI): the ratio of assets to liabilities, taking into account the most reasonable estimate of the expected rate at which members withdraw, die or retire from the Fund and the benefits they would receive at the time.

In this section we will use the term ‘funding ratios’ to refer to the ABI and VBI.

Refer to the more detailed definitions of these terms in Monitoring the DBD.

Given that benefits are defined and relatively stable compared to asset prices, the required return could be expected to increase as the Fund moves into a technical deficit position (VBI < 100), and reduce as the Fund moves into a surplus position.

Managing the DBD in the long term

As at 30 June 2019, the DBD is a $28 billion portfolio of pooled assets, with strong financial management. A member’s individual defined benefit is not directly determined by the market performance of these assets. Instead, all contributions are invested collectively in a diversified portfolio. This pool of funds is then drawn upon to meet members’ resignation, retirement, death and disablement benefits when they become payable.

Although defined benefits are not directly affected by market movements, an effective investment strategy is crucial to maximise the likelihood that DBD members’ benefits will be paid into the future. The composition of the portfolio supporting the defined benefits— for example, its mix between growth and defensive assets, and between domestic and international investments —is set by the Trustee, having regard to the need to pay out all members’ benefits as they fall due.

Currently the DBD’s asset portfolio is heavily skewed towards quality assets that generate sustainable income streams, with the potential for capital growth that we expect can, at least, keep pace with inflation.

The following pie chart shows the general asset allocation of the DBD portfolio as at 30 June 2019.

The Australian and international shares component is largely comprised of ‘blue-chip’ companies that have a history of paying dividends. The Property component is largely concentrated in high quality retail and commercial assets, and infrastructure includes ‘fortress’ assets such as airports.

Pie chart showing the following allocations: 9% property, 8% infrastructure and private equity, 14% fixed interest and cash, 59% Australian shares, 10% international shares.

The DBD’s central investment objective is to maximise the probability of generating sufficient returns to meet its future benefit payments. It is currently in a healthy position as reflected by a Vested Benefit Index (VBI) and Accrued Benefit Index (ABI) that sits comfortably above 100%.

Ideally this would allow the Trustee to adopt a more conservative investment strategy such as holding more bonds. However, yields currently on offer in the bond market are well below the returns required to satisfy the central objective, and expectations are that low yields will persist for some time. Accordingly, it is likely that the current strategy of holding over 80% of the portfolio in high quality growth assets will continue, although actual asset allocations may deviate within forward allocation ranges depending on prevailing market conditions.

Performance of the DBD portfolio

The performance of the DBD is best captured in measures such as the VBI and ABI, and not by reference to the actual portfolio returns.

Defined Benefit Division - ABI and VBI

The performance of the DBD is best captured in measures such as the VBI and ABI, and not by reference to the actual portfolio returns.

A line graph showing the quarterly values of the ABI and the VBI of the DBD between 1992 and 2018. During this period, the values of both the ABI and the VBI fluctuated well above and below 100%, reflecting movements in investment markets as well as benefit changes or improvements of the DBD. Noticeably, the VBI has fallen below 100% during financial crises such as the ‘dot com’ dip and the GFC but has recovered to a healthy position on every occasion. As at 30 June 2018, the VBI and the ABI are 118.5% and 129.1% respectively.

As shown in the above graph the VBI and ABI are now 118.5% and 129.1% respectively as at 30 June 2019.

Points worth noting are:

  • The latest dip in the VBI below 100 was not the first time it has happened. In fact, since the inception of the DBD, the VBI has fallen below 100% on at least four occasions and has recovered to a healthy position on every occasion.
  • The fact that we see gyrations in the VBI and ABI over time should not come as a surprise when taking into account the way in which assets and liabilities accrue and are accounted for over time. The liabilities of the DBD are the commitments made to members which, by their very nature, gradually increase over time. Assets on the other hand are far more volatile and subject to the vagaries of the market on a daily basis. Furthermore, the accounting rules provide that assets need to be re-valued on a “marked-to-market” basis. In other words the assets need to be valued as if they were theoretically being sold at prevailing market prices. 
  • The future course of the VBI and ABI is of course impossible to predict as they are subject to market forces and past performance is not an indicator of future performance. However, the design of the DBD has largely enabled it to stand the test of time and, given normal market conditions which include the occasional bouts of volatility, there is no reason to suspect that the long-term future will be any different.