QIC sets its own pace

Doug McTaggart is chief executive of the innovative $50 billion Queensland Investment Corporation. On today’s video, he explains QIC’s obsession with risk-adjusted yield and its new venture into private equity.

One of Australia's biggest public sector funds groups, the Brisbane-based QIC is dropping its holdings in Australian equities and switching funds into more conservative fixed-interest funds, even into inflation-linked bonds!

But QIC is also putting more money into private equity. In keeping with QIC’s principle of doing things “its own way”, McTaggart says QIC is not joining the queue pouring money into existing private equity '” rather this heavyweight of the funds management business is building its own private equity division from the ground up.

As McTaggart outlines, the group is also effecting change in the financial planning industry through developing its own financial planning division, Q-Invest, a fee-for-service business in the manner of MLC.

The interview

Michael Pascoe: Are you running a unique [element] in Australia '” a government owned but very commercial and successful investor?

Doug McTaggart: We are unique, Michael. I think we’re another example of Queensland choosing to do things differently and making a success of it. Because we were set up in the late 1980s, early 1990s to manage the funds for a select group of public sector-related clients. We’ve done that well. That business has grown but everyone has recognised along the way that for us to do the best job by our foundation clients we need to be commercially competitive across the board and that’s where we’ve gone.

Well now you’ve got $50 billion under your control. You’re outperforming the market. You’re involved in everything from government finance to superannuation. How does it all fit?

Superannuation, government finance, government insurance funds, private insurance funds, private sector clients across the board. We manage all the money to perform. Investment performance is our goal. Our stakeholder group is less concerned, I suppose, with generating a huge return on equity and more concerned about generating strong investment performance.

What do you mean, not such a big return on equity but a big return on investment.

We need to be a profitable organisation, we need to return dividends to the Government, but our focus is very much on generating investment performance and service quality. We are probably able to take a longer view than many funds managers. We are able to reinvest in the business in a way that many fund managers probably can’t and uniquely '¦ another unique aspect '¦ for our large foundation clients we manage all of their money, 100% of their money, so we can take a whole-of-portfolio view on how we manage their funds. So that makes QIC very much a client-centric organisation as opposed to a product-centric organisation. We’re not looking for the next-best product to take to the market. We’re looking to what can we do to generate investment performance.

From an investor point of view, how does that translate into the decisions you make on where to invest and when to invest?

Well, I think it aligns us better with investors than any other business model does and it really is about yield '” where can we find the best risk-adjusted yield in terms of what our investors are looking for? Do we need to take a slightly longer view than the market in setting up a business or setting up an asset class in order to generate good returns?

Can you give me an example of that?

We had just for our large clients established a private capital business. We’ve always had a very strong real estate or property portfolio. We are now into infrastructure and private equity. There are lots of ways you can get into the business at the moment but everyone is effectively trying to chase the gatekeepers and the funds out there. We’re building a business. We’re hiring the best people from around the world. We are establishing the business, rock bottom '” all the way through, to capture the whole value chain on that side of the asset sheet. So it’s a little bit different.

Private capital. It’s a crowded market. Doesn’t it worry you to get into it now?

It’s a very, very crowded market and look, let’s face it: what drives private markets is what is illegal in public markets and that’s private information. Where do you get that? You get that through hiring the best people. Our stakeholders have encouraged us to get out there and get the best people, to hire the best people, to get the best access and that’s what we’ve done. We’ve taken it very cautiously. We’re not throwing money away but our record today is being able to get into the best funds, get into very good assets. Again, we can take our time and look around and we very much take a global view, too. So these are global businesses, or these are global funds and at this stage the initial investments are nearly all offshore.

So you are investing in some of the big-name funds on the private equity side of the business, yes, but you’re also going direct yourself on ventures?

In the infrastructure space we are, but not on private capital. Private equity we will go down the route, once we’ve established the funds, maybe co-investment, but we’ll do that well before we think about direct investment and again that’s a crowded market in its own right. You know, you’ve got to walk before you run in this business, we find. We’re talking a long-term view in building the business.

