Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 78

Grattan and the fuss about Chile’s pensions

Recent press would have you believe that Chile’s pension system is the solution to the perceived cost problems in Australia’s superannuation system. This is due to a combination of media sound biting of a report by the Grattan Institute (and subsequently the Financial Services Inquiry) which, while interesting and a motivator for important discussion, is ultimately incomplete, open to alternative interpretations, and in my opinion flawed. The Australian superannuation system is highly complex – there is no silver bullet which takes it to the next level.

Chile’s default fund auction system

Chile has a well-regarded pension system. The overall system, which includes the government- provided pension, was ranked 8th out of 18 countries (each selected as having a developed retirement income system) in the 2013 Melbourne Mercer Global Pension Index (Australia ranked 3rd). The FSI highlighted an important feature of their system in its Interim Report:

“Other mechanisms could also be deployed to drive fees down. One example is the approach introduced in Chile in 2008, where — unlike Australia — superannuation contributions of all new members are placed in the same default fund. Default fund management is auctioned on the basis of fees, creating stronger competition between funds for default fund status. Since these arrangements started, the fees charged by successful bidders in Chile have fallen by 65 per cent, although fees on other funds have not fallen to the same degree.”

This comment was likely based on a report produced by the Grattan Institute titled, Super sting: how to stop Australians paying too much for superannuation.

Grattan Institute analysis of Chile’s pension system

In Chile, workers contribute to approved pension funds, known as AFP’s (Administradora de Fondos de Pensiones). Currently there are six AFP’s each offering five investment options based on investment risk (simply named funds A, B, C, D and E). The Chilean government implemented a broad range of pension system reforms in 2008, and to address concerns regarding the cost efficiency, the government introduced a tendering process. Every two years, all AFPs tender to be the default fund for new contributing workers. New defaulted fund members cannot leave the directed AFP for two years but can switch investment option. Each option charges the same administration fee. All existing members of the default AFP also have their fees reduced to the new level. Since introduction, the Grattan Institute notes that the successful tenderer fee has fallen 65% to a fee less than 0.20%. This headline number is definitely worthy of attention. Unfortunately AFP’s with large memberships have not been winning the tender recently and so the fee reductions have not benefited the majority of the population.

In my opinion the Grattan Institute adopts the view that a certain way to improve performance is to reduce fees. The logic of such a view, also shared by the Super System Cooper Review, is that investment management makes little difference to performance but fee differences make a large difference in performance. To support their view they undertake analysis which shows that:

  • Adjusted for system size, Australia’s super fund fees are much higher than those in other countries, as demonstrated in the following chart taken from the Grattan report:

  • Outperformance does not persevere (if a fund outperforms in one year there is little continuation of that outperformance in subsequent years). This argument is summarised in the following chart:

  • Fees are high because of the failure of account-holders and employers to put sufficient pressure on super funds to reduce fees

  • Super funds seek to differentiate by providing a range of product features and services, rather than focus on fee reduction

  • MySuper will not result in substantial fee reductions.

To reduce fees the Grattan report proposes a two-part solution:

  • Select default funds in a fee-based tender (similar to the Chilean process)

  • Encourage a more active choice program through the Australian Tax Office hosting a ‘choice platform’ which compares an individual’s current fund to that of the default fund (tender winner), and allow an opportunity to instantly switch to the default fund.

(As a side note, the Chilean experience of tendering is not viewed as a universal success. In 2013 a special committee of the Senate approved a range of measures including creating a publicly-administered alternative to the current privately operated system. This is in response to concern that the tendering process has not delivered population-wide benefits).

The Grattan Institute deserves commendation for producing some analysis and venturing some opinions which should, at the least, require self-reflection amongst super fund providers. Ultimately I disagree with their views and believe that their proposal would fail if implemented. Understandably there will be differences in opinion when a report is produced by people who are not directly involved in the superannuation industry (the three principal contributors are from an economics / academic background). While sometimes great industry innovations are generated by those from outside an industry, I don’t think we have a plausible game-changer in this case.

