Consolidation among Australian superannuation funds rolls on, but the country’s smaller pension funds can still thrive if they focus on building relationships with niche fund experts and make smaller, targeted investments, according to local market experts.  

A June 2020 report issued by KPMG estimated that in five years’ time, the current 217 regulated super funds will have shrunk to 138.

Linda Elkins, KPMG’s head of asset management, said: “We have seen merger activity ratchet up and the greater pressure put on by Covid-19 will only increase this. Significantly, we are beginning to witness larger-scale mergers in addition to the more common smaller funds consolidating.”

Small funds of under A$1 billion ($729.13 million) that want to avoid regulator pressure to merge for economies of scale need to recognise their limitations and focus on investment areas that help them stand out from their larger peers, said Paul Newfield, director of sector research at Melbourne-based asset consultant Frontier Advisors.

“The two ends of the spectrum – large and small funds, are increasingly using different investment tools,” he told AsianInvestor. “The small funds need to be very aware of what their competitive advantages are and not try to go head-to-head with the mega funds on peer group performance.”

Paul Newfield, Frontier Advisors

This is particularly important, given that the large are getting larger and the smaller are under pressure to merge. Canberra has said funds with under A$1 billion are considered marginal and viable candidates for mergers.

In July, First State Super and VicSuper merged to become Australia’s second largest superannuation fund, with $125 billion under management. And earlier this year the Australian Prudential Regulatory Authority (Apra), the market regulator, rolled out performance appraisal ‘heatmaps’ to highlight super funds it considers are underperforming.

Newfield said larger asset owners tease out cost efficiencies where they can and can invest in all asset classes globally.

“Where the pressure’s being felt is in the smaller to mid-tier funds, because as the larger merged funds create more cost efficiencies, the smaller funds are asking ‘can we deliver superior experience and returns for members?’”

PLAYING TO STRENGTHS

Small funds cannot compete on investment breadth, but Newfield said some small funds do an exceptional job by playing to their ability to make very targeted investments. He cited Mercy Super which, "despite being near the bottom quartile for size of fund, have been top quartile over almost any time period out to 20 years in terms of performance - by sticking to their knitting."

Smaller funds don’t have the resources to compete against large funds, he said. “They need to be more nimble, like going into more niche asset classes which larger funds can’t go into because they are too large.”

He noted that it makes little sense for a small fund to have several relatively small individual private equity or complex hedge fund holdings, due to “the cost of doing due diligence, of understanding the tax implications”.

On the other hand, “one of the areas where fund managers have consistently been able to add value over the years is in Australian small caps. If you’re a small fund, get yourself a skilful manager; you’ll pay a little bit more but you'll derive value relative to the benchmark.

“If you’re a large fund you are not going to spend time in Australian small caps, because once you allocate, you’ll just drown out all of the manager’s capacity for alpha.”

Indeed, large funds have become mostly beta-searching in most of their mainstream investment class investments.

“If you’re a A$200 billion fund and you’re putting 25% of the fund into Australian equities, you’re probably going to select market beta for that asset class and aim for additional returns in alternative managers, private equity and things of that nature,” Newfield said.

FEES UNDER PRESSURE

Smaller super funds can also take advantage of the erosion of fund management fees in recent years. An OECD report in 2018 showed that fees in Australia were among the lowest in the world, and they have dropped further since.

Yet while active fund management fees have dropped in both the retail and institutional channels over the past years, according to Brett Jollie, managing director, Australia at Aberdeen Standard Investments, specialist asset classes have resisted this erosion.

“The general trend for funds that are easily replicated, like large cap equities, is down but fees in alternatives and private markets have remained steady as investors are willing to pay for manager expertise,” said Alex Zaika, managing director, Australia at GAM.

 
Russell Clarke, VFMC

Russell Clarke, chief investment officer at super fund VFMC, told AsianInvestor the fees his organisation has pays for asset management over the last three years has seen “a modest reduction”.  

These drops are most apparent among hedge funds, where the traditional 2+20 fee structures (2% of annual assets and 20% of profits made) have become more like 1+10-15 in recent years. Clarke said he expects to see “a continued slow reduction” in fees. 

Newfield said super fund members are benefitting in two ways from fee savings. “A portion of costs savings are being passed downstream immediately to members on an ex-ante basis. Some of that capacity is then being utilised in other investment opportunities.”

He noted that if a super fund can save 1-3 basis points on fees that are “50% of your asset allocation, that’s quite a substantial fee saving as a dollar amount, which allows you to look at opportunities in private markets. Funds are then able to reapportion their money according to where they are going to get the best return”.