Just in equity investments '” to what do you put down QIC’s success there?

We’ve resourced a strong team, a big team. We have a very large team of equity analysts for an Australian team and, again, it’s with a view to invest in the business to get the investment performance. So we maintain a large team. We take a long-term view. We keep the funds sizeable and manageable. They take a keen interest in corporate governance and quietly behind the scenes. But again it all adds to performance at the end of the day.

How does that differentiate you from other funds managers?

Longer term, slightly lower turnover and more core in its approach. So, you know, our funds '¦ we haven’t got the best-performing funds in the country but they’ve been very solid performing funds over a long period of time, and that’s our risk adjusted return which is good.

What sort of weighting do you have in Australian equities now and has it changed lately?

For our big funds, it’s come down a lot. For our large public sector clients they were very aggressively allocating to equities going back a few years. They’ve done very well out of that but we have worked with them to diversify their asset allocation, their policy portfolio. We have unwound some of our listed equity positions, going more into private equity positions. Surprisingly '” or interestingly '” the funds have more fixed interest but we see them as a better match for our clients’ liabilities and, indeed, we have just invested a couple of billion in inflation-linked bonds and we believe that we’ve actually created a market in Australia for inflation-linked bonds because again we find them an ideal asset to match against our clients’ liabilities.

Just in general terms, what is your favourite asset class at the moment: inflation linked bonds or other things as well?

It’s a difficult question because we like growth assets in general. Equities have done well over time and equities will do well into the future, but what we’ve done in the equity space or the growth space is move out of listed markets. We’re moving out of listed markets more into unlisted markets and I think that’s a kind of international trend. But we’ve always seen value in fixed interest where a lot of other managers haven’t, in two respects: One, as a good match for liabilities and we have created that market in ILBs, inflation-linked bonds. We did that. It’s a very thin market. There aren’t many assets out there and the Australian Government in particular has not been issuing them so we went out and said to the big investment banks, global banks, 'You’ve got a lot of inflation-linked assets, why don’t you create some bonds against them’, and we’ve bought the income streams and that’s how we’ve built up a big holding there.

There used to be inflation-linked bonds issued by the Government.

There’s a huge demand if they decide to get out there. I mean they’re trading at yields of 8% in the UK. I mean it’s ridiculous.

So the Government could make money out of issuing them?

There’s a ready market for them to issue whatever they wanted. There’d be a lot of buyers out there.

And you’re making money out of investing them out of artificially creating inflation-linked bonds?

Yep. Why don’t they do it?

And why don’t other super funds want to do it?

Well they do. I think there’s a huge latent demand out there. What’s scared them off, I think, is the fact that you can’t buy '¦ there isn’t enough supply of physicals to buy them at a decent yield so you walk away. We’ve gone the other route and created a derivative space where we can get the yields. We carry the counter party risk but we’ve got good counter parties. I think other funds now might well follow that path and one of the reasons we’ve been active in promoting what we’ve done is we want to see that market grow. We’d like to see liquidity in that market because we’ll be a seller at some point.

What do you think is a reasonable yield for an inflation-linked bond?

We’re looking 3–3.5%.

Above the inflation rate?

Yeah, it will, which isn’t far off what equities do in more average times. Over the long run, you just [get] a little bit of a premium on that, but you know '¦

How big can you grow it?

Trying to source from Australia alone it’s hard, but we’ve gone global again. I think it could be a very big market.

Could you expand a little more on the move into more private markets rather than public markets. What’s driving it?

A couple of things. I think in the infrastructure space you can get inflation-linked assets. A lot of the regulated assets you buy give you an inflation-related yield or a growth-related yield so that’s good. There is the side benefit of reduced daily volatility or monthly volatility. There’s no such thing as a free lunch here but it does take some of the volatility out of the short-term returns, so that also helps.

The activity of private equity funds on public markets '” is that making them more volatile than you really like to see?

