Welcome to Finance and Fury, the Furious Friday edition.

Today – want to run through what is happening within the industry superannuation environment – not looking good

  1. With the market crash – cracks in the financial system are starting to appear – with almost no asset class but cash being safe – a lot of super funds have gone down in value – but this isn’t the only issue when it comes to industry funds
    1. The issue is the type of investments held – which have been placed in illiquid – i.e. hard to redeem investments – such as private equity, infrastructure or direct property – lots of funds have 25%-30% of their investment balances in illiquid investments – cant easily be sold down to meet redemptions
    2. So as people request switches out of their one size fits all allocations of ‘growth’ or ‘balanced’ to cash or other asset allocations like conservative, they are having a hard time to do this

When it comes to markets – the saying goes that ‘A rising tide lifts all boats’ – but a low tide can leave boats stranded on the shore line – quote that it’s only when the tide goes out that we discover who has been swimming naked – Think it was warren buffet who said this – in any case

  1. With the recent market declines – it looks like many Australian industry funds is looking pretty naked right now
  2. Think about this for a minute – inflows of $130bn p.a. of employer contributions and not much investment oversight from the regulator APRA – why not have a naked dip – nobody is really watching and you get a little cocky when the water level keeps rising
    1. Of the 530 super funds listed in modern­ industrial awards, 96.6 per cent are industry super funds. That’s some gravy train that essentially guarantees constant inflows of cash – which for the past decade has been seen as a guarantee of liquidity
  3. But now the tide has changed – and those who are now left naked are the trustees of the biggest industry superannuation funds and their board of directors

In this episode we will look at the current crises going through industry funds and the issue with illiquid investments