I make a number of points in response to the Grattan Institute:

  • Global cost comparisons have historically been difficult because every country’s retirement income system has a unique structure providing different features and services. Some services are provided or subsidised by governments. A simple chart (the first one above) as provided Grattan does not tell the full story (but clearly raises important questions)

  • The assessment of active management skill is flawed, most notably in the statistical tests applied against the objectives of the system. Super funds focus on long term performance and ultimately retirement outcomes, yet the statistical testing by the Grattan Institute focuses on the perseverance of short term performance. I question the relevance of this statistical test, especially when the large differential in fees observed in the early 2000’s no longer exists. Perhaps the short term test is conducted because it is more difficult to test longer term performance, as a much lengthier set of data is required. The key question is whether quality active management applied in well constructed portfolios will improve a fund member’s long term retirement outcome. This doesn’t just mean higher returns; it could also mean reduced risk. Surely the debate on active management needs to be a broad and forward-looking one. Based on the flawed construction of many passive indices, evidence of costly behavioural biases, and my own personal experiences of the impact of high quality active management on the return and risk outcomes of a portfolio, I believe that active management does have potential benefits. Surely super funds should have the choice about whether and how much they incorporate active management, rather than have that choice regulated away.

  • The report fails to address the issue of where cost reductions can be derived, rather alluding to the potential for cost savings similar to that experienced in Chile. Yet the Grattan report itself provides a useful chart on this very issue:

  • Based on this chart, from which areas can cost reduction be derived? It appears that investment costs are already quite low at circa 0.20%. Even if we assume a more conservative (higher number) for investment costs, we can see that the impact of a shift to passive management will deliver far lower benefits to those achieved in Chile. Indeed we can see that administrative costs alone are higher than the total fee for Chile’s last AFP tender!

  • Finally, recommendations need to have a high chance of succeeding in practice. In this case success should be measured as system cost reduction. Undoubtedly the creation of a super choice platform would be a costly exercise. It is debatable how much choice would actually take place given the disengagement of many and the alignment of workers to their industry super fund. It would also not surprise to see funds increase advertising expenditure around tax return time – another cost to members with no investment return benefit.

Complexity of our super system

Cost is a crucial issue on which regulators and the industry need to maintain constant focus, but I believe the cost debate has many nuances to it. Does the system as it stands provide too many services and features? What is the economic cost of the substantial choice provided to Australians? What is the cost versus benefit of the substantial regulatory requirements placed on super funds? Which areas of the cost structure (as per the third chart) have the greatest potential for cost reduction? Unfortunately given the complexity of our system, a simple solution is unlikely to succeed; rather an ongoing collection of micro reforms, combined with ongoing fund merger activities, will lead to system cost reduction.

A final comment on the active management debate: in my opinion the investment management industry is experiencing a period of unprecedented dynamic change. The focus on member lifecycle outcomes, post-retirement solutions, the balanced versus lifecycle debate, smart beta and minimum volatility investments, represent just a small number of the current challenges, or opportunities, depending on your view. The lens through which performance outcomes are assessed needs to be refined further. It is those from within the industry which need to provide greater leadership in this area. From here we can then justify the sensible use of active management strategies.

 

David Bell is Chief Investment Officer at AUSCOAL Super. He is also working towards a PhD at University of NSW.

 

4 Comments
SMSF Trustee
September 10, 2014

A question: fund managers generally, not just super, in Australia provide detailed information each year to help their investors fill in their tax returns. Is this a service that is provided in other countries?

I guess what I'm getting at is that I think we get a lot more than just funds management services for our funds management fees in Australia, but I'm not sure if that is recognised.

EG a lot of non-super investors in managed funds would incur much larger accountants fees at tax time if they held all the same portfolio directly than they pay to their fund manager. Is this explicitly allowed for in all these studies?

John
September 05, 2014

Everybody seems to ponder the question, do i have enough $$ to see us through.
I am 68, my wife 69 and we have no liabilities, no children to leave anything to....so we spend, not over the top but I often wonder would I spend the same amount of $$ in 10 years time when (and if ) I make it to 78. Would we go out as much as we do now, would we travel as much (tiring a bit now of the long haul to Europe and the US).

It would be interesting to hear from some of your readers who are now in their late 70s or early 80s...what is their experience in the matters i have raised?

