In this episode, we're revisiting a conversation originally published on 6 March 2019, with John Coombe, one of the true veterans of investment consulting in Australia.

John joined John A. Nolan and Associates – now known as JANA Investment Advisors – back in 1988, as the firm's very first employee. Over three decades, he helped grow JANA from a single client into a business advising on hundreds of billions of dollars for institutional investors across the country.

Investment specialist Daniel Grioli sits down with John to talk about the early days of investment consulting, the art of backing fund managers before anyone else will, the biggest asset allocation calls of John's career, and what really separates a good fund manager from a great one.

It's a conversation full of hard-won lessons from someone who's seen more than one market cycle up close.

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Overview of Podcast with John Coombe

Overview John Coombe Podcast

3:20 Got a job in superannuation, because I was the only one who knew how to use a PC 4:30 Spent most of my early days selling equities, because the market was so rampant. 6:30 Meeting some of the great investors two days after the '87 crash 9:00 Backing start-up fund managers 10:30 What went wrong with those managers that didn't make it? 17:00 The biggest asset allocation call in the firm's history 18:40 Shifting 15 per cent out of equities into property 21:23 Allocating nothing to US equities 29:00 If 95 per cent of risk is due to asset allocation, then why do we spend so much time on manager selection? 32:00 Never bet against the central banks 36:00 Do consultants add value? 40:00 Regulatory scrutiny of consultants; "throw them in the Thames and let them all drown" 45:00 Consulting is about making educated guesses. 49:00 Consulting is relationship management; don't kill it with being dogmatic 53:30 90 per cent of returns are driven by a manager's investment philosophy 58:30 There was a ton of money in hedge fund land being run on quant 1:01:00 Do performance fee ever make sense? 1:03:45 Tips for fund managers in dealing with consultants 1:08:00 Discussing the different consultant models. 1:12:00 Is consultancy getting too concentrated in Australia? 1:13:00 John's tips for institutional investors 1:14:00 Are CPI targets set today achievable? 1:17:00 The biggest challenges for instos today 1:18:00 A word of warning

Full Transcript of Episode 138

Daniel Grioli 01:12

Welcome to the i3 Insights podcast. My name is Daniel Grioli, and today I am joined by John Coombe. We first met back in 2011, when I interviewed for a job with John at JANA. Fate intervened, and it wasn't to be. My first impression of John was that he's more than happy to call a spade a spade, so I'm really looking forward to this chat. For listeners in Australia, John probably needs no introduction, but for the rest of you, here's a brief intro. John is a 30-year veteran of the investment consulting business. He joined John A. Nolan and Associates – now more commonly known as JANA Investment Advisors – back in 1988, as John Nolan's first employee. JANA has grown from a single client to around 100 institutional clients, with over $350 billion in client funds under advice. The firm also oversees a further $90 billion in implemented consulting portfolios for its clients. We cover so many interesting topics in this conversation, including what investment consulting was like in the early days, the traits the best fund managers share, whether asset allocation is an art or a science, and much, much more. So, without further ado, I'd like to welcome John to the podcast. John, thanks for joining us today.

John Coombe 03:14

Thank you, Daniel. How are you?

Daniel Grioli 03:16

I'm great, I'm great. So, we usually get started by asking our guests about their background and how they got into their career. How did you get started as an investment consultant?

John Coombe 03:28

Well, I started as an accountant at the SEC, and I was very fortunate that a good friend of mine, Terry McCreadon – who I think you know, who's now on the board of MLC Super but was also CEO of Telstra Super and UniSuper – phoned me up one day. I'd worked with Terry in the Treasury Department, and he said, "Coombsy, come and have some fun in the superannuation fund," because he was CEO of the SEC Superannuation Fund, which at that time was, I think, something like the fourth- or fifth-largest super fund in Australia. So I joined the superannuation fund, not knowing anything about investments but knowing a lot about a thing called a personal computer. The SEC ran everything off a big mainframe, but the superannuation fund had just bought a new investment management system that required a personal computer, and as I was the only person at the SEC who knew how to use one, Terry thought I'd be ideal for the job. So I started working with Steve Thompson, who's now at Cooper Investors and is a terrific equity investor. Steve taught me a lot about equities, and I used to do some of the bond investing too.

Daniel Grioli 04:57

Do you remember what that first piece of software was?

John Coombe 05:00

I can't, but it's the one all the custodians used for a very long time as their bolt-on to do Australia, because it had a tax module on the side. I honestly can't remember the name of it, but it was a very interesting time to be in the markets. I joined in '85 or '86, and we were selling equities all the time because the market was so buoyant, trading at all-time highs. I still remember Steve and I used to get told off – we'd go to an investment committee, and John Niland was the chair. John would say, "I told you guys to sell X percent of the share portfolio," and we'd say, "We did, but the market had recovered, and we're back at the same level as before." I think I spent the first two or three years just selling shares all the time. We had a big portfolio, and we got involved in things like the takeover of Fosters by Elders, and all the corporate shenanigans that went on in the late '80s. It was actually quite insightful as a young man doing that.

Daniel Grioli 06:27

So you clearly weren't working in a fund that delegated investment management out. Sounds like you were doing everything in-house.

John Coombe 06:33

That's the start of – oh, John A. Nolan and Associates. John left the SEC – he was head of finance – and started up John Anthony Nolan and Associates, or JANA, in 1987. It started the day after the crash, and I was fortunate: two days after the crash, John and I went up to Sydney to interview managers, because the SEC had decided to outsource part of their Aussie equities to external managers. I met Rob Maple-Brown two days after the crash, and I met some of the great names of the time – Sedgman and a few others. Two days after the crash, and a 40 per cent drop in the market in one day – we've not seen it again, thank goodness. I can assure you it wasn't much fun that day.

Daniel Grioli 07:42

Do you remember what you were talking about at the time? Was it just the crash, or–

John Coombe 07:46

No. We talked about philosophy a lot, and John, as you know, has a strong belief that corporate culture and corporate structure matter a lot in investment management – he learned that from Budge Collins in the United States. So when JANA started, we had two relationships: one with Intersec in Connecticut, who were the first to do global surveys of equity managers, and the other with Budge Collins and Associates out of Newport Beach. Budge ended up becoming PIMCO – well, Collins Associates ended up becoming PIMCO – and essentially they used to fund up start-up managers. They always said that was where all the return was, and they'd fund a lot of young start-ups, which eventually led into the hedge fund world for them, though not for JANA. But that's how their business evolved.

