Superannuation - It Isn't A One Size Fits All

If we are to believe everything in the news these days, the superannuation industry appears to be facing an existential crisis; that is except the industry, or union super funds. The union funds were somehow able to avoid the wrath of the Royal Commission, even though they continue to replicate many of the models that are coming under question. What triggered this article was the seemingly constant bickering that has been occurring between the union funds and both SMSF and corporate or retail superannuation accounts; we’ve all seen the advertisements. Yet both SMSF and union super fund member numbers continue to grow.

1. Performance

The Industry Super Alliance were outspoken in their view that the Future Fund should not be considered as an alternative superannuation option. The primary reason? The fact that the best industry super funds had outperformed the Future Fund over various reporting periods. Yet this comparison brings to the fore a misunderstood fact about the union fund sector; they do not publish risk-adjusted returns.

Risk-adjusted returns are important when it comes to measuring the performance of people in or nearing retirement. It is all well and good to produce market leading returns, but when these returns have been delivered by taking more risk than the alternative, it is a major cause for concern. In some cases, up to 90% of so called ‘balanced’ funds, is invested into risky assets like private equity, listed shares and smaller companies. The problem with this focus is that it doesn’t consider that retirees need to draw capital at inopportune times.

Most investors still compare their portfolio to the industry fund sector, yet the comparison is decidedly unfair for a few reasons:

1. They tend to compare to the best performing fund each year, not the average;

2. The headline grabbing ‘balanced’ funds are actually classified as growth by independent researchers due to their higher risk approach;

3. The published returns do not reflect the actual performance of each investor within the fund.

The most accurate comparison is to Chant West’s average return for each category, with the average Balanced fund actually delivering just 6.2% for the 2018-19, not the published 10%.

2. Transparency

Industry funds do not offer any index, nor do they report their performance or asset allocation in a consistent way. This is where we believe the biggest issues lie, which are thankfully finally being addressed by the research sector. An investor in one of these funds would likely have no idea that they are actually allocating private equity, mezzanine finance, or direct lending to the low-risk component of their portfolio, rather than the risk portion.

What may actually be the biggest risk for investors, is the discount rate used by these funds. The discount rate is used to value unlisted assets like property, infrastructure, utilities, toll roads and the like. It is typically set based on prevailing interest rates, or the ‘risk- free’ rate plus an additional margin for risk. Due to the reliance on unlisted assets for their returns, the discount rate has become one of the biggest risks for the sector, as it determines the price of a huge amount of their assets. Yet it is incredibly difficult to actually identify what this rate is from any investment reports.

One other issue worth considering is the ‘low fees’ charged by industry funds. There is no doubt that a 0.66% fee sounds impressive, but what do you get for it? Outside of six-monthly statements and an attractive website, very little. I’ve spent hours on hold to receive little more than general advice available on ASIC’s Money Smart website. If you need any specific financial advice or support outside of your account, you are looking in the wrong place.

3. Demographics

An interesting piece on the issue facing industry super funds was raised by Phil La Greca of Super Concepts recently. He highlighted the fact that the surging tide of demographics may actually be in the favor of SMSF’s. Phil’s research highlighted the fact that members of SMSF’s tend to be in pension phase, whilst members of industry funds tend to be in accumulation phase. The evidence was the net cash outflow of some $34.9bn in 2015-16 for pension payments and the net cash inflow into industry funds of $38.1bn sourced solely from contributions. Why does this matter?

Well, most industry super funds have delivered strong returns by investing higher portions of their capital in unlisted assets that offer limited liquidity. They are able to do this because most of the members are not drawing down on their capital, in fact as highlighted, they are receiving $38.1bn each year (and increasing) which must be invested.

This results in a conundrum for industry super funds if they continue to attract increasing numbers of SMSF or corporate super fund members as their cash flow will disappear. The result being that they will need to consider holding substantially higher low risk investments, including cash, which will impact heavily on their returns going forward. You can’t fund pension payments from unlisted, illiquid assets. Some may say SMSF’s have actually contributed to industry super’s performance by allowing them to remain focused on the very long-term.

"The surging tide of demographics may actually be in the favor of SMSF’s"

4. Governance

The final concern relates to experience, and it is the overall governance of the sector and the wishes of its members. The construction of boards for most of these funds remains enshrined in legislation or the trust deeds of the fund, limiting the quality and diversify of potential board members. Yet the membership of these funds is increasingly diverse; Australian Super has some 2.2m individual members. Are these members’ interests, with such diverse backgrounds, really being appropriately represented by members of the ACTU alone? APRA has begun cracking down on extravagant sponsorships and corporate events.

There is seemingly no question from the ACCC when the sector purchases another airport, partners with a builder to construct a new toll road or increases the cost of using these assets. It is interesting that the vertical integration implemented by the banks that is now being broken down, is actually being implemented by the union funds in the form of employing their own advisers, outsourcing to ‘independents’ and only offering advice on their own products.

Where to from here?

It’s important to be clear, industry funds are not non-profits or charities, they exist to benefit their members. They are therefore run as businesses like any other entity, operating their own news services, banks, consulting and funds management companies. We believe there is room for all types of superannuation funds in Australia and different people are suited to different accounts; it isn’t one size fits all.

Drew Meredith, Director & Adviser Wattle Partners