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Super is struggling to please anyone

Most of us working in the superannuation industry can be rightly proud that in spite of all the tensions and internal debate, the system is largely successful. The Australian super system is ‘doomed to success’ because of generous tax concessions, a strong adequacy lobby pushing for increased contributions and a sophisticated array of industry bodies and service providers to galvanise our collective efforts.

But an existential crisis looms in legislating a ‘purpose for super’. To what seems like a simple question, the community responds with a variety of competing answers, some of which challenge what we currently do.

Divergent views on assumed purpose

A survey released last week by the retail industry super fund REST claims “… almost three quarters of more than 1100 over-50s … place one of their main aims for their super proceeds as not being retirement income for themselves, but ‘for helping the kids’”. 72% of them intend to help with school fees and house deposits or provide an inheritance.

The Treasurer, Scott Morrison, joined the chorus in the AFR saying “Some people see it as an inheritance pool, others see it as wealth creation,…”

Sadly, while my own mum and dad don’t have that attitude, the survey also highlights the contrast between high ambitions and short achievement. 55% of members do not believe they will have enough to comfortably retire.

We can write this off as just another example of the sense of entitlement of the baby-boomer generation, or we can actually see that on some level the system has shortcomings that need to be addressed.

After 25 years of compulsory super, could it be that super satisfies no one? The government is unlikely to relieve intergenerational social security costs, nor will superannuation returns be enough to provide the generous retirement members expected.

If member (and government) expectations are so skewed towards higher final balances, the logical conclusion is that the whole industry has been labouring under the false assumption that a slow and steady low-cost balanced risk strategy is what members want. In the world described by the REST survey, a high-growth, wealth creation strategy rather than a meagre low-return income strategy, is likely to meet more objectives.

Cost concern is outweighing generating quality returns

MySuper has produced a low-cost, vanilla approach that, from an investment strategy perspective, almost guarantees to reduce long-term absolute returns. Superannuation researcher Warren Chant was quoted saying:

“What MySuper did was to offer the only way for retail funds to compete by introducing more indexing. Having more passive management is a step backwards.”

Gone are the high cost, high alpha assets with uncorrelated returns, replaced by passive indexed approaches delivering an unmitigated ride on the market beta.

While this article is too short to delve the depths of the debate on active versus passive management, a variety of investment approaches have been scaled back or abandoned, not because they don’t deliver alpha, but because the cost is too great to bear. While downward pressure on fees in general must be a good thing for consumers, and entirely appropriate for a compulsory system, the extent to which quality returns can be achieved has undoubtedly been compromised.

Australians missing private equity opportunities

My own involvement as a co-author of the annual Private Equity MediaAustralian Institutional Investor Survey of Private Equity & Venture Capital Investing” has demonstrated to me the seismic changes underway. We have charted the decline in money allocated and an erosion of internal teams in seniority and expertise devoted to private equity.

Flying in the face of conventional wisdom in each and every developed pension industry across the globe, Australia stands alone in its abandonment of private equity.

Recent academic research has provided accumulating evidence that private equity investors have performed well relative to reasonable benchmarks … private equity funds have outperformed public equity markets net of fees over the last three decades. The outperformance versus the S&P 500 in Harris et al. is in the order of 20% over the life of the fund and roughly 4% per year.  Consistent with that net of fee performance, Axelson, Sorenson and Strömberg (2013) find outperformance of over 8% per year gross of fees.” – Harvard, April 2015, Working Paper by Paul Gompers, Steven Kaplan and Vladimir Mujharlyamov, titled “What do Private Equity Firms Say They Do?”

Cambridge Associates publishes an Australian survey of private equity results which, time after time, resiliently shows not only a more stable pattern of returns than the listed market, but higher levels of outperformance against public markets than those quoted in US studies.

Ironically, the private equity industry in Australia is thriving by sourcing its capital from pension funds in other countries, who remain astounded that the local industry has little interest in a rich vein of returns and diversification sitting on its doorstep.

One feature of super funds in other countries is the preponderance (although reducing) of defined benefit funds. Their attitude to returns is razor sharp because of the clarity of the trustees’ hangman’s noose: that is, actuarial hurdle rates to ensure solvency. It is typically these funds that are greedy for efficiently squeezing return from their risk budget. Assets like private equity have for much of the global industry become a near universal inclusion to meet their goals.

The return goals for defined contribution funds are no less onerous but they are also less immediately visible and the REST survey casts some dim light upon these goals. However, this is just one example of how the rush to satisfy the MySuper fee agenda may have lurched our industry away from achieving the ultimate objective of its own members, and the government.

There are many competing objectives to which the super industry must show deference, but it seems that healthy returns should be the last place to make a compromise. An industry that draws upon the largess of the government for generous tax concessions might be better insulated from change if its members are enthusiastic about results. However, from what we see from the recent REST survey, member gratitude has faded.

 

David M Brown is Chief Investment Officer at PacWealth Capital in Port Moresby; Licensed Investment Manager of the largest private sector super fund in PNG, NasFund; a Non-Executive Director of ASX-listed Clearview Wealth; and has managed pension, superannuation and insurance assets in the UK and Australia for over 25 years.

4 Comments
Warren Bird
November 17, 2015

Is this article seriously asking about the purpose of super, or is it just a veiled ad for private equity?

A lot of super funds invest in private equity. All have been attracted by the generic statistics that argue private equity outperforms public markets. Whether it does so by enough of a gap to justify the additional risks inherent in the asset class is another matter, but on the whole it should and does seem to provide a higher return than the listed markets.

But selection of the right manager in private equity is the trick. I've spoken to the CIO's of funds that have had a wonderful outcome from private equity, and I've spoken to CIO's who hate the sector because their experience was very different. I don't believe it is as simple as this article makes it - it is definitely not a case of merely buying private equity and enjoying the spoils.

I could argue that private equity is struggling to please everyone, which might be a good title for another article.

David Brown
November 26, 2015

Warren - thanks for the idea for the next article. However, this one is clearly about confused agendas leading to poor investment outcomes. My February Cuffelinks article entitled "Back to the Future" raises the point that the FSI identifies the pre-eminent objective of super is the provision of retirement incomes and all other objectives are nice to haves but not essential. http://cuffelinks.com.au/back-future-murray-crafts-db-outlook/ Post retirement income is expensive to obtain and requires the very best in terms of returns and the very best in terms of skill to achieve it. I hope the article above gives just one (of many) example of how the Australian super system may have traded great returns (albeit difficult to secure without the right skill set) for easy, cheap and cheerful.....

dean smyth
November 12, 2015

Hi Guys ... I think we should spend all our super and have a good time, my Mother worked a domestic job for years to own her small home... she was in the same nursing home getting same level of care as her friend that never worked a day in her life, so WHY bother... Mum had to sell her house to fund her Nursing home...the other couple got it all on the TAX payer... ME! and YOU...!

And all the other medications Mum paid for... they got it at next to nothing...it cost me $$ to work why bother?
Why are we not rewarding the workers with lower tax's etc....? I wish someone had the guts to speak out! Noel?

Gary M
November 12, 2015

Personally I think there was too much navel gazing about “the purpose of super” but it seems to be the flavour of the month.

 

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