Jim Savage
September 05, 2014

David - very thoughtful piece, and we'd love to chat. Give Grattan a call!

Steve Schubert
September 05, 2014

Good article David. I just want to comment on "administration costs". It is pretty clear that super admin in Australia is not a high margin business - some players are doing it tough and we are not overrun with new market entrants. So, why do costs in Australia appear high by international standards? Here are some contributing factors, each which adds a few bps to costs:

• A strong, but costly, regulatory regime with high compliance costs and levies to recover the Regulators’ costs.
• The requirement for funds to calculate and pay a range of taxes – in most countries funds are not taxed.
• The large size of the SMSF sector means that average account balances in other funds are lower than they would otherwise be, and this affects the ability of funds to benefit from scale (SMSFs are excluded from international comparisons).
• Australian members typically have more choice (of investment option, insurance, fund etc) than in many countries. This has a cost and has also contributed to multiple accounts for many members which has added to costs.
• Finally, many countries do not provide death and disability benefits through retirement plans. This has been a valuable feature of Australian funds but adds to administrative costs.

 

Leave a Comment:

     

RELATED ARTICLES

Grattan’s Super Savings flawed but essential reading

The most complex super system in the world

6 stark superannuation policy differences

banner

Most viewed in recent weeks

Is it better to rent or own a home under the age pension?

With 62% of Australians aged 65 and over relying at least partially on the age pension, are they better off owning their home or renting? There is an extra pension asset allowance for those not owning a home.

Too many retirees miss out on this valuable super fund benefit

With 700 Australians retiring every day, retirement income solutions are more important than ever. Why do millions of retirees eligible for a more tax-efficient pension account hold money in accumulation?

Is the fossil fuel narrative simply too convenient?

A fund manager argues it is immoral to deny poor countries access to relatively cheap energy from fossil fuels. Wealthy countries must recognise the transition is a multi-decade challenge and continue to invest.

Reece Birtles on selecting stocks for income in retirement

Equity investing comes with volatility that makes many retirees uncomfortable. A focus on income which is less volatile than share prices, and quality companies delivering robust earnings, offers more reassurance.

Comparing generations and the nine dimensions of our well-being

Using the nine dimensions of well-being used by the OECD, and dividing Australians into Baby Boomers, Generation Xers or Millennials, it is surprisingly easy to identify the winners and losers for most dimensions.

Anton in 2006 v 2022, it's deja vu (all over again)

What was bothering markets in 2006? Try the end of cheap money, bond yields rising, high energy prices and record high commodity prices feeding inflation. Who says these are 'unprecedented' times? It's 2006 v 2022.

Latest Updates

Superannuation

Superannuation: a 30+ year journey but now stop fiddling

Few people have been closer to superannuation policy over the years than Noel Whittaker, especially when he established his eponymous financial planning business. He takes us on a quick guided tour.

Survey: share your retirement experiences

All Baby Boomers are now over 55 and many are either in retirement or thinking about a transition from work. But what is retirement like? Is it the golden years or a drag? Do you have tips for making the most of it?

Interviews

Time for value as ‘promise generators’ fail to deliver

A $28 billion global manager still sees far more potential in value than growth stocks, believes energy stocks are undervalued including an Australian company, and describes the need for resilience in investing.

Superannuation

Paul Keating's long-term plans for super and imputation

Paul Keating not only designed compulsory superannuation but in the 30 years since its introduction, he has maintained the rage. Here are highlights of three articles on SG's origins and two more recent interviews.

Fixed interest

On interest rates and credit, do you feel the need for speed?

Central bank support for credit and equity markets is reversing, which has led to wider spreads and higher rates. But what does that mean and is it time to jump at higher rates or do they have some way to go?

Investment strategies

Death notices for the 60/40 portfolio are premature

Pundits have once again declared the death of the 60% stock/40% bond portfolio amid sharp declines in both stock and bond prices. Based on history, balanced portfolios are apt to prove the naysayers wrong, again.

Exchange traded products

ETFs and the eight biggest worries in index investing

Both passive investing and ETFs have withstood criticism as their popularity has grown. They have been blamed for causing bubbles, distorting the market, and concentrating share ownership. Are any of these criticisms valid?

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.