Well we’re in an interesting phase right now. I don’t know that it’s making listed markets more volatile but it’s certainly getting people to think about how they value unlisted companies and I have a view that the unlisted players, the private equity players, might be using different valuation metrics than the listed space, maybe achieve a cost of debt capital. They get a longer time horizon. They can take these things private and get rid of all the regulation. They’ve got a longer timeframe. There’s lots of reasons why they might be valuing some of these listed companies more highly than the markets have been and looking for opportunity there, particularly as you said earlier on, their unlisted assets in their own space are getting a bit pricey. So they’re certainly having a big impact on unlisted markets at the moment. And companies that you wouldn’t expect to be doing well are doing very well on the prospect they might be taken out.

Who do you think is right in the valuation matrix?

That’s a good question, that’s a very good question, and there is I think a global debate going on right now as to (A) is that occurring and (B) if it is occurring, which one is right. I think at the end of the day you might want to put your money on the private equity players if those four facts as I said are in fact true. Alternatively, there’s simply too much money out there and they’re coming in and paying too much then we might take five years to find out they’ve done their dough.

With your interest in inflation-linked bonds, is that also an indication that you are concerned about inflation being on the rise? That, with so much easy money in the world.

Look that’s a minor concern. That’s a minor concern. At the end of the day, the global industry is going down, certainly in the super space and the DB space in particular '” the defined benefits space in particular '” is going down the path of trying to match liabilities. We had a tough, tough experience going back to the early/the late 1990s and early 2000s so it is really more about investment policy [in those years] about economic outcomes.

You also have Qinvest. Could you explain that?

Qinvest is a joint venture with Qsuper, the large public sector superannuation fund. It’s a 50:50 joint venture and this was established, again, I think a fairly bold move for the day back in 1994 to provide financial planning advice into the Qsuper membership, which is a very large membership '” 400,000–500,000 members. Qinvest is open to the public; it is a public offer or financial planner if you like but its core focus is on Qsuper. It is a fee-for-service financial planner. always has been and I think it’s very much removed from some of the criticisms that other financial planners have of being product pushers into the marketplace.So again it’s that part of the Q family adding value to the client as opposed to necessarily trying to add value to the stakeholder, the shareholder.

And demand for Qinvest services? For fee-for-service?

Huge. Huge. I think the company has something like $2–3 billion a year under advice, which is a very, very large financial planning firm. The constraint that we have, that I’m a director of Qinvest representing QIC, the constraint we have is the constraint that applies to all financial planners '” they just can’t find enough of them.

It would seem that given the availability of fee for service financial planners, the public is happy to use them.

Absolutely. And I think there is some scepticism among the public but once they get in and experience the service and we know that most Qinvest clients '¦ they’ve gone around and kicked the tyres; they’ve talked to other financial planners; they do the rounds. But we get very good feedback once they settle down and enjoy the service.

And Qinvest financial planners are free to recommend any product?

They absolutely are. They’ve got a very long product list. They’re not remunerated by product. They’re remunerated for their service and we remunerate them on a performance system where the performance is related to the outcome for the client, not the products they sell.

Where do you see financial planning going as an industry? Obviously you’re a part of it. You’re a competitor with the mainstream planning organisations.

I think it is going down the fee-for-service route. It will take time. The industry has to recognise that there are two elements of the equation. One is the cost of the service and the other is how the client pays for it. Once they agree the cost they don’t care how they pay it '” whether it comes off their asset base or whatever, but as long as it’s an agreed amount. MLC’s going down that model '¦ have adopted that model. Other big funds will do the same thing so I think it will very much be at the end of the day whether the product is unbundled, where the member knows, or the client knows what they’re paying for. They pay an agreed amount and the remuneration mechanism is a matter of choice.

We’ve got the situation with the industry where aside from the straight-up commission, financial planning groups charging a listing fee to funds managers, the platform fees. Do you find that ethical?

