The challenges caused by Covid-19 are seen likely to accelerate consolidation of the pension industry, notably in Australia, as smaller funds struggle to compete for assets and face increasing pressure to improve returns.

Earlier this month, Australia’s assistant minister for superannuation, Jane Hume, said the coronavirus crisis had exposed structural weaknesses in the country’s retirement savings system because funds, whose members are from industries such as tourism, retail or hospitality, have been impacted by widespread layoffs.

Her comments followed a KMPG report published on June 9 that predicts the number of industry super funds will shrink from 38 currently to 21 in five years. It is predicted that by 2029, just 12 will be left.  

According to the report Transformation in the superannuation industry, the expectations are for more mergers to come, particularly among profit-for-member funds, as the industry faces new challenges brought by Covid-19.

In Malaysia, the chief executive of Employees' Pension Fund (EPF), Tunku Alizakri Alias, acknowledged in a June 18 interview with a local radio station that EPF’s traditional strategic asset allocation did not take into account the potential impact from a crisis. Like many pension funds that have reported declines in returns, EPF posted a gross investment income of RM12.16 billion ($2.85 billion) for the quarter ended March 31 – its first drop in three quarters.

Alizakri added EPF needs to evolve its allocation strategy, however, competition for overseas assets has become more intense. “The competition is getting tougher, and the level of competition is different. So, that’s why when we say moving out of Malaysia is not as easy as pressing a button because the fund managers out there, they have their picks,” he said. EFP invests 30% of its assets abroad.

Indeed, “often the barrier for small funds is their governance and resources to seek out opportunities,” Taro Ogai, head of investments for Asia Pacific at Willis Towers Watson, told AsianInvestor, adding that they “sometimes struggle to access unlisted real assets.”

Taro Ogai
Taro Ogai

Not all funds are equally well equipped to handle shifts in the landscape, APRA said in a May 27 report “Myths and misconceptions should be no barrier to super consolidation.” “The impacts flowing from Covid-19 will be significant for some funds, accelerating sustainability challenges that otherwise would have emerged over a slightly longer timeframe,” APRA said. The regulator urges pension funds who are suffering from falling asset prices, liquidity pressures and declining inflows to consider finding a buyer.

The challenges faced by smaller funds have already sparked a consolidation wave in Australia well before the onset of Covid-19. Among the most recent deals was a merger between VicSuper and First State Super. The merger, which will complete by July 1, 2020, will create one of Australia’s largest superannuation funds, managing more than A$125 billion ($85.4 billion). The funds said “size and scale create opportunities that can make a real difference to members’ retirement savings over the long term.”

Equipsuper and Catholic Super have also decided to join forces, and their merger is expected to be completed by December 2020. The combined entity will manage more than A$25 billion. Another tie-up was between Hostplus and Club Super, which completed their merger in November 2019.  The retirement fund for the hospitality, tourism, recreation and sports sectors with A$45.6 billion of assets said the “merged fund would be stronger, with additional economies of scale.”

Ogai added that the “crux here is that funds should focus on the advantages that a merged entity brings to the combined member base. M&A creates an opportunity for merged entities to be ‘stronger than the sum of the parts’, however, to achieve this it is critical to find a merger partner that is philosophically aligned in how it derives value for its end-users.”

DOES SIZE MATTER?  

So, does size matter to a fund’s performance? Ogai said that small funds have the ability to diversify into niche asset classes that some larger funds can’t access, adding that diversification is not just about illiquidity and real assets.

“Alternative credit and hedge funds are other ways of getting access to diversification and varying degrees of illiquidity,” he said.

In fact, apart from Australia, mergers of pension funds in Asia remain rare. More common are partnerships or the pooling of funds by pension schemes and business groups.

For instance, South Korea’s National Pension Service launched a W1 trillion ($860 million) fund with SK Group to invest in Vietnamese companies in December 2019. The fund is reportedly managed by South Korea’s SKS Private Equity and Stonebridge Capital.

The Public Officials Benefit Association (POBA) also has a fund worth about 900 billion won with a Danish pension fund to invest in Europe’s real estate market. It has a separate fund with California State Teachers’ Retirement System to set up a $312.5 million joint venture into equities of US multifamily residential real estate.

Jang Dong-Hun, Poba’s chief investment officer, told AsianInvestor that South Korean pension funds, unlike Australia’s superannuation funds, are structured differently with each fund having their own objectives and practices, and therefore mergers are difficult to achieve.

“The Defined Benefit and Defined Contributions schemes are run by different companies and governing bodies with their respective managers, whereas in Australia, individuals may choose the superannuation fund at which they want to park their retirement funds,” he said.

Regardless of the investing structure, Ogai said “there is probably no optimal size for a fund.” Importantly,  the fund’s investment model should be “appropriate to its size and evolves as that size changes,” he said.

“For example, at different sizes, a fund is able to develop various sources of competitive advantage, such as building internal teams. However, small funds can be nimble and opportunistic, provided they have the optimal governance structures in place and work with the right external partners,” he said.