Unisuper’s Westfield battle a sign of things to come

The recent dispute between Unisuper, other investors, and Westfield over the restructuring of Westfield Retail Trust (WRT) as “Scentre” provides a great case study of the changing investment priorities of Australia’s super funds.

Notwithstanding that the proposal ultimately succeeded, it failed on the first attempt to get 75% approval due to the opposition of a group of large and small investors, including Unisuper.  That is not an experience Westfield is used to.  The various Westfield entities have been restructured on several occasions in the past decade or so, and the Lowy family is used to getting its way.  So what was different this time?

It’s a complicated transaction with some simple themes:

– WRT was a relatively simple vehicle – it owned prime shopping centres and collected rents.  It yielded ~6%, which had grown annually since inception, with low gearing.  Boring, but an effective and low risk income producer. 

– Scentre was the proposed end state of merging WRT with Westfield Group’s other interests in Australian shopping centres (mostly part-interests in centres already owned with WRT), and crucially, WRT buying the management rights for the portfolio from Westfield Group. 

– Relative to WRT, Scentre was a different investment, going from a landlord collecting rents, to a landlord plus property manager plus property developer – with much higher levels of gearing.  This combination is seen in offshore property vehicles, so it’s not so much a question of whether it made sense in its own right, but it represented a material change in the nature of the investment. 

Most of the public debate centred on the (perceived to be high) price for the management rights that Westfield Group expected WRT unitholders to pay.  Unisuper was not supportive of the price, but their argument against the restructure, which can be found here, is considerably more than this alone.  For us, the interesting part relates to the objections to changing the nature of the investment.

As an aside, it would be fair to say that if a mandated manager in an institutional portfolio (of real estate assets or anything else for that matter) unilaterally changed the nature of the mandate in a material way, their mandate would likely be short-lived.

The core of the Unisuper argument goes like this:

– We were perfectly happy with the WRT investment profile – 6%+ yield, growing yield, low risk, low gearing.  

– Scentre may offer higher growth (though uncertain til delivered), but it comes at a price, higher gearing, and higher risk (all of which are certain).

– Our members do not value that new trade-off. 

And that’s the bit that’s really interesting – the proposition that fund members do not value adding capital growth potential (with an associated increase in risk) to an existing attractive yield return profile.  In other words, income streams such as WRT are rare and valuable, so don’t mess with them, even if there is upside.

This is something we have noted in the past few years via the Tria Australian CIO Study – an annual in-depth interview program with a broad sample of CIOs of major Australian institutions.  While theory suggests that investors should be indifferent to whether they receive returns as income or capital gains, this does not seem the case in practice. Arguably individual investors have always expressed a preference for income, and we have also seen increasing incidence of CIOs expressing a preference for the certainty offered by low volatility income streams.

This is most evident in super fund pension divisions, the fastest growing part of the system. Funds increasingly manage their pension divisions differently to their accumulation divisions – partly due to the tax exempt environment, but just as often with an income focused portfolio to provide a closer match to pensioner income payments.

It’s not just a pension division phenomenon.  Some CIOs have reflected on the experience of their funds through the financial crisis and concluded that a lower volatility profile is equally desirable in their accumulation divisions, which also favours investments with an income flavour.

With the minimum payment from an allocated pension account being 4%, the more typical payment being ~6%, and Australian government bond yields at 3-3.5%, any investment offering a reliable, low risk yield significantly north of that range is highly appealing.  Super funds will want to load up on it, and they won’t appreciate it being tinkered with once acquired.  Expect more flexing of muscles by super funds to protect and enforce the return profile their members increasingly want to see.