Fund mergers a folly when they undermine value

Fund mergers need to be genuinely justified and in the best interests of members with the pursuit of scale for scale’s sake being a folly if small-to-medium-sized funds are delivering real value to members. This is part three of a roundtable.

Mike Taylor (MT) – managing editor, Super Review
Alex Hutchison (AH) – CEO, EISS Super
Andrew Proebstl (AP) – CEO LegalSuper
Andrew Boal (AB) – leader, Willis Towers Watson
Russell Mason (RM) – superannuation partner, Deloitte
Helen Davis (HD) – chairperson, Superannuation Complaints Tribunal
Glen McCrea (GM) – policy director, Association of Superannuation Funds of Australia
Wayne Sullivan (WS) – director of marketing, Frontier Investment Consulting

MT: Okay, I think we’ll move it along and one of the questions we’ve asked on our survey this year is about fund amalgamations and mergers and there’s been all sorts of hand signals getting sent from APRA and elsewhere about mergers. And the question is do we need any more mergers? I’m going to start with you, Andrew, because I happen to know you’ve got a bit of a view on this.  

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AP: Well, look, I think the answer is certainly yes, but there obviously needs to be the right funds getting together with the right funds rather than the right fund getting together with the wrong fund. So growth for growth’s sake is not really, you know, really going to achieve possibly the best outcome. 

It’s got to be consistent with the strategy of the organisation and maybe the strategy needs to change to accommodate a future merger but it’s just not all about getting bigger. It’s much more important, I think, to focus on being better, whatever that means, and for any particular organisation that will mean different things and it will mean being different sizes, structuring a business in different ways. 

So the middle of the industry, the mid sized funds, by that I mean something like between $5 billion and $20 billion, who have multi occupational group membership, you’ve got to ask the question, the obvious question is well, those funds, don’t they look a lot like Australian Super? Why don’t they all just bundle up into Australian Super? What are they doing that’s different or providing some different benefit in their current structure that perhaps Australian Super, as one example, is not already doing?  

So I think all the focus that tends naturally, for some reason, automatically fall on smaller funds, needs to be spread across the industry. Yes, definitely small funds have to justify their existence, and just that earlier proposition, mid sized funds do as well and the very large funds are going into territory that they’ve not been before, internal management investments, all sorts of risks come with that and, you know, it probably will stretch the governance structures that they’ve had in the past. 

A lot of the overseas funds that have gone into in source management have actually put up separate companies or organisations to manage the investment part of the business and had a separate board to manage the fund overall and some, you know, in Australia, CBus has got an example or a version of that model. Some of the other bigger funds that are going down in-house management to my knowledge haven’t separated that function in that way and the question must be asked, should they? Is that a model they should be embracing? 

But the point is ultimately, every part of the industry has to justify its structure, approach, and value proposition to its members ultimately and the regulator, of course, will have an interest too. So yes, I just think the discussion needs to be a wider discussion about the purpose of the whole industry, not just a particular sector that’s easy to pick on. 

MT: Alex, as another fund CEO.   

AH: Michael Easton’s message yesterday of unity, I think in the superannuation industry is important. I think if you reflect on that, that’s important and having diversity, as stated previously, and being competitive is also important. 

Scale for scale’s sake really doesn’t mean a lot at the end of the day as long as you provide a competitive offer to your members you will win, and not everybody wants to be a mega fund. 

Really, if you look at the value proposition that we have at EISS it is all about service to the member and really servicing our occupation group. We have other people not necessarily from our core occupation group but everything we do is focused on those members and in particular, for example, insurance. Our insurance is heavily classified towards, blue male workers and the cost benefit to those people is significant compared to if they had to go differently. 

So the bigger size – there are some benefits for being a big fund but also I think if you have compelling value proposition just on the number of dollars, frankly is irrelevant. It’s all about how you stack up compared to your peers, no matter how large you are scaled, you know, I think scale is a meaningless debate in and of itself. 

MT: Wayne, you’ve worked in large fund land and you’re now out in the consulting land but what’s your view? 

WS: Completely agree with those points and I think if you take a $2 billion fund and a $3 billion and then merge, what have you got? A $5 billion fund, probably not a whole lot of difference and benefit that comes with that but there is a watering down of a lot of other benefits that those smaller funds had initially. 