Daniel Grioli 08:55

Okay, so you mentioned backing start-ups early – that was going to be one of my questions later on, but you raised it, so let's cover it now. John's been quite active over the years in identifying managers early. Do you think that's been a big part of your success?

John Coombe 09:14

Without a shadow of a doubt. I think we've helped a lot of managers get started – they've done fantastic jobs for our clients and the members who benefit from that – and it's been really interesting to see the growth in the market, in guys (and ladies, sorry) willing to back themselves and have a go. It started very slowly. Andrew Sisson was one of the first, at BT – well, I suppose Robert Maple-Brown really was the first, wasn't he? Initially we had money with Maple-Brown Abbott. As I say, I think I'm the only consultant who's sacked them twice – there's a long story behind that, we won't go into it – but it has been a big part of our success. Budge was right: if you can get good talent early, when they don't have much money, they make a substantial amount for your clients in the early days.

Daniel Grioli 10:28

One of the criticisms often levelled at consultants is that they're afraid to back managers early, because they're putting their reputation on the line when they take an idea to a client, and also that they want managers with a lot of capacity, because they need to get 20 consultants into a manager to get scale on their research. What is it about JANA that allowed you to do something other consultants were afraid to do?

John Coombe 10:57

John's very entrepreneurial himself – remember, he started JANA with a little bit of backing from Bruce Cook. John is a starter of small businesses, and he understands that. I think the most important thing from our perspective is that we try to make managers profitable, because the last thing you want – and it happened to me once, won't happen again – is to back a manager who isn't profitable. That's a disaster reputationally, because they end up shutting down, and you end up having to find another manager and lose some credibility with clients. Look, we haven't got every start-up manager right – I'll confess to that – but the hit rate's pretty high. It's not 100 per cent, though I'd like to lie and say it was.

Daniel Grioli 11:57

I'm sure there are some stories there – maybe you'd feel comfortable telling us about some of the ones that didn't go so well. You don't have to mention them by name, but what went wrong?

John Coombe 12:09

Generally, the one common trait among the ones that haven't worked was the backing and the capital structure of the organisation. It wasn't that the people were poor investors – quite the opposite – it's just that they didn't have the corporate backing, the corporate structure, to get them through that start-up period before they became profitable, and that put too much pressure on them.

Speaker 3 12:44

[inaudible]

John Coombe 12:45

And then, if you've got a team of four or five, not everyone's got the same financial backing. If you have a person who's, say, got a couple of kids in private schools, etc., they can last for a while off their savings, but after a while the missus is in their ear, asking when they're going to get a real job and start bringing in money to pay the bills. So that's generally the pressure point in that start-up phase – that first year or two.

Daniel Grioli 13:21

Okay, so coming back to the early days at JANA – you'd joined John at JANA. What did you do? What did you start out doing?

John Coombe 13:31

I did everything. There were only two of us.

Daniel Grioli 13:36

But what was consulting like back then? What sort of questions were you helping clients with?

John Coombe 13:40

We were trying to convince clients to get out of balanced funds and into sector specialists. I'll give credit where it's due – John basically started the trend of telling clients that managers aren't good at everything: pick them for what they're good at, give them money in that asset class, and build a portfolio from the best managers in each asset class. We were pretty radical early on – well, it was the way the SEC was run; we had a team running fixed interest, a team running equities, a team running property, etc. So it wasn't foreign to us – it was how we ran money at the SEC. In fact, if you went into the bigger balanced shops back then – BT, AMP, Colonial here in Melbourne, National Mutual – they were all run on the same lines, all with specialised sector teams, but the product sold to the marketplace was a balanced fund. Most people had three balanced funds. MLC's whole premise in the corporate super world was, "We will be the median fund in the surveys, and then you can put your hot-shots wherever – but we'll always give you a median return in the survey." It was a very successful campaign; they had a third of all corporate super. So we came in with the idea that you could pick specialist managers and get a better outcome.

Daniel Grioli 15:27

Okay, so what was the reception to that idea in the early days? Did people think you were crazy, or did a particular event change minds?

John Coombe 15:36

I think we got a bit lucky with the property boom and bust at the end of the 1990s. John had formed a view – and he was right – that property was overvalued, partly because the SEC was a big property owner. The SEC Super Fund owned properties down St Kilda Road, and we'd been selling them to anyone who wanted to buy, but there was all this new property going up on Collins Street – 333 Collins and so on – being built at the time, cranes everywhere. Finance was super competitive, and the banks were lending like crazy. So we told our clients not to own any property. The first three clients we had – if they had property, we sold it; if they were in a balanced fund that held property, we got out of it. They literally ended up with no property. We also started working for Australian Super – or ARF, as it was then – and for REST, and it was a beautiful place to start, because they had all their money in either AMP Capital Guaranteed or National Mutual Capital Guaranteed. We took those portfolios, and all the new cash flow, and put it into asset classes we thought would do okay. The asset class we thought would do terribly was property, so we stayed right out of it. Those clients had a fantastic run through the early 1990s because they didn't own any property. We were probably the first consultant ever to take the National Mutual and AMP property unit prices, graph them, and use that as our proxy for the Australian property market. AMP had dropped their property unit price by something like 20 per cent, and National Mutual had dropped theirs by 5 per cent – there was something wrong at National Mutual in Melbourne, which subsequently there was. So we said, "There's an anomaly here – these property prices are starting to look reasonably cheap relative to the share market." We made the biggest asset allocation call, I think, in the firm's history, with Western Mining, which had no property. Don Morley was the chief financial officer. John went on holidays in mid-January to go fly-fishing, because that's what he loves to do, and I was left with instructions that if the stock market kept rising to a particular level, I was to call Don, and we'd switch 10 per cent out of equities and into AMP property, all in one day. The stock market hit that high – I think it was the 18th of February, I'm not 100 per cent certain of the day – but it was up 73 per cent in twelve months. I think that's historically the highest one-year rolling 12-month return. Anyway, it was up 73 per cent, and I phoned Don. I still remember the call – Don said, "Are you certain, John?" and I said, "Yes, Don," with all the conviction I could muster.

Daniel Grioli 19:30

You were on a rocket ship – about to go to the moon.

