“The APRA findings highlight the challenge in the retail sector to demonstrate scale advantages rather than see superannuation just as an opportunity to generate profits,” Dunnin says.
Watching for exceptions
Warren Chant, principal of superannuation consultants Chant West, argues that scale is just one of a number of factors that contribute to performance differentials between funds. “Scale has allowed funds to deliver superior performance over the longer term. Large funds, however, do not always outperform small funds. A fund’s decision regarding where to invest is also important,” he says.
Chant attributes the long-term outperformance of industry funds over retail funds to industry funds being more prepared to invest in unlisted assets (including alternative assets such as private equity, infrastructure and hedge funds) as well as more actively managing their asset allocation positions. The reason why industry funds are able to invest more in unlisted assets is not to do with scale but because of their more stable memberships and relatively stronger cash flows than retail funds.
Industry fund net contributions represent about 10% of their average net assets, compared with 5% for retail funds. Industry fund inflows are also more stable, with more than 80% coming from compulsory Superannuation Guarantee contributions, compared with about 50% for retail funds.
This helps, in part, to explain why more people don’t move from retail funds to industry funds, even though industry funds are better structured to continue to outperform retail funds.
Liu says there are two main reasons why members of under-performing funds are unlikely to move en masse. The first is due to the lack of member engagement. The mandatory nature of Australian superannuation and the increasingly complex retirement savings system implies that many people have limited willingness and knowledge to comprehend and engage with the superannuation system.
“In short, people often don’t care or they have inadequate levels of financial literacy to compare funds and to make sensible and informed decisions of where else to invest,” says Liu.
Most people do not make active decisions and stick to the default nominated by their employers, even though they are presented with a large number of choices – for example, choice of fund and investment options. Others, who are willing to engage but unable to choose, often rely on someone else, such as a financial adviser, to make decisions on their behalf. The lack of member engagement and heavy reliance on financial intermediaries highlights the deficiency of consumer-driven competition in superannuation.
Liu says the second reason people continue to pour money into under-performing funds, particularly in the retail sector, is due to the supply-driven competition with funds competing to capture distribution networks of financial advisers via incentives. Commission-based incentives motivate advisers to recommend particular products whether or not they are in the best interests of members. The presence of conflicts of interest in financial advice and the lack of capacity for ordinary people to determine the quality of financial advice further contribute to the system’s inefficiency.
Industry reforms
Up until the introduction of Future of Financial Advice reforms and the banning of commission-based advice, most people who sought advice were more likely to be directed towards a comparatively more expensive retail fund.
A 2007 Rainmaker Information study found that not one of the top 30 financial planning groups had included an industry fund on their “approved product” lists – that is, the set of funds they were authorised to recommend to clients.
“Both reasons tell you the system is inefficient, which drives many of the Cooper Review recommendations, including the introduction of MySuper,” says Liu, who is referring to the Super System Review panel chaired by Jeremy Cooper that in 2010 proposed the establishment of no-frills MySuper products by all funds that want to be a default fund nominated by an employer.
Legislation pertaining to MySuper passed through federal parliament last month, establishing a minimum standard for default superannuation investment options. Pauline Vamos, chief executive of the Association of Superannuation Funds of Australia, likens the standard to the “heart tick on food”, and says MySuper offers Australian workers a super account with defined fees, no commissions and a highly transparent investment approach.
“All ingredients must be disclosed and products must meet certain standards and be authorised by APRA,” Vamos says.
While MySuper should help those super-fund members who are disengaged from their retirement savings, or who don’t want to make investment decisions, the onus should always be on fund trustees to generate decent returns for members regardless of scale.
Mergers that centre on the idea of saving costs need also to be mindful that the real goal should always be returns. After all, members cannot retire on a cheap administration fee alone. But they can retire on a sizeable lump sum that was accumulated because of good net returns.