What might be more interesting is if you had a $10 billion fund and a $15 billion fund that merge – now you’ve got a $25 billion fund that will more quickly become a $30 billion or $40 billion but I don’t see a lot of conversation around funds of that size merging and probably unlikely to because they probably feel as though they’ve got enough scale to push ahead themselves. 

So again, reflecting back on ASFA, I’ve been on the conference committee for 10 years and I was thinking about what changes I’ve seen during that time, well one of the changes that I haven’t seen is that 10 years ago we were having a conversation like this saying there’s going to be a lot of mergers, mergers need to occur and that hasn’t really changed in 10 years.  

There’s been a few that have happened in the last decade but not nearly as many as we thought might happen 10 years ago and I don’t know that the industry is necessarily a whole lot worse off because that hasn’t occurred. There will be other reasons that will be contributing to some of the headaches but I don’t think that’s necessarily one. 

MT: Andrew?  

AB: Just touching on briefly on scale. You can access scale through service providers, and there are different ways to do that. The only part we really can’t access scale is through the management of the fund, the trustee model, the management that goes around that. That’s a relatively small part of the overall cost of running a fund. 

The diversity, I think, is a really important point, that you have mega funds, the middle funds, the smaller funds. If you live in a world with only mega funds then who invests in ASX stock number 493? They have to own the company to get any meaningful access to that stock. 

So smaller funds are the ones that will have meaningful investment in small cap stocks. So different size funds have different investment approaches as well. So diversity is a good thing. 

The final point I think is what the industry has been striving for is to effectively engage our membership around their superannuation and that requires the trust and so if funds don’t quite have the same scale as the ones sitting next to them but they’ve engaged their members and they’ve got trust, do we want to lose that? I don’t think so. 

MT: Helen?   

HD: I think that’s an interesting point around the trust and would reinforce it. I think the comments around the table about every fund, like small, medium, large, just a fund, what’s the value you bring to your membership? And I think that plays to diversity. 

Different individuals, if you like, value different experiences, or different outcomes so that that’s a good thing. Reflecting on the graph Helen showed yesterday about the portion of funds that were in a net cash flow that’s going out, that’s obviously a very different world to managing. So I think that that will have a reality around some of it.   

The other thing is that the point around some of the corporate funds, there are some funds that are closed, are on a net cash outflow, they’re sustaining sort of an ageing of the fund, if you like, as an entity but when does that transition over? 

So succession into another fund and I think at that end certainly coming up that there’s going to need to be a lot of thought, okay, how do we but for the remaining group of members in here, look after them to the best of their interests because given the outflows or pending outflows we won’t be able to do it on our own.  

AB: It’s a good point though, when managing cash flows is possibly the greatest reason why two funds will want to emerge. 

MT: Glen? 

GM: I think diversity. I agree with your point. Diversity and value for members ultimately to me are the hallmarks and the justification for funds continuing to exist and I think about some different markets, the petrol market and supermarkets which are areas I’ve worked on in the past, where we’ve got the opposite problem where you’ve got some very strong players who, you know, governments are concerned may have too much power and I think we need to be very careful because I think there is an ideology by some that we want to head in that direction. 

But I use the supermarkets as also a positive example and you have your corner store and you have the shopkeeper there that you’ve known for years and knows what you want and that’s why I think there is a role for small funds, that provide value to members. 

I think the other thing is if we’re fair dinkum about doing something about mergers, we need to look what are the barriers to exit. So it’s an economic term but basically means what are holding funds back from merging?  

Things spring to mind – equivalent rights. I still don’t think we’ve got there, legacy products and the concept of sort of inherited liabilities. I think there’s issue that funds at the moment are really focused on the regulatory burden so some of them aren’t even thinking about that. 

Capital gains tax under stronger super we allowed some relief, I think we need to look at that. And then ultimately the funds, I think we need to be realistic, a cultural fit is really important. We need if two funds are going to get together they’ve got to have that cultural fit to make it work. So I think we really need to look at those things before we sort of come back and say why haven’t mergers been happening because I think there’s a few things that are holding it back. 

