New ISN research shows retail funds failing consumers

Australians collectively hold more than $1.3 trillion in superannuation savings. However, new research by ISN shows that while not-for-profit funds are delivering returns above basic market rates, the for-profit sector is seriously underperforming. This needs to be addressed to restore confidence in the system, says ISN’s Chief Economist, Sacha Vidler.

In September, Industry Super Network (ISN) released new research that reveals Australia’s not-for-profit superannuation funds have, on average, significantly outperformed retail superannuation funds over the 14-year period June 1996 – June 2010. The research also found that while not-for-profit funds provided better returns than the risk-free cash rate and a diversified investment strategy, the retail sector in general failed to even achieve the cash rate of return (after adjusting for tax and administration costs).

The research paper, entitled A comparison of long term superannuation investment performance, was written by ISN’s Chief Economist, Sacha Vidler. The research is based on official APRA data.

“This paper examines in detail the long term performance of our super funds to see whether they are up to scratch – and whether they are delivering on our super system’s promise of a markedly better retirement for all Australians,” says Sacha.

“The analysis shows that some of the biggest household names in super are failing their members – providing substandard returns that are less than cash and with high volatility. If retail funds had not underperformed over the past 14 years, Australians’ super nest eggs would be $83 billion higher than they actually are now.”

Key findings of the report include:

• retail funds have on the whole underperformed cash (a risk-free investment) even after making suitable deductions for administration and earnings tax
• the internal rate of return to investors in retail superannuation funds lagged the not-for-profit funds by 2-3% per annum
• if retail funds had earned industry fund returns, retail fund member assets would have grown to $426 billion by June 2010, instead of the $343 billion actually achieved
• not-for-profit fund members benefit from economies of scale – both in terms of fund size and average account size – but retail fund members do not typically receive any benefit from increased scale; and finally
• over the 14 year period, asset allocation has been a significant driver of net returns, with an allocation to major unlisted asset classes having a positive effect on returns on average and an allocation to foreign assets and foreign currencies having a powerful negative effect on returns.

David Whiteley, Chief Executive, ISN, said the research is unequivocal evidence that retail superannuation funds are not measuring up to their not-for-profit counterparts.

“This research shows that the Australian retail superannuation sector is yielding for the most part unacceptably poor returns to its members. It is extraordinary that the practices of major retail super funds over a long period of time have reduced the returns of their members to the point where their super would be better invested in the bank.”

Assessing long term investment performance

The research compares the long term investment performance of the four key APRA regulated sectors – corporate, industry, public sector, and for profit retail funds – to each other, and to suitable benchmarks.

Over the 14 financial years from June 1996 – June 2010 (including two significant market downturns), APRA-regulated funds provided returns averaging 5.01%. But there were substantial differences between the different fund sectors:

• corporate funds returned on average 5.84% per annum
• industry funds returned on average 5.35% per annum
• public sector funds returned on average 6.30% per annum
• retail funds returned on average 3.66% per annum.

The average cash rate of return over this period was 4.23% per annum.

An analysis of volatility in annual returns by sector found that there was very little difference between sectors on this basis. The superannuation sectors had broadly similar volatility, further highlighting the very wide differences in average returns, says Sacha.

The research also investigated the impact of profit-orientation, scale and account balance on superannuation returns. The results confirm previous research that profit orientation is the prime determinant of returns.

“Either economies of scale are not available to retail funds – or, much more plausibly, retail funds do achieve economies of scale but the benefits go to shareholders and other stakeholders, as opposed to members,” comments Sacha. “This is compounded by the fact that retail funds are paying 2.6 times the market rate to outsourced entities.”

With the research finding marked differences in fund performance between the not-for-profit and for-profit sectors, the question must be raised as to how Australians’ retirement savings can be protected from significant underperformance by the retail sector, says Sacha.

“More than half of Australian superannuation accounts are in retail funds. Given the outcomes of this research, it will be important to act urgently to ensure that Australians’ retirement savings are not eroded by poor performance and inflated fees in the retail sector over the next 14 years, as they have been over the last 14 years, especially with the Government’s proposed increase in the Superannuation Guarantee in the pipeline.”

The full report is available here.

For more information about the report, contact Sacha Vidler: svidler@industrysuper.com

Report: A comparison of long term superannuation investment performance

Industry Super Network has released a new report -  A comparison of long term superannuation investment performance, that compares the average performance of for profit and not-for-profit superannuation sectors over a 14-year period, using published APRA data.

