Uncertainty and volatility two things to count on says NSW TCorp’s chief investment officer

The CIO of NSW’s TCorp, Stewart Brentnall, says greater policy intervention and market volatility will require the $109.9bn fund to increase its risk focus and tolerance.

Growing policy intervention and market volatility in coming years, driven partly by geopolitical tensions, will require the $109.9bn TCorp fund to increase its risk tolerance, says Stewart Brentnall, who manages the NSW government’s fund management arm.

Investors would have a tough time adapting to higher interest rates and inflation after decades of price stability and low rates, with private equity and real asset investments facing a particular challenge because of their dependence on leverage, said Mr Brentnall, who has been TCorp’s chief investment officer since 2017.

“In the short term, we no longer have that policy setting that has pushed long-term bond rates down and encouraged money into equities,” he said. “Inflation, interest rates, and probably foreign exchange rate settings will be more market driven than policy driven over the next few years.

“And because of the increasing importance of geopolitics in markets, we are going to have a more volatile time where there will be more frequent bouts of inflation, whether that be because of demographics and pockets of demand, or whether it be because of recurring supply issues in constrained markets.”

That volatility would force central banks to become more proactive in controlling inflation “both up and down” through monetary policy over shorter cycles, Mr Brentnall said.

“We expect shorter term and more volatile cycles, more profound, more proactivity from reserve banks, potential bouts of inflation, and therefore, more interesting and potentially challenging market environments.”

While the settings had changed, the fund – which manages assets backing NSW’s State Super defined benefit pension, state insurance liabilities, as well as special purpose funds – was “still expected to deliver the same returns, maybe for a bit more risk”, he said.

“That lends itself to a slightly more dynamic approach in fund management. And it lends itself to test our risk budget a bit more strongly and make sure that we are really using every element of the risk budget that we’re given.”

For TCorp this means scrutinising risk more thoroughly as well as a higher tolerance for it.

TCorp last year embarked on an efficiency program led by NSW Treasurer Daniel Mookhey that included merging six government funds worth $43bn into one.

TCorp chief investment officer Stewart Brentnall.

The consolidation of the six funds is expected to be completed by the time the 2024-25 state budget is released later this year. It “will deliver operational efficiencies as well as considerably higher returns, which will reflect an investment strategy employing a more efficiently used risk budget”, Mr Brentnall said.

“The Whole of State Fund will not have constraints and limitations that some of the current individually-run funds (do). This is a further example of driving higher returns from better use of risk in the challenged investment environment we are in.”

Last year, Mr Mookhey also scrapped debt-funded contributions to the NSW Generations Fund, a debt retirement fund created by former premier Dominic Perrottet. It was seeded in 2018 partly with the proceeds of the sale of the WestConnex motorway. Mr Brentnall said it would not receive allocations until the state budget is in positive territory.

He said inflation in places like Australia and the US was unlikely to continue declining all the way to the 2-3 per cent targets, but he believed “the back of inflation has been broken” as supply constraints after the pandemic had been cleared.

The energy transition and the continuing onshoring trend, however, would keep inflation higher.

Mr Brentnall also said equity markets were “probably not discounting any significant geopolitics problems” but “the Russia-Ukraine war could go on for years, Middle East tensions could escalate”.

Therefore, the 70-strong team of investment professionals Mr Brentnall leads did not have “such a constructive view on equities”, he said.

“We believe the appropriate position to take is a more diversified portfolio that provides resilience against a number of different environments rather than trying to predict a one-off to get right but equally quite possibly get it wrong.” He said the fund’s strategy had recently changed, with a de-allocation to developed markets equity alpha (or skill-based non-market bets) and higher allocations to alphas from investment managers focused on Australian equities, alternative and credit markets.

The fund is also looking at other “idiosyncratic or other forms of alpha” including potential investments in late-stage private equity managers.