Welcome to Finance and Fury. The future landscape of superannuation – the rise of megafunds through compelled mergers
Numerous bodies, including regulators and government, have been keen for superannuation funds to merge
- The merging of several larger superannuation funds are currently underway creating so-called mega funds. On the flipside, there are smaller superannuation funds, particularly niche funds who focus on areas such as ethical investments, that are holding out against the pressure to merge.
This episode – we will focus on the issue of mergers in superannuation, where it can bring benefits and where it cannot – implications for the future of superannuation
The consolidation of superannuation funds is primarily being driven by APRA and superannuation trustees – believe such moves can improve the super system and lead to better outcomes
- This belief is supported by findings from the Productivity Commission (2018) review of the efficiency and competitiveness of the Australian superannuation system. Three findings pertinent to mergers were:
- Compelling cost savings from realised scale have not been systematically passed on to members as lower fees or higher returns. Much scale remains elusive with too few mergers.
- Rivalry between funds in the default segment is superficial, and there are signs of unhealthy competition in the choice segment (including product proliferation). Many funds lack scale, with 93 APRA-regulated funds — half the total — having assets under $1 billion.
- The default segment outperforms the system on average, but the way members are allocated to default products has meant many (at least 1.6 million member accounts) have ended up in an underperforming product, eroding nearly half their balance by retirement.
- APRA – Academic study conducted – found that generally members benefited from being in larger superannuation funds for three reasons:
- Larger not-for-profit funds provide diversification benefits of investing in more asset classes including unlisted property and private equity.
- Larger funds avoid the scale diseconomies in investment returns documented in studies of equity mutual funds.
- Larger funds make substantial savings by spreading fixed operating costs (such as IT infrastructure) over a larger asset base
Projections – Major areas – APRA: Corporate, Industry, public sector and retail – the SMSF which is ATO
- The number of APRA-regulated super funds in Australia is set to shrink considerably. In its Super Insights Report (2019), KPMG estimates APRA-regulated funds will fall from 217 to just 85 in 2029.
- Corporate funds will fall from 24 to six; industry funds from 38 to 12; public sector funds from 37 to 15; and retail funds from 118 to 52.
- the number of SMSFs is projected to grow from 596,225 to 770,759 by 2029.
- Australia’s super assets have ballooned to $2.9 trillion as of September 2019, making it the world’s fourth-largest retirement savings pool. The nation’s super assets are forecast to more than triple to $10.2 trillion by 2038, according to Deloitte’s recent report – Dynamics of the Australian Superannuation System
- According to Rice Warner’s Superannuation Market Projection 2019report – within five years – the industry will be dominated by nine funds controlling $1.7 trillion
- includes a merged QSuper/Sunsuper with $350b of assets, AustralianSuper with $325b, AMP with $200b and UniSuper with $150b.
- Looking forward – When combined with the strong growth of super savings to $10.2 trillion by 2038, these megafunds will make super funds an increasingly powerful force in corporate Australia, particularly in listed markets.
- If funds continue to hold a similar allocation of assets to Australian shares as they currently do, Deloitte says they will “dominate the Australian Stock Exchange holdings” and estimates the proportion of the ASX owned by super funds will almost double to 60 per cent by 2038
Beyond what the productivity commission mentioned – Why merge?
- Outflows and sustainability –
- Net cash outflows The aging population is another reason that there is pressure to merge. As the demographic of a superannuation fund’s membership ages, there will be an increasing level of outflows from the fund. According to KPMG (2019), in 2018 one-third of funds were in an outflow position, while the median fund retained approximately 17 cents in every dollar received.
- Sustainability of superannuation funds Of course, outflows need to be at a sustainable level and APRA is concerned that this may not be the case for many superannuation funds.
- Liquidity issues – super funds with outflows may struggle
- Increasing the scale of the funds due to the size of the super – The benefits of scale can include:
- lower per member operating cost (for example, the cost of developing technology can be shared over a greater number of people)
- more influence to advocate on behalf of members – more powerful companies –
- Issues – Best interests duty of what is in the members actual interests or the superannuation funds interest
- trustees will also need to consider whether the transfer would breach the obligation to perform duties of acting in the best interests of their members
- has been lots of talk about why small or under-performing funds have not merged with large funds –
- Small vs large funds – If a small fund has high fees, high investment costs, high operating costs and it merges into a larger fund that has lower of all of these, all else being equal, it is a very clear case for the small fund
- However, while it may only be marginal impact to the large fund, it is difficult to prove how the merger is in the best interests of its members.