The report finds that retail super funds do not typically pass on benefits of scale to their members and pay above market rates for in-house services. As a result, retail super returns to their members have lagged not-for-profit funds by an average of nearly two per cent per annum, reducing super savings by thousands and national savings by tens of billions.

Click here to read the report.

Market volatility raises question of longevity risk

The recent volatility seen in global stockmarkets raises one important issue that Australia has overlooked, says ISN’s Chief Economist Sacha Vidler – How to effectively manage longevity risk in our superannuation savings system.

In recent weeks, measures of stock market volatility have hit peaks seen previously only in the midst of the global financial crisis. Very few of us gain from the gut-wrenching swings that such volatility brings, but (surprisingly) some do.

Once again, revenues are roaring for online stockbrokers (who had been lamenting the relative stability of global markets in the last few months of the 2011 financial year), because while prices have dropped, trading volumes have soared to terrific levels.

Another tiny group who thrive in tumultuous times are the economic commentariat who gain a captive audience – of retirement savers, mortgaged families and underemployed youth – for their ruminations about the workings of capital markets beyond anyone’s control, and seemingly even the experts’ understanding.

This time around, the commentariat even became the story as debate (politely) raged over whether Westpac’s Bill Evans was ahead of the pack or lost in the wilderness for predicting an imminent downturn in economic activity – and therefore interest rates.

But then, we economists can’t not write about it, can we?

Managing longevity risk

Increased market volatility highlights important issues in superannuation policy – notably, the one area of superannuation policy untouched by the suite of reviews currently drawing to a conclusion: the retirement phase.

Ripoll, Henry and Cooper have looked at financial advice, contributions, tax, data standards, e-commerce, multiple accounts and default funds, but not the retirement phase – and particularly the question of whether retirees currently face excessive investment and longevity risk.

Investment risks – already top of mind due to market volatility – have been put in the spotlight by a prominent industry identity, former Future Fund CEO Paul Costello, who questioned the appropriateness for retirees of the Australian asset allocation model with its high allocation to growth assets.

Longevity risk is the risk of outliving your money, and is clearly important as the population continues to age. There is an important gender dimension to longevity risks, because women on average live longer and have less super savings with which to generate retirement income.

Longevity risk is addressed through provision of income for life (and the life of the spouse).  For most Australians, the only coverage for longevity risk is from the public Age Pension. Individuals who hope for a higher standard of living than that provided by the public pension bear the remainder of that risk.

There is no policy incentive (such as more generous tax or pension means-test treatment) for retirees to invest in income products which manage investment or longevity risks, even though there is a case for a public interest in a sharing of this risk between the state and the individual.  And current regulations mean that longevity risk products such as traditional life annuities can only be offered by a Life Office, not your superannuation fund, with investment and accounting rules ensuring very low effective rates of return.

Traditional life annuities also have other disadvantages, including that the pricing is set at the moment of purchase, with some retirees doing far better than others out of this instant capital crystallisation.

ISN is currently researching a product offered in several jurisdictions overseas in which fund members would bear investment and longevity risks – but collectively rather than individually.  Assets held include some growth assets, though typically at less than 50 per cent, and investment returns are smoothed over time according to objective and transparent rules.

Payments are made for life at a level influenced by the mortality of the pool of members.  There usually isn’t explicitly indexation in such products but inclusion of some risky assets will tend to provide a natural hedge against inflation.
We will also be looking at the policy obstacles, if any, to the introduction of such a product in Australia.

The Australian superannuation system is something to be proud of, but it is a notable oversight that none of the powerful tools that shape the system in the accumulation phase – mandates, incentives and defaults – are employed in the retirement phase. In time, this will need to be addressed.

For further information, contact Sacha Vidler at svidler@industrysuper.com

Unlisted assets key to investment performance

While infrastructure and other unlisted asset classes are hot button issues on the economic agenda, they have also played a significant role in the superior investment performance of many industry funds.

Debate about improving Australia’s infrastructure is a feature of everything from discussions about the mining boom to promises by the newly elected Victorian and NSW Government for improved transport services. Although this reflects the importance of infrastructure in the ongoing growth of the Australian economy, it is also a clue to the important role these investments are playing in boosting the retirement savings of working Australians.

Investments in unlisted property and infrastructure assets have been a key element contributing to the excellent investment performance of many industry super funds in recent years. Industry super funds often have significantly higher allocations to unlisted assets than their retail fund counterparts. Data on ‘growth funds’ from research firm Chant West for 2009 indicates retail funds only allocated 9% of their portfolio to unlisted assets while industry funds allocated 28%.