John Coombe 19:34

I suppose we were lucky, because the '87 crash was still fresh in people's minds, so it wasn't that hard a sell, though it wasn't an easy one either. We shifted something like 15 per cent in the end, out of equities and into property, and to be blunt, it was timing from heaven, because – I don't know whether you remember – in 1994 Alan Greenspan started raising interest rates.

Daniel Grioli 20:07

I was in primary school.

John Coombe 20:09

You were in primary school. But he started raising interest rates, and that was the only year the bond market had ever lost money – ever, in history, because we'd reconstructed all the index history back over time. So it was fortuitous: here we were in property, which had been hammered, and out of equities, which were getting absolutely slaughtered as bond rates rose. It was a lovely call.

Daniel Grioli 20:43

I had the pleasure of interviewing Jeremy Grantham in his office back in February, and one of the things we spoke about was his early career and some of the early calls he got right.

Speaker 3 20:54

Yeah.

Daniel Grioli 20:54

In that conversation, we discussed the importance of getting a big call right early. Do you think that's been a big part of JANA's success? Would JANA be JANA if you hadn't?

John Coombe 21:08

If we'd seriously got that wrong... it's hard to say, in hindsight, but at the time it was – the stock market's up 73 per cent, everything looks rosy, interest rates falling – none of it felt like a big call. I think the next biggest asset allocation call we made was coming into 2000, in the tech boom. We were working for Wesfarmers, and one of the premises we had from Michael Chaney – he was CFO at the time, before he moved into the CEO role – was a mandate to maintain their surplus for as long as possible. They were our first client, back in 1988, and we'd kept the surplus. Coming up towards the tech boom, we convinced Michael that he should have virtually no US equities – none whatsoever. The market was frothy, but that was a year and a half before it peaked. You were probably still at school then.

Daniel Grioli 22:48

I'm starting to remember this period.

John Coombe 22:50

The peak happened in March 2000.

Daniel Grioli 22:55

So what was that year and a half like?

John Coombe 22:58

It was painful. At REST we'd gone down to 10 per cent in global equities, the lowest they could go, and I remember saying to John, "We can't go any lower in global equities, so let's be smart about it – why don't we hire a value manager, because they've cleaned up and aren't buying any of this rubbish?" We went to the REST board and said we were going to hire a global value manager – the best of the worst, because the value managers were all terrible, underperforming the index by 10–15 per cent. We hired the best of the worst, which was Brandes in those days. The following year, the US stock market was down something like 35 per cent, and that portfolio was up – it was magic. About 65 per cent of stocks hadn't risen in the dot-com rally, but the following year that 65 per cent rallied, while the other 35 per cent, trading on enormous valuations, plummeted – some of them ceased to exist. So the market was down a lot overall, but by number of stocks, 65 per cent actually rose the following year. As long as you were in the value manager, you did okay. That was really interesting. I remember going along to events – I'd shifted up to Sydney by then – and we'd put together 20 pages of presentations for clients to prove why all this technology stuff was just smoke and mirrors, and that it would always end in tears. I'd go along to present at BT, and they were buying everything we were saying was rubbish. I remember a conversation at an AMP function with Jeff Rogers – you know Jeff – who was firmly in the camp of "you should be in global, you should be in tech." I said, "Jeff, so you're willing to give up franking credits and tax benefits" – because the full franking regime was in vogue then – "just to go and buy something that has no earnings?" It was quite a funny little exchange at that meeting, and I remember Michael Lillicrap from REST sitting next to me. I don't know who won, but at least the point was well made – it was entertaining.

Daniel Grioli 25:54

I can't help thinking, as you talk about these shifts – and the question of peer risk comes to mind – were institutional investors far less concerned about what other funds were doing back then, when making those sorts of shifts?

John Coombe 26:10

Yeah, a lot less, but the biggest change in super came when the Coalition came to power and introduced choice. Choice, by its very nature, takes the asset allocation decision away from trustees and puts it onto the individual investor. That, in my opinion, was the biggest change in the super industry, because prior to that, everyone just ran their own balanced fund based on the membership profile – and in a lot of cases, defined benefit liabilities, etc. By the end of the 1990s, choice had been introduced, and by its very nature, once you introduce four or five different options, you've narrowed the range within which you can move the asset allocation – because a balanced option can't look like a growth option, and it can't look like a capital-stable option either. You've really narrowed the range, and I always said to anyone who'd listen that this stymied asset allocation. Ray King and I used to talk about how everything in a fund's outcome came out of its asset allocation. I said that's history now, because once you've introduced choice and narrowed the range, the amount you can get out of asset allocation, in terms of its impact on your portfolio, is also narrowed. So choice was the biggest change.

Daniel Grioli 28:02

Did choice also have an impact on the way trustees approached their roles?

John Coombe 28:09

Yeah, because they also introduced licensing of trustees, which is partly why JANA sold the business to MLC/NAB in 2000. We were about 80 per cent corporate funds back then, and all of them were talking about moving into a master fund, or getting out of super altogether. No corporate fund we worked for wanted their executives doing 30 hours of training to keep a licence – they just wanted to offload it, which was a real shame.

Daniel Grioli 28:54

Well, it sounds like it was quite an interesting and dynamic industry before everybody decided to give it away.

John Coombe 29:03

Yeah, it was, and there were lots of funds. APRA probably didn't like the fact that there were so many corporate funds, but back in those days, super was part of the whole package you offered employees. Government funds offered higher contribution rates in some cases; there'd be a staff superannuation fund where staff were given bonuses and additional contributions into their super, and then the wages employees were in a separate scheme, and so on. It was really seen as part of the HR benefits regime – much less so today.

Daniel Grioli 29:53

You touched on the topic of asset allocation, and it's something I've always wanted to ask about. There have been various studies, and the number varies from study to study – some say it's 50 per cent, others 75 per cent, 90 per cent, or 95 per cent (usually it's risk, but sometimes return) that's determined by asset allocation. If that's the case, and you look at what a typical institution spends on trying to find active managers to pick stocks, the fee budget is probably somewhere between 20 and 50 times what they spend on consultant advice for asset allocation, depending on the size of the fund. So I've always wondered: if asset allocation is the most important part of the investment decision, why are you paying 20 to 50 times more for the other stuff?

John Coombe 30:49

Because history tells us it's the hardest game in town – and Jeremy Grantham would have touched on this.