  1. Industry funds have had a good ride over the past decade – it has been demanded that the corporate sector­, especially the big four banks who are also regulated by APRA – take money from their owners and give it to causes deemed worthy by these industry super funds – like the capital notes that form part of the bail in regulations
    1. However – these are still deemed liquid as they can be traded on the secondary market
  2. Industry funds have been complacent – Consider the causes of the arroganc­e and power of large industry­ super funds.
    1. Even up until 2016 – they didn’t need to disclose the true costs of their investment options – the MER or ICR for a lot of investment options went from 0.3% to over 1% in some cases overnight as soon as the regulations changed – as borrowing costs, management fees had to finally be disclosed
    2. They have been coddled by an industrial relation­s agreements that mandates that industry funds be flooded with contributions due to the default agreements – has given them the sense that inflows can cover redemptions or transaction switches
  3. Easy to get complacent – With that guaranteed inflow of cash, it’s hardly surprising that industr­y super funds have grown fat and lazy about risk – it isn’t their money after all – but they made two critical assumptions which are currently being tested:
    1. Number 1 – that these vast inflows would alway­s exceed the outflows – either in the form of switches in investment options or what they had to pay pensioners in the income stream phase, along with rollovers out to alternative super platforms where you can decide where your money is invested
    2. Number 2 – they could keep less of their assets in cash or liquid assets to meet redemp­tions – and place these in illiquid investments like private equity, infrastructure of direct property which can provide generous investment valuations to help returns appear higher
  4. In fact, they doubled down on this bet by investing more and more of their members money into illiquid assets — they filled their portfolios with infrastructure, real estate, private equity­ and other forms of long-term assets that can’t be easily and quickly sold to meet redemptions – one thing I have noticed over the past decade – go back to 2010 – the investment options within industry funds didn’t have much in the way of these alternate investment asset classes – but now they make up about 1/4th of most balanced options
    1. The benefit of this is that these illiquid assets can’t be easily valued­— experts will tell you that the valuation of illiquid assets is essentially guesswork.
      1. think about a share portfolio – liquid and easily valued – based around the share prices on the daily market – but now apply this to private equity – companies that aren’t listed and only get a guess work valuation once a year – or unlisted property – which again has some private company give you the guesswork as to what is might sell for
      2. If you don’t have a deep and liquid market into which to sell an asset, you really have no idea what that asset would fetch if and when the time came to sell
  • This was a major issue in the GFC – lots of assets that were illiquid in nature had to be frozen for redemption – in the property sector, a lot lost 80% of their value due to fire sale tactics
  1. But to date – The fact the valuation of illiquid assets is open to huge ­variation was a terrific advantage in so many ways for industry ­insiders during the good times.
    1. Industry super funds could use boomtime assumptions to prod­uce inflated valuations to prop up their performance relative to retai­l funds that don’t have the same guaranteed gravy train of inflows to invest in unlisted long-term asset classes.
    2. That gives the industry funds one heck of a competitive edge and those inflated performance figures make for handsome ­bonuse­s for employees of industry funds and asset managers such as IFM.
  2. This apparent outperformance by industry super funds seems to made APRA and many others turn a blind eye to this practice – as long as on paper the returns are there, there is no reason to look further –
  3. Hence – industry funds have been able to resist sensible regulation by pointing to their “healthy” performance, and have received exemptions from the kind of stock-standard rules that govern other trustees of public money.
  1. Now the tide has gone out – some of the largest industry funds have sold to members as “balanced” investments – now don’t look to be so balanced – Over the years – Industry funds have turned their balanced funds into not so balanced funds – chasing greater returns – and investing in a risky way all to drive the most inflows through competing in their internal special Olympics – when you see ‘best performing super’ only comparing industry funds – not other platforms that provide tailed asset allocations in funds which have beaten the industry funds year on year
  2. Few examples – of current major industry funds and their current asset allocations
    1. Balanced funds – rule of thumb – I work off a 35% defensive (cash and FI) and 65% growth – but needs dependent
    2. Aus Super – 3% cash, FI 12% and Credit 5% = 20% defensive – which is growth – have 25% in illiquid investments between Private equity, infrastructure and direct property
    3. Sunsuper – Even worse – have 3.5% in cash, 9.7% FI – bit over 12% in defensive – have 26% in illiquid investments between Private equity, infrastructure and direct property
    4. QSuper – More in line with balanced – but only recently – 40% in defensive – but majority of their FI investment is in Corporate debt – but 22% outside of this is still in illiquid investments
  3. With the recent market decline – a crisis is emerging and has exposed the illiquidity issues industry funds face
    1. Funds have been relying on inflows – but many of their members have lost their jobs or lost hours of work, drying up the guaranteed flow of new super­annuation contributions
    2. In addition – government has announced an emergency and temporary exemption allowing members in financial trouble to withdraw up to $10,000 a year from superannuation for each of the next two years.
    3. The liquidity problem facing industry super funds has been compounded by the fact many members have been switching from what the industry funds call “balanced” options into cash options, requiring funds to liquid­ate long-term assets in the “balanced­” options.
  4. This new environment has forced industry funds to slash questionable valuations of illiquid assets in their “balanced” funds to avoid redeeming member­s or members who switch out of balanced funds into cash options getting a windfall at the expense of members who remain in the “balanced” funds.
    1. So it is starting to show cracks in how these funds have been investing funds – has been allowed to occur due to the lack of transparency within the reporting requirements of the industry funds – so the jig is up. When comparisons between industry super funds and retail funds are adjusted for risk – industry super funds don’t look so healthy after all – it has just been the fact that investments have been in ‘illiquid’ funds that get non-market valuations that the risk to return measures have been allowed to be manipulated
  5. Now that the tide has gone out, we can see two issues with greater clarity.
    1. First, trustees of industry super funds haven’t done a stellar job of managing risk through the full economic cycle, through good times and bad. There was too much compla­c­ency from more than two decades of uninterrupted economic growth. And maybe some naivety too: Australian industry funds are relatively new, emerging only in the 1980s after the introduction of compulsory superannuation payments.
    2. Second, APRA stands condemned for letting industry super funds get away with second-rate governance and poor management of risk through the full econo­mic cycle.
      1. The biggest question is how this group has been protected from scrutiny and sensible regul­ation for so long, and what can be done to end its immunity from the kind of critical examination the rest of the financial sector has alwa­ys faced
    3. The other issue when it comes to the industry sector is their voting power, and buying power,
      1. Board members often send their salaries back to their unions which can be passed onto political parties
      2. In addition – before the crash the super industry made up $3trn of funds – Aus GDP is about $2trn along with the share market being about $1.6trn –
  • This political power is part of the reason for the large push for the super guarantee charge contribution increased from 9.5 per cent to 12 per cent – more guaranteed inflows at the expense of private employees take home pays
  1. Starting to hear talks and requests from the industry funds where they may be requesting bail outs – Consider the hypocrisy of these super funds now wanting a bailout to deal with a liquidity problem of their own making – they got greedy and wanted to show that they had the best performances during­ the boom times – been going on for years
    1. Now their mismanagement has exposed risks that their members­ have been told about – as even as someone who
    2. And the same industry funds want the Reserve Bank of Australia (aka the taxpayer) to bail out their members to protect their boards from claims of mismanagement. The industry funds no doubt will point to the help the government is giving the banks as a preceden­t for a bailout.
    3. To date -nothing from the government to do this – which is good – people should honestly know the gambling game that industry funds take with their money – but what the gov should have done is actually require APRA to do its job
      1. It boggles me to how the industry fund sector has escape scrutiny of its dirty little secrets for so long – had the royal banking commission into financial services – which occurred after banks sold off their financial services arms – so they aren’t the ones regulated – but remaining financial services professionals –
    4. The mismanaged industry super funds is compelling evidence that ­workers should be allowed to keep more, not less, of their hard-earned money
      1. Might sound weird for someone in financial services to say – but I like freedoms – hence people can choose to SS their income rather than being forced to through increased SG payment

 

Summary – This market crisis exposes the poor management of millions of Australians superannuation funds –

Why I have been against industry funds – choosing where money should be placed over individuals choosing where they money is investment in other super platforms that allow you to decide

 

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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