Australia’s superannuation system has been reshaped over the past two decades by market forces and regulatory reform, creating an industry that has significantly consolidated and is widely acknowledged globally as a strong system.
We all want to strive for better member outcomes and while the Government’s superannuation budget initiatives are generally in the right direction, one proposal, whilst well-meaning, appears interventionist and flawed.
Subjecting super funds to an annual performance test – creating a ‘league table’ index and blocking underperformers from taking new members – is overly simplistic and will have potentially significant, negative impacts on investment outcomes for members.
I fear that the drive to be within 0.5% of a simplistic portfolio benchmark test as proposed by the Government, with harsh consequences for failure, will incentivise a focus on simply being average, rather than being great.
This flies counter to my 20 years’ experience in the industry which has witnessed diverse approaches to objective attainment, including funds “bucking the trend” by early adoption of investments in unlisted infrastructure and property, internalisation, backing start-up managers and entrepreneurs through investing in private equity.
We take many of these innovations as industry norms today, but at the time when these were adopted, they were innovative and required courage to take a carefully calculated risk. Many of these approaches have been enormously beneficial to members.
Instead, the Government’s proposed benchmark test has potential for less innovation, amongst other consequences detrimental to super fund members.
Firstly, trustees may become significantly more index aware, resulting in asset allocation and investment approaches based significantly on an index and peers, rather than investment opportunities that are considered in the best interests of members.
Secondly, trustees may become more fee conscious, resulting in approaches that limit access to high potential return but higher cost investment opportunities that would be expected to improve returns and/or reduce risk (e.g. including nation building infrastructure, property, and support for entrepreneurs through private equity and small public companies).
Thirdly, we could see trustees being less prepared to adopt longer term investment approaches better suited to the long-term nature of superannuation for fear of failure of not meeting the performance test.
Fourthly, market behaviour might actually continue to focus on shorter term measures, resulting in net cash outflows from some very high quality, strong long-term performing funds that have weaker shorter-term performance.
Fifth, the new benchmark regime assesses funds on only one criteria. In reality, the best fund for any member is a combination of risk alignment, performance objectives, investment approach, appropriate insurance, and service levels including advice.
Finally, this proposed change may drive the market towards an oligopoly structure. There seems to be a view amongst some policy makers that only eight to 10 mega funds (or less) is optimal.
Even with a hypothetical industry of only four mega funds, there will be one upper quartile and one in the lower quartile. There are limits to killing the bottom quartile, and you may create a system that achieves ‘mega scale’.
However, this comes with diseconomies of scale and concentration of risk with massive funds under management under the purview of a shrinking and smaller group of fiduciaries.
To highlight what this might look like for super, consider the outcomes from the Banking Royal Commission. This highlighted the issues with a large, conglomerate sector with only subtle differentiation between participants, where the structure of that large industry has created other issues, including agency risk.
The Government’s approach ignores that natural market forces and regulatory changes over the last 20 years that have resulted in heightened competition, consolidation and pressure to maintain strong member outcomes – particularly since Stronger Super was introduced in 2013.
The annual performance test also undermines the evolution of recently developed regulatory initiatives which take a more holistic view of performance. The Australian Prudential Regulation Authority’s (APRA’s) member outcomes and heatmap evaluations have the capacity to highlight underperformance, across a broader range of measures.
The ink has barely dried on recent regulatory innovations such as member outcomes. The industry at large should be focusing on further development of existing regulatory approaches aimed at developing a wider range of aspirational targets and benchmarks for members retirement outcomes.
We, as an industry, can do better than what the Government has proposed.
Matthew Griffith is principal consultant at JANA.