Daniel Grioli 30:57

Absolutely.

John Coombe 30:58

Mean reversion works, but sometimes it takes a long time, and sometimes you get regime changes. I don't know whether you talked to Jeremy about the profit-share component.

Daniel Grioli 31:16

We did, but–

John Coombe 31:17

GMO always argued that the stock market was over-earning, because the share going to shareholders was higher than historical norms – and that hasn't come down. Whether that's a permanent shift, I actually do think it is. A lot more people are remunerated nowadays through share ownership – if you work for a bank, part of your bonus is in shares that get issued. So there's a higher percentage of people whose remuneration is linked to the stock of the company they work for. But with asset allocation, there are a lot of times when you shouldn't do anything. Sometimes I go along to clients and think, "What am I going to tell them?" because markets are a little expensive at the moment. In the longer term, whether you look at EPS, PEs, or free cash flow – none of the metrics look cheap. No market does, but then it becomes a relative game. Am I going to take my money out of the stock market and put it in cash at zero – or, if I'm overseas, negative, paying for my cash to sit in the bank? How crazy is that? Or put it into a bond market and get negative real yields after inflation? Or stay in the stock market and earn a yield, even though I know there's going to be volatility around that capital? Well, I've learned one thing in 30 years of consulting.

Daniel Grioli 33:07

Just one?

John Coombe 33:08

There's one lesson you should learn, Daniel. It's a very simple lesson.

Daniel Grioli 33:12

Please, enlighten us.

John Coombe 33:13

Never bet against the central banks – you can go out of business. I learned that from Tim Hughes. He bet against the RBA back in the 1990s, running bond portfolios in his own little business. He bet that inflation was going to get high and that the Reserve Bank of Australia wouldn't control it. He put duration positions on for that outcome. Three or four years later, he was out of business – his clients had given up on him, and he was never right. The Reserve Bank has kept inflation in its target range pretty much ever since it got that mandate. So if central banks are pump-priming the world, or their own economies, you don't want to go short equities. You seriously don't want to be short equities. You might take a little off the top – be one or two percent underweight because valuations are high – but you wouldn't punt ten. Did you ever consider repeating–

Daniel Grioli 34:22

–your trick from the tech bubble, maybe hiring a value manager here or there to fade the valuations?

John Coombe 34:30

Yeah, obviously, if one part of the market is doing things that you hope are smart – so if part of the market's trading at a 25 per cent discount to the rest, what do you do? You should go and have a real, hard look at it. There might be a structural reason you shouldn't be there, but if there's no structural reason, you probably should buy it. So you should be looking within asset classes for the cheapest, least risky way to invest – but at the broad asset allocation level, you'd be a very brave person to bet against the central banks. I love risk models, but everyone knows 90 per cent of all risk comes from the equity market, so it doesn't matter – as soon as I own one equity, I'm in strife from a risk perspective. It's a matter of looking even within equities: is there somewhere in the market that looks much more attractive than somewhere else?

Daniel Grioli 35:34

I'd be interested – because you obviously deal with more trustees than I have – but in my experience, I've found it much harder to convince trustees to make shifts within asset classes than between them. It always seemed easier to say "we're taking money from equities into bonds" rather than "we're shifting between investment grade and high yield," or "between emerging markets and developed markets," or something like that.

John Coombe 36:00

Well, I think–

Daniel Grioli 36:03

–I've never understood why.

John Coombe 36:06

I think our trustees are getting more sophisticated, and the fact that they've got internal teams means they look to them, and if their internal team agrees, that reinforces the decision – it's not so much them making the call as backing their team. It's about the meeting of the minds between your internal team and your consultant; there'd have to be a very big differential between those for trouble to start, because no trustee wants to see their consultant fighting with their internal team.

Daniel Grioli 36:47

Well, there goes their legal protection, if that happens – what do they tell the judge?

John Coombe 36:52

Don't know.

Daniel Grioli 36:53

So, I'm going to put you in the hot seat now. There have been a lot of studies – I saw one recently that came out of Oxford Business School–

Speaker 3 37:01

Yep.

Daniel Grioli 37:02

–calling into question the value investment consultants add by picking managers.

John Coombe 37:07

Yep, I read the article.

Daniel Grioli 37:09

I'd love to hear your take on it.

John Coombe 37:11

Maybe they're right? I look at our results across our client base, and we do have mixed results, but in general, in Aussie equities, our managers have added value. In global, they have too, but it's been less consistent – more about style, and us calling different parts of the market, like emerging markets. When we've called EM right, our clients have really benefited, but we've probably stayed in too long, if I'm honest, and that's dragged returns down. Value has been very difficult over the last five years in global in particular, and since we have a value-oriented philosophy, that's been hard, though we've still done relatively well compared to others. My criticism of that particular study is that it looked like they were looking at retail returns, not wholesale returns. If you look at retail products, some managers have six or seven different products in them, ranging from growth to value to core–

Daniel Grioli 38:40

–different share classes, and–

John Coombe 38:42

–all that sort of stuff. So I worry about that. They haven't narrowed the field to one manager, one product – you know what I mean – they're comparing apples and oranges. Some of those funds have a million dollars in them, and some have billions. I know which one matters most for the outcome of most investors, so I read it with a lot of interest, but I struggle with academics looking through performance tables and coming up with conclusions – they might well be right, but the article also highlighted that the really big international consulting firms have a process where they rank managers, and if you're a client, you're meant to end up with the top three or four. If you're one of those big firms, advising, say, $500 billion or a trillion dollars worth of assets, and you're trying to put it all into the same manager configuration, you're going to cause massive issues. We don't do that.

Daniel Grioli 40:06

Well, you'd give up the edge we spoke about earlier – backing interesting managers early. You pretty much rule that out.

John Coombe 40:14

We'd never do that anyway. We don't believe four managers should always make up the lineup, because it doesn't take into account the client's risk profile, etc. Some of our clients couldn't stand having some of the small-cap managers we use, where, yes, they add value over time, but they can be five or six percent under benchmark in a given year. Or really aggressive, high-octane, concentrated portfolios, down five percent in a quarter but up ten over the year – wonderful when they're up ten over the year, terrible when they're down five in a quarter. So you've got to have managers that fit the client's profile as well.

Daniel Grioli 41:02

So you've mentioned you're not entirely convinced by academics looking into investment consulting – what about regulators? Consultants have received a lot of scrutiny in the UK.