We’ll decide again what we want to get into, but having said that, if you want to sell a product in a supermarket you can get it at the front of the aisle, you can get it at the top of the aisle, you can get it at the bottom, or the bottom row. There’s price discrimination occurring all kinds of ways. So I’m not going to pass a moral judgement on it. I would simply say that’s not something we choose to do.

Being government-owned with the big Q standing for Queensland, are you under any pressure to skew your advice, skew your investments in the Sunshine State?

Not at all and never have been. The politicians who created QIC '” and there was a line of them '” were prescient in their approach. They took the view, rather thoughtfully, that left unconstrained there would always be a temptation to try and meddle and so they wrote into the act that established us, rules against doing that. Now you might well say, 'Well, they could always change the legislation at the drop of a hat but let me tell you, the legislation’s now enshrined in stone and the practice has been so good, the outcome has been so good, I don’t think any politician would dare meddle with that. So they have created the environment, they have created the beast and now they live with it and they like the outcome. So we never have been ever under pressure. We don’t expect we ever will be. We have no particular Queensland buyers in terms of the investments but we do in terms of generating a return for our clients, which at this stage largely come from Queensland but the base is diversifying. We invest globally today.

Is there a social responsibility to Queensland on some of your investments '¦

No. No.

'¦ just by the nature of where your headquarters is and what your investment team hears, and the success of Queensland '¦ that’s been overweight in any way?

Look, to the extent that that generates a policy of spin-off for Queensland, for Brisbane, for Queensland and the state so be it. I would simply say to other funds managers, 'If you look out the window here, which you can’t see where the camera’s pointed, why wouldn’t you be up here?’ With today’s technology you don’t need to be where the markets are. If we can hire a manager of Japanese equity out of Edinburgh you can be anywhere to manage anything in my view and so we’re very happy being in Queensland. It’s a great place to live and work.

And there’s a chance to look at the Queensland economy as well. The boom’s been on. It continues. What’s there to pick up the bit of slack if the Federal Treasurer’s right and the resources boom does come to an end?

Look Queensland’s got a fairly broad-based economy outside of manufacturing. We don’t have a big manufacturing base but we’ve a very big services sector and Queensland has done pretty well out of the commodities boom, but my personal view is that the commodities boom quantity price strength has pushed the value of the dollar up to the point where it’s actually squeezing the traditional service and manufacturing-related industries. So if the commodities boom comes off, the state that’s going to be hurt is going to be WA. Queensland will hold its own because our service sector will pick up to fill the void and NSW and Victoria will probably do better. So we’re suffering a little bit of the old Dutch disease at the moment and not too many people are talking about it.

Queensland has also benefited from having relatively cheap housing compared with Sydney. Given the population growth which drives the services demand, is that coming to an end?

No it’s slowing though. When you look at the data and deconstruct the data you find that the prime driver of interstate and migration or migration into Queensland has been property prices down south. You could sell in Sydney, come up here, buy mortgage-free and have cash left over. And the big spikes in migrants coming up, migrant numbers coming up here, have been on the back of strong Sydney house prices. You can see in the data at the moment is that Sydney house prices come off, migration out of New South Wales is slowing a lot. We haven’t had more migrants coming up from Victoria now for a few years. They’re still suffering the Kennett effect there, so those numbers will slow but off a high base, so it’s a cyclical thing. So while the cycle will take those numbers down the trend is still strong and it will pick up again.

One of Ian Macfarlane’s parting comments as Reserve Bank governor was that if you don’t like Sydney house prices, leave '” is coming true?

Well it’s not just the migrants coming from Sydney. We’re actually picking up a lot of international migrants coming into Queensland now, so I suppose Sydney’s gotten too expensive for the new people going there and those numbers are picking up as well, so we’re getting it from both sides.

Queensland is immune, though, to another degree of interest rate rises. I mean the demand here is so strong a quarter percent, another half a percent, wouldn’t have touched the sides?

I think it will have the same cyclical effect it will have in all the states. And in fact at the margin but Queensland is still coming off a high trend so the impact here would be less felt than it would be in the other states.