WS: You’ve also got boards of directors that effectively have to vote themselves out of a job with the mergers as well so there’s another boundary.  

RM: I think the merger debate has been wholly overplayed. It’s often played by people who have a vested interest. There are lots of vested interests in this industry. 

Andrew Boal makes a great point, even a smaller fund gets economies of scale through their administrator, through their insurers, through their investment managers. So it’s really the internal management and some of the member services where you may struggle, that’s a small part of the cost. Some mergers make sense and you’ve seen some occupational mergers, and I’m looking at Andrew Proebstl, it’s happened in the legal industry, it made a lot of sense. It happened in the electrical industry between funds there. But people want different things. 

Not everyone wants to be in a mega fund. You use the motor vehicles as a comparison, every car will get you from point A to point B, some people want to buy Mercedes, others are happy with a Hyundai and they should have that choice. Likewise with super they should have the choice. The cost differential is minimal and I’ve yet to see a good debate or a good argument put forward that smaller funds underperform larger funds and I’ve seen some great performance from some of the funds at the smaller end of the scale. So I don’t think members are disadvantaged and I think choice and diversity, has been said around the table a number of times, is a great thing. 

WS: There’s going to be a really good session today, actually, on that point around scale and there just doesn’t seem to be a correlation between size of fund and performance. So the numbers speak for themselves on that basis. 

AB: And from time to time you do see numbers that show differences, one way or the other. Often that will be that, you know, larger funds might have more direct investments in property or infrastructure or something and you go through a period of time when listed markets underperform so those that have those higher weightings just naturally outperform. So understanding why is far more important than just looking at numbers. 

AP: Because the question of fees, as Russell says, the research tends to say that the fees of small, medium and large tend to gravitate around a certain level and the question to ask is if a fund is hundreds of billions of dollars, why are their fees not demonstratively lower than the fees that are three or four or two billion. There’s something missed.  

WS: An answer to that question, and I think it comes back to fund management fees which are ad valorem. So it’s a pretty strange model, frankly. 

AP: It’s like there’s a dis-economy of scale. 

WS: Well, there’s certainly no benefit flowing back to the providers of the capital, for example, the numbers here Rice Warner’s report looking at the industry from 2011 to 2014, MER basically went up slightly in that same time, FUM increased by more than 50 per cent. So you can look at the funds management industry, there’s a session today they’re pretty healthy, McKinsey’s 2015 asset management survey of US, North American investment firms suggests that the operating margins reached 33 per cent, up 11 percentage points from 2009. So there’s a lot of money flowing through, flowing out of the industry into that sector and I think the industry probably needs to look at the investors, that the owners of the capital need to look at applying different models on how they pay. 

As CEOs, there will be very few parts of your business where you budget to a percentage of your assets and when I was a marketing manager at funds, my marketing budget didn’t go up or down according to the assets. 

They were managed on a fixed dollar basis and yet on this side, they’re not managing on a fixed dollar basis when it comes to investment fees. They accept that as they’ve got twice as much money they will pay twice as much in fees and I don’t think the complexity increases if you’re if you had two fund managers and you gave one a $200 million mandate and you gave another a $400 million mandate would you expect to pay the second manager twice as much? But over time, that 200 will grow to 400 and you will end up paying twice as much. So there’s a lot of money flowing out of the system in that area. 

AP: I think Ashby Monk was saying the other day talking about some of the size of the fees – it’s a much bigger issue overseas, elsewhere. 

 I think in the Australian system, the superannuation funds here have been better and I think you’ve got to keep focused on it. I think the funds will keep focussing on it but you talk to international managers coming into Australia and this is the hardest market they face. The fee pressure they face coming into Australia is enormous. 

They get away with much higher fees in other markets with bigger streams of money than they get in Australia and some of them choose not to come here because why would you come to Australia? I can get much higher fees with the same money in the US or other markets. Australia is too fee competitive.  

WS: But I think the pressure should be enormous. I don’t think that’s a problem. 

AB: No, no, I think that’s a good thing. 

WS: I think the pressure could be dialled up a whole lot more.  

AB: But you’re right, once you continue to grow you need to keep reminding yourself to have that conversation with managers about value the rating and what they’ve been paid for it. 

Part one

Part two

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