John Coombe 41:13

Yep, and probably justifiably so. I actually made a comment after the 2000 tech bubble that I'd throw all the UK consultants in the Thames and let them drown. I think they did an appalling job – the average UK pension fund had something like 85 per cent in equities, global and domestic. The interesting thing was, having had Wesfarmers with no US equities, we'd actually have been better off with no UK equities and no German equities either, because those two markets performed even worse than the US, since the big telecom companies in both went to extraordinary valuations.

Daniel Grioli 42:09

Vodafone – a huge part of the UK market.

John Coombe 42:12

I think it was 15 per cent. And News Corp.

Daniel Grioli 42:15

And Nokia as well, in Finland.

John Coombe 42:18

So you would have been better off getting out of the European markets entirely. Anyway.

Daniel Grioli 42:26

Well, that moves me on nicely to my next question. How is consulting different in Australia compared with other countries?

John Coombe 42:35

Well, having never consulted in another country – other than New Zealand. Does that count?

Daniel Grioli 42:42

It counts. We'll say it counts for the New Zealand contingent.

John Coombe 42:44

It is completely different, let me tell you. They're much more internationally oriented and focused on absolute return in the way they think about markets, which is quite refreshing. There are no surveys over there – they don't care.

Daniel Grioli 42:59

Would you end the surveys tomorrow if you could? Do you think they help?

John Coombe 43:03

They don't help.

Daniel Grioli 43:04

I don't think members ever read them.

John Coombe 43:06

Members never look at them.

Speaker 3 43:07

Yeah.

John Coombe 43:07

The only people who look at them are trustees and consultants.

Daniel Grioli 43:11

Where I get really scared is when I see people's variable compensation linked to a survey – I've seen that a couple of times. There are some large funds that do that, and I think it's a real issue.

John Coombe 43:23

Yeah, but I do think it's an issue – though you could argue the survey is the collective wisdom of all participants in the super industry at a point in time. I'm not 100 per cent certain about that, but it could well be. I had a colleague, Rob Clark, who was CIO at Rothschild, where their asset allocation for their balanced fund was set to be the average of all the other funds in the surveys. He and I had wonderful debates over glasses of red wine about how stupid that was, in my view, and how correct it was from a business perspective, in his. So it depends whether you're running it as a business – if you are, you do have to be aware of where your competitors sit, because you don't want to be out on a limb for too long and have it cost you the business.

Daniel Grioli 44:34

What qualities make a good investment consultant?

John Coombe 44:39

A questioning mind, willing to ask really stupid questions at times.

Daniel Grioli 44:46

What's the dumbest question you've asked? I can remember starting out not knowing what tracking error was – that was probably my dumbest moment, trying to figure out tracking error. I still don't know that the answer is particularly useful, but–

John Coombe 45:05

I asked a bond manager about convexity once – clearly didn't know what I was talking about, even though I'd managed bonds myself, which is funny in hindsight. But no, I just think a consultant should have a view, while realising their view isn't necessarily right – it's just a view. There's nothing right or wrong in investments, really; you've got a view, someone else has a view, and you can use that to question them and gauge the strength of their conviction and knowledge. I used to ask people about Wesfarmers all the time – they were our first client, and I got to know them really well. I even bought shares in it, because I thought they were the smartest people around. I'd go along to fund managers and ask them about Wesfarmers, and it was clear I knew more about the company than the people I was paying to manage the money, because they clearly had no idea what management was doing inside it. That, to me, was a real knowledge point. We also worked for Mayne Nickless, and I remember the company secretary at the time – I won't name him – telling me something that made it clear the company was in trouble. I'd go and talk to friends in the funds management world, and they'd say, "Oh, it's a wonderful company, going fantastically." Three months later, it profit-warned, but everyone still loved them. So sometimes you get insight through your contacts – you can't obviously go and share that, but you can use it to test people's knowledge about things.

Daniel Grioli 47:01

Okay, talking about fund managers – do ex-fund managers make good consultants, or is it a different skill set?

John Coombe 47:10

Consulting is a really funny art, because you come up with ideas, you listen to a whole lot of people, then you have to put it into two words on a piece of paper, hand it to somebody else, and debate whether you're right or wrong about the future.

Daniel Grioli 47:30

Because you're not really doing anything other than offering opinions, are you?

John Coombe 47:33

Correct, at the end of the day. That's why I worry about people who are so sure of themselves that they think they actually know what's going to happen. We're in the game of looking into the future and making educated guesses about what might happen, then building portfolios that can hopefully survive through those scenarios – but you really don't know which scenario will play out, you have no idea. I can paint you a picture of doom and gloom, and I can paint you a picture of rosiness – it's all in the delivery.

Daniel Grioli 48:16

I think that's a really important point about making educated guesses – you see it in lots of different ways in investing. A stock manager might get less than half their picks right and still make a lot of money, because the ones they got right, they backed heavily.

John Coombe 48:35

Sure. There's a value manager I asked this question of: their hit rate on the first dollar they put into a position was less than 50 per cent. Their hit rate on the second dollar was 52 per cent. Their hit rate on the third dollar – in other words, when they were doubling down – was 75 per cent. So you think you got it right when you put your first dollar in, you still think you're right when you add to it, but you only get really brave on the third dollar, when you're more confident. Generally, if you're right, that's the position you make the most out of. Really interesting studies.

Daniel Grioli 49:19

Yeah, I've seen similar dynamics with growth managers. There's a tiger cub I'm thinking of whose hit rate on stocks is less than 40 per cent, and yet the alpha has been phenomenal, because where he's backed something with a larger position, his hit rate has been much higher.

John Coombe 49:39

I'd bet he starts slow, and as his conviction builds, he puts more and more in.

Daniel Grioli 49:47

You're probably right. So my question is: if so much of investing is about testing educated guesses, how do you make that easier to do in a highly regulated, bureaucratic, committee-based, consensus-driven environment like super? To me, all of those things almost get in the way of forming and testing hypotheses. So how do you manage the tension between the two?

John Coombe 50:17

By admitting that you don't know everything – and I learned this from John early on – sometimes you give way on the little things that really don't matter. It's like, "They might be right, I might be right, I'm not going to fight over this – you can have that one." But, a bit like Jeremy and his – what does he call them – his points–

Daniel Grioli 50:53

His blue chips.

