Shadow treasurer Joe Hockey is promising Australia a sweeping inquiry into the financial sector, including the $1.3 trillion superannuation sector.
"There is a structural risk associated with superannuation because of its sheer scale over the next 10 to 15 years," Hockey recently told The Australian Financial Review. "There is going to be more money in superannuation and funds under management than there is in the banking system."
Commonwealth Bank CEO Ian Narev has also waded into the debate with his warning that the country’s big banks may not have enough money to lend — after announcing a $7 billion profit.
The architect of Labor’s superannuation reforms, Jeremy Cooper, has said regulators need to plan for superannuation savings to grow so big they become the fifth pillar of the banking system.
Against this backdrop, a report released last week by ASIC into "asset consultants", the gatekeepers of the financial system, makes for very interesting reading.
Asset consultants provide investment advice to wholesale clients, including superannuation funds. The ASIC review found the industry’s business model was conflicted, because asset managers are related parties who often recommend the products they also sell.
So among all the calls for a system-wide review, are we getting lost again in the political fluff?
The 2010 Super System Review, initiated by Labor and led by Cooper, highlighted one critical point — the industry entrusted with Australia’s savings seems to have forgotten its function: to optimise Australians’ retirement incomes.
Australia’s superannuation system is the envy of many countries around the world. Year after year Australians continue to pile 9 per cent of their earnings into superannuation. Treasury forecasts that increases in the superannuation levy to 12 per cent by 2019 will see savings double to $3 trillion by 2020 and increase to $5 trillion by 2030.
However, the banks and other participants are major beneficiaries of Australia’s compulsory superannuation system. "Wealth management" is a very lucrative business indeed; fees are levied on the dollar amount of assets under management. And assets under management are guaranteed to swell by 9 per cent a year, every year, unless fees or market movements erode them.
Unfortunately wealth management is often more lucrative for the wealth manager than for the investor, as wealth managers both under-deliver and over-charge.
This problem of underperformance is clearly illuminated by the 2011 SPIVA (Standard & Poors Indices versus active) scorecard ratings. Every year S&P releases a SPIVA report that tracks how well expensive active equity funds have performed against various Australian equity indexes (which comprise a standard list of companies) across a period of up to five years.
An active equity fund has an investment manager who actively selects individual stocks from indices with the goal of outperforming the average market or the index.
The 2011 SPIVA report highlights the problem: 70 per cent of actively managed funds have underperformed the Australian S&P200 index over a 5 year period. Investment managers’ records when it comes to international equities are as dismal, with 70 per cent of actively managed international funds failing to beat the index.
The problem is compounded for investors, because that there is no clear evidence how they might pick the 30 per cent of funds that did outperform the index themselves if they chose to. Another S&P report which looks at the persistence of fund returns demonstrates this point: only between 3.2 per cent and 9.7 per cent of superannuation funds managed to maintain a ranking in the top half of fund performers over a period of five consecutive years. A random selection would expect 6 per cent.
In short, picking yesterday’s star performer is a sure fire way to end up with tomorrow’s loser. The phrase "past performance is not an indicator of future performance" is found in all fund disclosure documents. It is the best and the most consistently ignored piece of advice from wealth managers.
What about across superfund sectors? Is there any difference in gross investment returns?
Well, no to that idea as well. As Nexia Australia superannuation specialist Barclay Judge says, "…neither retail, industry or self-managed funds have proven to have superior investment returns".
Leaving investment returns aside, high costs are the real problem. The Cooper review illustrated this well. MySuper, an outcome of the review, prescribes a low cost simple superannuation product and commendably tackles the problem of cost head on.
Actually, costs have turned out to be a far stronger predictor of net investment returns to Australians than any other variable. An APRA study in 2008 found costs are a key driver why industry funds continue to outperform the retail industry sector. Researcher SuperRatings estimates average fees in Australia are 1.3 per cent, with some fund managers charging as much as 4 per cent. ATO data reveals small self-managed superannuation funds have average fees of just 0.54 per cent.
It’s powerful evidence that shows fees have not reduced in line with the massive economies of scale the large players work with — which are only set to grow larger.
The recent ASIC review into asset consultants, which found conflicts of interest, provides a starting point to understand why. The ACTU cites figures from APRA that superannuation funds are involved in related party transactions with asset consultants. It believes these arrangements have forced up fund fees.
Trustees are meant to owe their primary duty to investors/members; but when many of the trustees are also employees of the same companies that the fund pays to manage the fund’s affairs, a clear conflict of interest exists.
The second reason is superannuation fund structures involve many layers, each of which adds cost. The funds often outsource investment management services to asset consultants.
Lastly, there is not enough effective competition. The Cooper review identified that up to 80 per cent of members rely on the default employer option to determine where their superannuation is directed, irrespective of the default fund’s performance or costs.
Interestingly, with respect to fund costs the difference between sectors (the for profit and not for profit) is marked — industry funds win hands down. As not-for-profit organisations they return any profit to members and a 2008 APRA report showed they consistently outperform their retail cousins largely because their costs are lower.
Which is why the introduction of the MySuper reforms effective 1 July 2013 is a major step forward. The reforms will cut investors’ costs by up to 40 per cent and help focus the industry on the core purpose for which it exists: to optimise retirement incomes for investors.
But in a tragic twist the not for profit industry funds may become the biggest losers from the MySuper reforms — reforms modelled on their low cost model.
The productivity commission has recently announced proposed plans to change how super funds are selected for inclusion in Australia’s 122 industrial awards; changes which may allow the for profit sector greater access to a sector dominated by the industry funds. Ironically, AMP has said their low cost MySuper product should have the right to be included in all industrial awards.
On top of the Cooper recommendations, government and industry seem to be on the verge of reaching a consensus on how to use superannuation balances to fund productivity-enhancing long term infrastructure projects. Minister for Superannuation Bill Shorten has backed the notion on the condition that returns are suitable. But even with recent improvements from the Cooper review, the system still seems to exist to service industry intermediaries rather than its investors.