- Failed mergers – not all internal players of super funds her on – contention over job roles has been blamed for the failure of some mergers to occur
- proposed merger between Australian Catholic Super (ACS) and Australian Catholic Superannuation and Retirement Fund (ACSRF) to create an $18 billion fund in 2018 came unstuck when the former demanded that it be able to appoint the chair of the board
- failed merger came under scrutiny at the Royal Commission into Misconduct in Banking, Superannuation and Financial Services Industries, with Commissioner Hayne inquiring why it mattered who merged into who
- Efficiencies not guaranteed – especially the scale or operational efficiencies
- Where fee arrangements are tied to volume (either in value of assets or number of members), scale efficiencies might not be as easy to achieve as one might assume.
- However – increased bargaining power can see a renegotiation of terms with service providers to reduce the cost base for all members – look at the PDS for super – has management fees, ICRs, operating costs, borrowing and property costs –
- but require that trustees have an active strategy for managing outsourced functions – otherwise, there is no incentive to reduce these fees as the percentage scale just means more money
- One benefit which is promoted is that these super accounts will have access to direct investments into areas such as property and infrastructure – but this comes with a downside – need to be managed with liquidity risks
- Lack of membership diversification of choice of funds – impacts of the coronavirus on the superannuation system had revealed a structural weakness that had long been hiding in plain sight; the failure to diversify fund membership, which can be as dangerous as failure to diversify investments – we need to ask ourselves whether such proposals which essentially double down on the same set of risks are wise… Are such mergers – motivated more by super’s industrial relations legacy than by modern-day concepts of prudent risk management – to the benefit of their members?
- Is there going to be a role for smaller superannuation funds – reasons for mergers is that the majority of chronic underperformers are found in the smaller-end of the superannuation industry – not the whole story
- Smaller funds may not have scale – but they can have some advantages in some situations
- smaller superannuation funds are nimble and are able to take advantage of small but profitable investments that the larger funds overlook because it is not worth their time for the amount of money involved – or cannot take a position worthwhile into
- Managed funds have issued with this – move the price of assets when buying in or selling – reduces the returns
- Niche funds– a subset of smaller funds that cater to particular interests, such as ethical investing – may also struggle to play an important role in the superannuation ecosystem where mergers are being promoted by policy –
- These services could be lost if they were swallowed up by larger funds
- Would provide limited options or ability for members to line their superannuation up with their investment philosophy
- some of these funds are seeing rapid inflows of members and funds- been the fastest growing superannuation funds over both one and five year timeframes for inflows
- Smaller funds may not have scale – but they can have some advantages in some situations
Implications for the industry if consolidation continues
- Study by KPMG 2019 -consolidation is likely to see the rise of what has begun to be known as the ‘mega funds’ – that have ownership over most of the ASX – control companies –
- Super funds are expected to use their increasing clout – over the past 15-20 years – industry funds were largely passive shareholders – but this has been changing – becoming activist shareholders
- funds are starting to invest based around climate change and corporate governance – called environmental, social and governance (ESG) decisions
- Might have seen in the news about the divestment from Coal companies and other industries
- One of the most important implication is that the power of superannuation funds – particularly that of mega funds
- Some concerns – example – Australian Super and Westpac in the AUSTRAC scandal – AustralianSuper, Cbus and Hostplus did not support a spill of the Westpac board (other shareholders were pushing for) following the money-laundering scandal in 2019
- Best in class classifications – While slightly tangential to the discussion about mergers, the Productivity Commission recommendation are to have a top 10 ‘best in class’ default superannuation funds based around performance
- Has an overlap with mergers and what the industry will look like – though it is important to note that just because a superannuation fund is one of the largest funds does not necessarily mean it will be one of the top-10 ‘best in class’ funds
- For those outside of the top-10 ‘best in class’ default superannuation funds, inflows are going to become more of a problem as they will have to rely on people to make an active choice to join their superannuation fund
- But no guarantee that the best in class would be that next year or the year after
- This will likely cause further consolidation across the industry as many funds will no longer be able to rely on default members to prop up inflows – basically getting a stamp – further consolidating power into the top super with FUM
- Predictions are that over the next 15 years superannuation will increase from $2.7 trillion to $4.8 trillion, discounted to today’s dollars – There are two factors which have a range of implications: 1) Continued consolidation. 2) The increase in FUM which greatly surpasses GDP – where there may not be enough assets to invest in reducing the quality of investments
Applying this to your own situation –
- Pay attention to your accounts – the merging may have issues that impact you as well –
- May have to update things like Binding nominations –
- Also would want to double check contributions are updated
Summary – The superannuation industry looks set to go through a period of consolidation at the behest of APRA and the government
- The aim of this is to create better outcomes for members by driving underperforming funds out of the system.
- However – the practical issues around mergers is complex – such as what advantages this will bring, and whether it is in members’ best interests
- Regardless it is likely that we will see the rise of mega funds and a decrease in the number of smaller funds
- Mega funds are expected to have increasing power over corporate Australia and through that, the economy
- But like a lot of policy – it may not work out as intended and have large unintended consequences
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