John Coombe 50:55

It's like career points. You don't want to throw them all on the line – keep a little bit back for the big day, when you really want to take a big swing and convince people to buy the best manager in the worst part of the market, because that's when you'll make a lot of money. But you're going to need career points to get there, so give up on the things that don't make any difference at the end of the day – the 1 per cent manager that doesn't change anything – but on the big one, be ready to stand up and fight hard.

Daniel Grioli 51:39

Okay, so those moments only come along–

John Coombe 51:42

–every now and again.

Daniel Grioli 51:44

So it's a bit like Warren Buffett's punch card – you've got about ten career calls, and if you thought of it that way, you'd be much more careful about making sure that you–

John Coombe 51:55

Well, it's like today – at JANA, we probably haven't changed our asset allocation views for nearly three years, and you could say, "Aren't you being weak?" But the reality is we've been in this hiatus of easy money for nearly ten or fifteen years, and basically you're punting against the Reserve Banks of the world. The regime's starting to change, but it's still easy money wherever you look. So it's right to be cautious about taking big asset allocation calls – sometimes. Other times, no – you've got to stand up for your convictions and hit the table – but that's not very often.

Daniel Grioli 52:44

So how do you learn when to play it safe and when to swing the bat? Is that just experience – getting belted up a few times?

John Coombe 52:54

Having a few chairmen phone you up and say, "John, that didn't go so well today." Look, it's an art – it's relationship management, and you have to be careful not to kill the relationship by being dogmatic about something where you might have a nine-out-of-ten chance of being right, but you might still be wrong. So, humility.

Daniel Grioli 53:31

I think there's some great advice there. So, you've been privileged to meet some of the best fund managers around the world.

John Coombe 53:41

Yep – one of the great highlights of my life, actually.

Daniel Grioli 53:45

I'm glad to hear you say that. So you're the perfect person to ask: what makes a good fund manager? What are the common traits, and on the flip side, what are the red flags that mean you're out of there as soon as you see them?

John Coombe 54:04

It isn't humility, interestingly enough. The really great fund managers I've come across have an investment philosophy they truly believe in, live by, and are 100 per cent wedded to. It can be growth, value, or quality – but they have a philosophy. At the end of the day – my colleagues hate me saying this – I think 90 per cent of returns are driven by a fund manager's investment philosophy, and about 10 per cent comes from their skill at picking the better stocks within that philosophy.

Daniel Grioli 54:52

I agree – it's markets that pick managers, not the other way around.

John Coombe 54:56

Yeah, but it's the conviction in the manager to stay the course. The other thing is they've generally been successful somewhere before – school, sport, or otherwise – and have this desire to win. They know what winning feels like, and they want to have that high again. A bit like a runner who keeps running marathons for the adrenaline – they know what winning is like, they like it, and they keep wanting more of it.

Daniel Grioli 55:30

Okay, and on the negative side?

John Coombe 55:32

This is probably one of the reasons Australian fund managers aren't too bad against the rest of the world – Australians are actually very competitive. But I'll be honest: the worst ones I've come across have come out of broking. They know how to sell a story, but they're not investors in any real sense – they moved to the buy side because they got sick of the sell side, but they listen too much, and they're not great investors. The other red flag is a bit of hubris. I remember walking out of one fund manager meeting – he'd told me he and his team were the smartest people in the world and worked the hardest, and I said, "How do you know that? I've been a consultant for 20 years – tell me how you know you work the hardest." You should have seen him trying to bluster his way around it. We see straight through that now – they have no idea.

Daniel Grioli 56:45

It's funny you say that – it never ceases to surprise me how little fund managers really know about their competition.

John Coombe 56:55

No, I was–

Daniel Grioli 56:56

–constantly amazed at that, and it's worse–

John Coombe 56:58

–when you go into the big financial centres, like New York and London. I'm amazed in London – it's not that big an area, let's be honest.

Daniel Grioli 57:10

A square mile, or thereabouts.

John Coombe 57:11

Yeah, but it's pretty concentrated. You go and ask a fund manager in London who their competitor is, and they don't know.

Daniel Grioli 57:24

You'd think they'd be running into them–

John Coombe 57:25

–around the corner.

Daniel Grioli 57:26

Oh, you'd think they'd be running into them at AGMs, seeing each other on the register, or at least looking at who else is on it.

John Coombe 57:32

No, it's funny – they just don't care, and they focus on their own business.

Speaker 3 57:37

Which is–

John Coombe 57:38

–I don't really understand that.

Daniel Grioli 57:40

It's the ultimate irony – their business is to be students of business, and if they're not applying their skills to their own business, in their own industry, what are they doing? I do laugh–

John Coombe 57:51

–at fund managers who tell me how they've advised company management on how to run their businesses, and I'm thinking, "Boys, you don't know how to run your own business – telling someone else how to run theirs, I'd have a little more humility." But honestly, fund managers generally aren't great at running their own businesses. I quite like the ones who know that and hire a business manager, or have an equity partner who handles all of that, because most of them are good at the investing side.

Daniel Grioli 58:26

That's an interesting observation. So, in terms of funds management, it seems to be becoming more and more quantitative. Do you think that's a good or a bad thing?

John Coombe 58:42

I actually think it's been this way for a long time, and a lot of people haven't noticed – screening by style and other quantitative techniques have been going on for at least 20-odd years, so the fact that it's now gone the whole hog and taken analysts out of the loop doesn't mean it's any bigger overall. Ian Patrick was the one who pointed this out to me, and I should have listened to him harder: around 2007–2008, there was a hell of a lot of money in hedge fund land being run on simple quant strategies, particularly in Asia. It had all built up over the prior three or four years – long-short, Asian equities, Aussie equities, a bit of global – and the number of people doing it had exploded, as had the dollars behind it. Even the internal prop desks were running quantitative processes. So I'd argue it was bigger then than today. The biggest phenomenon today is passive–

Daniel Grioli 1:00:37

–smart beta as well?

John Coombe 1:00:39

Well, not really–

Daniel Grioli 1:00:42

–not big by size, but it's growing.