This different approach to asset allocation has proved to be a vital performance differentiator for industry super funds as unlisted assets have both outperformed most other asset classes and also been less volatile, according to Industry Super Network (ISN) Chief Economist, Dr Sacha Vidler.

‘The outperformance and reduced volatility of unlisted assets has been an important source of competitive difference for industry funds and is a vital factor in their impressive investment performance,’ he says.

‘To date Industry SuperFunds have campaigned on low fees and charges and no commission payments. However, investment outperformance is also a major feature of funds and consideration should be given to such focus in the future.’ 

During the global financial crisis (GFC) unlisted property and unlisted infrastructure experienced a shorter and shallower downturn than the precipitous crash which occurred in listed markets.

This has had important implications in supporting the long-term investment returns received by industry super fund members and highlights the important role these assets play in the portfolio of industry super funds, Sacha explains.

For example, many funds have invested in unlisted assets via Industry Funds Management’s pooled funds and the manager has recorded an investment return of 12.48% (after tax and fees) per annum since 1995. The major Australian unlisted property index returned 9.4% per annum over the same period.

For more information about the unlisted investments of industry super funds contact Dr Sacha Vidler at svidler@industrysuper.com.

Taking the long view on ESG

Corporate disasters such as the phone hacking scandal engulfing News Limited and the BP oil spill in the Gulf of Mexico highlight why long-term institutional investors need to take an active interest in the governance and risk management processes within the companies in which they invest.

Super funds invest on behalf of fund members to generate solid, long-term investment returns and to minimise investment risk and financial loss. Given these goals, an increasing number of funds are coming to the view that active engagement with the large companies in which they are significant shareholders will form part of their approach to investment, according to Industry Super Network (ISN) Chief Economist, Dr Sacha Vidler. At the same time as they are considering active engagement, super funds are altering their overall approach to investment, he says.

Dr Vidler was speaking following his recent address to the SMSF World Australia 2011 Conference in Sydney on 21 June on ‘Wealth Creating and ESG Investing’. ‘The traditional view in the Australian listed equity market is active funds management pays for itself.  However, we are increasingly seeing some of the biggest super funds becoming more conscious of cost; partly by reducing the number of fund managers they use, and partly by an increased use of passive or index investment,’ Sacha explains.

ISN’s research suggests that the last decade of investment by super funds provides further support for the view that asset allocation (the weighting of competing asset classes) is the main determinant of investment returns, with asset selection (the weighting of assets within asset classes) being of lesser importance – particularly in listed asset classes.

One factor which over time will tend to drive greater engagement by super funds as shareholders is the high level of concentration in the Australian equities market.  The largest 20 stocks on the Australian share market account for over 50 per cent of total market capitalisation, and this group of course includes the big banks and miners. 

But despite the intense concentration of value in the share market, there are over a hundred Australian equities wholesale products being marketed to super funds.  These managers must be trading significant volumes of these assets between themselves; a tower of effort that may not appear that productive from the super fund member’s perspective.

‘As major investors, regardless of the funds managers they use, super funds can’t avoid being exposed to these large corporate entities, so it raises the question of how to best manage the inherent risk of being invested in such companies,’ Sacha says.

He expects the significant shareholdings in large Australian corporate companies held by super funds to drive them to increasingly focus on how the companies are managing the various risks they face.

‘Funds are only just beginning to think about these issues now, and the widespread commitment to the UN Principles for Responsible Investment (UNPRI) in Australia (and around the world) is one indicator of that.  However, if you look 10-15 years ahead, there is likely to be an increasing focus by super funds on how big companies are run, as this has significant implications for their own performance given they are major shareholders.’

This in turn is likely to encourage funds to work together to deal with this issue. ‘Economies of scale are very important in this area and a collective approach is essential. The Australian Council of Superannuation Investors (ACSI) is likely to be at the centre of this process as it requires specialist research which needs to be carefully co-ordinated with the trustees and fund managers,’ Sacha explains.

Interest in engaged shareholding is likely to increase as super funds and the industry itself mature. ‘The only way to manage the risks on behalf of members is to take an interest in this area. This should provide much better information, lower costs and better control for industry funds which participate,’ he says.

For more information about engaged shareholding and industry funds contact Dr Sacha Vidler at svidler@industrysuper.com.