Many in Australia’s $2.8 trillion-sized superannuation industry are disappointed with the Productivity Commission’s final report into the competitiveness and efficiency of the system. This is because the Productivity Commission has abandoned the proven, low cost industrial default system in favour of a choice-first architecture that has been ground-zero for consumer harm.
We now read that the Government may be seriously considering adding the Future Fund to headline a group of top funds comprising the Productivity Commissions so-called assisted choice list.
In its final report the Productivity Commission showed that many of those individual members who had attempted to make good choices were defeated by proliferation, finding themselves in costly and poor performing products. The Productivity Commission noted that “If people believe that, on average, greater control over assets and more options increases their net returns, the facts belie this.”
There are over 200 large APRA regulated entities and 600,000 self-managed funds. On average, the vast majority of these notably underperform the not-for-profit part of the industry.
The Royal Commission and Productivity Commission have helped to remind us that the that the standard operating procedure of many for-profit funds, namely the proliferation of thousands of differently branded and priced products, seems to have be designed to make good choices by consumers less rather than more likely.
But these problems are not universal. Many not-for-profit funds have come out of the Royal Commission with flying colours. Moreover, the Productivity Commission’s final report findings are consistent with what the APRA and SuperRatings data have shown for years: that industry super funds (and not-for-profit funds more broadly) categorically outperform retail funds and self-managed super funds, and that the industrial default system generally does a good job of connecting members to good products whereas member choice and market forces does a poor job of connecting members to good products.
Industry super funds (and not-for-profit funds more broadly) typically invest in unlisted equity. They own and develop infrastructure and property assets – consistent with a diversified, patient, long-term approach to allocating capital – and, on average over the long term they outperform their competitors. This approach also helps to develop domestic supply chains, fosters technological change, productivity and rising living standards in Australia and overseas.
Rather than building upon the ‘exceptional’ part of the superannuation system, it seems the Government may be considering handing the keys to the default super system to the Johnny-come-lately Future Fund, to effectively operate as a single national public offer, public sector default fund.
Certainly, the Future Fund has some positive features.
Compared with the average growth-orientated super fund it has performed well over long time periods. But there are serious challenges associated with relying on it as a defacto nationalised default fund.
First, reducing competition in the default market to a list of providers including the Future Fund, fails to acknowledge the evidence that individuals consistently make bad choices in superannuation.
Perpetuating the choice model does nothing to assist to build the future Australian economy. The Future Fund itself would soon be so large that it could experience dis-economies of scale. It will likely find few appropriate large sized investments in the local markets and so would be forced offshore.
Second, there would be serious political risks for future governments. A single public sector fund may become heavily politicised and effectively viewed as a guarantors of retirement incomes that cannot reasonably be delivered. The temptation for politicians to exploit a single public sector fund to pay for all manner of short-term policy fixes is likely to be too great to resist.
Third, whilst the Future Fund performance has been quite strong since its inception in 2007, direct comparisons with public offer super funds are difficult.
It was shielded from the worst of the GFC. Most of its seed capital was Telstra shares and it had already converted 40-50 per cent of its portfolio into cash when the GFC occurred. This preserved capital positioned the fund to outperform during the subsequent market upswing.
Also, unlike public offer funds it does not pay tax (including having sovereign immunity offshore in some cases). It does not have to maintain member accounts, manage pension payments, nor does it need to run marketing campaigns. It does not have to maintain cash reserves to manage outflows.
Finally, it is quite a high cost investor. For example, total fees in 2017-18 were in excess of 150 basis points which is very high for the sector.
A better (if imperfect) comparison is provided by comparing the investment performance of the Future Fund with IFM Investors’ Australian Infrastructure Fund which is not public offer. Here the Future Fund underperforms by a significant margin since inception.
Perhaps the best way forward for the superannuation sector is to go back to the future. For example, in the 1980s the industry consisted of a few very large funds with a number of small and medium sized funds which tilted off these. Such a structure today would encourage innovation (for example, small funds can specialise in niche investments) and therefore more effectively compete for membership dollars. Certainly, a consolidated superannuation sector would be in a better position to design innovative retirement products which pool risks and so deliver better outcomes for retirees.
In terms of the superannuation sector, this translates to a balanced "wholesale" market structure where funds offer streamlined products, competing with each other on the basis of risk adjusted long-term net performance. Such a model is best retained under a custodian framework that retains the industrial and cultural foundations of the system that strikes a balance between the efficiency benefits of competition and social cohesion benefits of mutuality and so building trust.
To the extent that the market is unable to weed out chronic underperforming default funds, a duel strategy is possible.
First, the Fair Work Commission default fund selection process should be allowed to operate as intended. It should be obliged to remove underperforming funds from awards. Second, APRA should do more to encourage funds to merge when it is in the best interests of members to do so.
The advantage of this approach is that, unlike the Commission’s shortlist approach, it does not rely on individuals making good choices – when the experience is that they often do not.
While the Future Fund may superficially appear to offer a clean-slate solution to a set of insurmountable problems, we should build the system on what already works, always acting in the best interests of members at every step.
The challenge is to make default superannuation work even better for all members, not only those lucky enough to be in good funds already.
This article was originally published in the Australian Financial Review on 15 January 2019.