John Coombe 1:00:44

Yeah, and there are a lot of techniques being used – long-short, alt-beta, and so on. Don't get me wrong, but I don't think it's as big, in aggregate, as it probably was back in '07/'08. We actually took our medicine and got out of nearly all our quant exposure around 2008/2009, because I felt the regime was wrong for quantitative techniques at that point – too much volatility in style rotation. We didn't really get back into quant until 2011. So quant isn't a process that works all the time, in my view – it works most of the time, but it can get crowded, and value signals are classic signals; if value's getting hurt, your quant strategies will get hurt too, because–

Daniel Grioli 1:01:52

–the Fed has its hand on the scale?

John Coombe 1:01:54

Well, quant always gets hurt when value and quality get hurt, because that's the backbone of probably half the strategies out there.

Daniel Grioli 1:02:07

Do performance fees ever make sense for clients? They're great for managers, but–

John Coombe 1:02:19

I've worked with a fund that wouldn't hire a manager unless they had a performance fee – at one stage, 80 per cent of all their equity and bond managers were on performance fees. They thought it incentivised better outcomes. I don't think it changed the outcome at all – I don't think a manager tries harder just because of a performance fee than they would running a standard fee structure. That's talking about long-only managers. In the hedge fund world, I think performance fees drive everything, but I think they're structured wrong – performance fees calculated off a cash benchmark just–

Daniel Grioli 1:03:14

–are totally wrong, because it's a benchmark that doesn't reflect the risk.

John Coombe 1:03:18

It just feels wrong – it feels like a transfer of wealth that, in hindsight, history will look back on as one of the greatest transfers of wealth from the people who had it to the people who wanted it, without giving much back in return. I'm not talking about performance fees for a private equity manager doing returns in the high teens or low twenties – that feels fair. I remember at the SEC, when I first started in super, we hired some of those "baby tiger" managers you mentioned earlier, because Collins had introduced us. I remember – and this is my memory – back in 1986, we wrote out a $21 million cheque to one of those tiger managers, and the trustee board hated it so much that we sacked the manager the following year. It's terrible, but–

Daniel Grioli 1:04:24

–it stuck in their throat?

John Coombe 1:04:24

It stuck in their throat – they couldn't stomach it. I think it was a 20 per cent take, so he'd made $120 million for us and we paid $20 million in fees, but they couldn't stomach paying the 20. It's funny, isn't it?

Daniel Grioli 1:04:41

It's a very behavioural thing. Some of our listeners are fund managers – what tips can you give them before they talk to you again?

Speaker 3 1:04:51

I don't know.

Daniel Grioli 1:04:53

I would–

John Coombe 1:04:54

–come with a good business case. Don't walk in with a wish list – you need to know certain things before you present how you're going to operate. What does my capital structure look like? What's my investment philosophy? In which markets am I going to make money, and in which am I going to struggle? How much do I need to break even? What does my team look like if I'm successful? You'd be surprised how many people, when you ask that question, have no idea. You might operate in the early days on the smell of an oily rag, but if you're successful as a fund management business, you're going to need more people, and that should be built into your plan. How long can I last before it really hurts, if I'm funding it myself? How long is my funding partner going to stay with me? Those fundamental questions have to be answerable – maybe not in the first meeting, but definitely by the second. The first time, you might ask me a few questions about what you should do. The second time, you'd better have answered those questions and come in with a business plan, because you can't walk into Ian Patrick at Sunsuper and say, "Look, Ian, back me – I've got no backers, I don't really know what I'm doing, I just want to do this." You've got to go into a big fund like Sunsuper, or REST, or anyone like that, with a plan for how you're going to make their members better off. You've got to have a value proposition.

Daniel Grioli 1:06:47

How often would you see managers come in with a half-baked business plan?

John Coombe 1:06:51

It depends whether it's the first meeting or the second. Usually, by the second, they've got it worked out – the first might be a bit iffy. We're in a privileged position, because, as you mentioned earlier, we've backed a number of firms over the years, and a lot of young people who want to start up come and ask for a bit of advice. I give it for free these days, so they don't have to buy me a coffee anymore, which is good – I'll let them off the hook. But yes, you've got to understand what the business will look like in its growth phase and its mature phase. It's interesting – people generally know what the growth phase looks like and how hard it might be, but they haven't necessarily worked out the economics of the mature phase. The backers of boutiques are sometimes in a similar boat. Some have got it right now, but in the old days, the backer would take a cut all the way through, and when the manager becomes really successful, that cut becomes a big number, and the people running the money don't like it.

Daniel Grioli 1:08:10

Yeah.

John Coombe 1:08:10

So there has to be a recognition of what a mature business looks like, as opposed to a growing one.

Daniel Grioli 1:08:16

That's a really good point. If things go badly, the backers have generally risked money they could afford to lose, but the person – or people – having a go have lost a lot more, because it's all tied up in their–

John Coombe 1:08:30

–career, for a very long period.

Daniel Grioli 1:08:33

So they're the ones really taking the risk. But as you say, the arguments happen when things go right, because that's when everybody's unhappy about their respective slice of the pie.

John Coombe 1:08:43

Yeah, no, it's a real issue.

Daniel Grioli 1:08:46

You touched on this early in our conversation, and I wanted to come back to it in more detail. JANA started out as a privately owned firm, then became part of a much larger public company, and now it's a private firm again.

John Coombe 1:09:01

Part-private.

Daniel Grioli 1:09:02

Part-private. So some of your competitors are divisions of public companies, and some are owned by their clients. Do you think the business model of a consultant matters?

John Coombe 1:09:15

I do, though I'll hedge my bets here. If I were running a big multinational – and we all know who those firms are – I'd want to be part of a big organisation, because I'd be going into markets where I'd need some financial backing, since I might be in those markets for three or four years not making any money – in fact, losing money, because I've hired people. I've seen my contemporaries in places like Hong Kong, Seoul, and Japan go five years without coming close to break-even. So if you're really global, you do need to be part of a big organisation with deep pockets. And let's be honest, the big firms nowadays are part-owned by insurance companies, fund managers, or life companies – those owners have deep pockets.

Daniel Grioli 1:10:30

But their consulting arm is generally a rounding error on the parent company's revenues, and not–

John Coombe 1:10:36

–necessarily, not if they're into the outsourced-CIO model. Having just–

Daniel Grioli 1:10:44

So then in the US–

John Coombe 1:10:47

If you think the UK has done it, it's nothing compared to what's happening in the US, where you've got small government funds outsourcing the CIO function, and it's not just the consulting firms – it's Vanguard, Morgan Stanley, Goldman Sachs, everyone's in the game. It's a very, very competitive space.

Daniel Grioli 1:11:11

Is that going to happen here in Australia?

John Coombe 1:11:13

No, I don't think so. Well, it sort of already has – that's what's been called the exodus of corporate super, left, right, and centre. It happened. No, I think we're in a consolidation phase here. My answer is, it depends on how big you want to be. If you want to stay in your own market and just be excellent at what you do within your own hemisphere, you can probably get away with employee ownership, and that's probably the best model, because you get buy-in from all the senior consultants. But then there's always the point of changeover from one generation to the next, and whether you've got that right – whether the next generation is building up equity over time as they become more important in the business, so that, in the end, you can take the senior consultants out in an orderly fashion rather than causing a corporate event. When you look overseas, whether at fund managers or consultants, that's generally what's happened: one generation hasn't filtered the equity down to the next.

Daniel Grioli 1:12:32

Hasn't filtered it down?

John Coombe 1:12:34

Hasn't filtered the equity down over time, so they end up as massive equity-holders who need a corporate event to extract their wealth, because the people underneath can't afford to buy them out.

Daniel Grioli 1:12:46

Okay.

John Coombe 1:12:47

So it depends what you want to be. If you want to be the biggest consultant in the world, you'd better have somebody with a big chequebook behind you.

Daniel Grioli 1:12:56

In terms of consultants, there used to be four main ones in Australia institutionally – a lot of smaller ones too, but–

John Coombe 1:13:04

In the 1990s, there were 20.

Daniel Grioli 1:13:06

There were 20. Now you could argue there are almost only two of any real size – we won't say who they are. But whether it's two, four, or some other number, is the market getting too concentrated? Is there enough diversity of views?

John Coombe 1:13:23

No, it's nowhere near that concentrated. I'd argue there are 20 consulting firms today if you count the 15 or so sitting inside funds like AustralianSuper, Sunsuper, etc.

Daniel Grioli 1:13:43

Because people are internalising the function?

John Coombe 1:13:44

Yeah, they've internalised part of the consulting function. So it's not just the four or five of us – we're an add-on to internal teams now, helping them and providing breadth, while they provide the depth. So I don't think there's only four – I think there's something like 15, once you count the internalised teams.

Daniel Grioli 1:14:15

That's an interesting take on the concentration issue. So, moving on to the home stretch, I have a couple of quick questions–

John Coombe 1:14:24

–make it hard? I've got five seconds to answer each one?

Daniel Grioli 1:14:31

You can take longer than five seconds, but I'd like to finish on a note where we have some practical tips for institutional investors, whether they're your clients or other institutions. What are some common mistakes you see institutions making that they should avoid?

John Coombe 1:14:53

I think the sole purpose test is a wonderful one – don't get distracted by all the other things around super. Concentrate on delivering member returns. You can get a little distracted at times by the peripheral stuff.

Daniel Grioli 1:15:16

I think that's good advice. Most institutional balanced funds target CPI plus 4–5 per cent. Is that realistically achievable, and if so, what can funds do to achieve it?

John Coombe 1:15:31

It's more like three to three-and-a-half for a balanced fund, near enough, but it's achievable on average – though we don't need any big mistakes along the way. Look, the margin over inflation we're going to achieve over the next decade is going to be lower than what we achieved over the last ten years, because of where we're starting from. If we'd had this conversation in 1998, I'd have said the returns out of a super fund over the next decade were going to be lower than the decade before, because of the starting point – and I agree with Jeremy here, the starting point is vitally important to what you can expect over the next decade. We're starting relatively expensive, in a historical context. If we stay expensive over the ten years, we'll probably get a balanced return of CPI plus three. But if we go from expensive to cheap, the next decade could be quite difficult, because we're starting from an expensive point.

Daniel Grioli 1:16:54

Okay, and how can they achieve it?

John Coombe 1:16:54

I wasn't a great believer in private equity in the old days – I was a bit sceptical – but when you look at what our funds have been able to achieve owning businesses in the infrastructure space, and I'd add owning property in the property space, if you do private equity well – doing a lot of co-investments and things like that – I think owning businesses, owning the capital structure, and controlling how and when you allocate capital across it puts you in control. If you really do that well, there's a lot of money to be made.

Daniel Grioli 1:17:42

Aren't you worried those businesses are getting more expensive than public equities, with a lot of money chasing them?

John Coombe 1:17:48

Yes, of course. But if you own a great business, with good management that you've incentivised properly, the fact that you control when to put more capital in to help it expand, and when to draw out your dividends – you're in control. And if you do it really well, I do think these are wonderful ways to generate wealth.

Daniel Grioli 1:18:19

Okay, so what would you say are the biggest challenges facing institutional investors at the moment?

John Coombe 1:18:26

Getting set into the assets we just talked about, because you're right, a lot of people have reached the same conclusion I've just articulated, and a lot of them are trying to get into that space. Many of them are saying, "For the next decade or so, we're in a growth phase, and after that, a mature phase," so in the growth phase they're getting set into these businesses and paying up to do it. Only time will tell whether they've paid too much – it'd be lovely if you could buy these wonderful businesses at half of what we have to pay today, but we're in a competitive space. The one warning I'd give everyone is that the world has much more savings today than it has ever had historically. Look at China – you took 500 million people out of poverty and turned them into capitalist savings machines. They're looking for investments, looking for places to put their money – as are hundreds of millions of other people – and that doesn't even account for all the extra wealth the average Australian, the average person in the UK, or the average American has generated. Every one of those people is looking for somewhere to put their money to generate a real rate of return. We're in a world full of money looking for investment returns.

Daniel Grioli 1:20:07

Okay, final question: what are three things institutions can do to improve their investment decision-making?

John Coombe 1:20:16

We talked about philosophy before – be very clear about what your investment philosophy is. It will serve you in all circumstances. If you have a belief system, it will stand you in good stead going into the future. You won't get everything right, but you'll have a story to tell your members: "We're managing the money this way, for these reasons." As long as you're disciplined about that, you will win in the longer term, whether your philosophy is growth or value. You win in the end if you're disciplined. It's the ones who waver between what they believe one minute and the next that get into trouble.

Daniel Grioli 1:21:02

Okay, John, it's been an absolute pleasure having you on the podcast. Hopefully we can have you back as a guest in the future.

John Coombe 1:21:10

Thank you, Daniel. All the best.