Australia’s superannuation fund industry, is undergoing its latest round of political pressure, with the government seeking to radically overhaul fund fees, performance and oversight.

If successful, the plans could help superannuation funds pressurise their third party fund managers to cut fees, but industry associations warn that it may also instil a more risk-averse mindset that makes super funds less willing to delve into risky or alternative assets.

Australia’s superannuation industry is set to receive an increase in contributions from 9.5% of employee incomes to 12% from July 2021 as legislated by the country’s last Labor government. But the current Liberal (conservative) government wants to also conduct a radical overhaul of the superannuation fund fees, performance and oversight.

There is a political imperative at work in doing so, suggested one industry observer. “The government is livid over the behaviour of industry [superannuation] funds,” he told AsianInvestor.

“The government has long been concerned with the flow of money that goes from industry funds to trade unions. They think, with some justification, that this helps fund the Labor Party. Labor has been able to outspend the coalition in election campaigns."

David Carruthers,
Frontier Advisers

The proposed new measures aim to protect members from poor outcomes and encourage funds to lower costs. From July 2021 the government will require superannuation products to meet an annual objective performance test. Persistently underperforming super products will be prevented from taking on new members.

Senator Jane Hume, assistant minister for superannuation, announcing the new measures, said the 16 million Australians covered by the superannuation guarantee are paying A$30 billion ($21.12 billion) per year in fund fees.

"This is more than the A$27 billion Australian households pay on their energy bills or the A$12 billion they spend on water bills."

Despite that, 3 million accounts invested in underperforming funds that manage over A$100 billion.

David Carruthers, principal consultant and head of member solutions at investment consultancy Frontier Advisers, told AsianInvestor the government's central tenet is for consumer competition to improve the system.

COMPETITIVE FEE CUTTING

The effort to cut fees makes sense. Australian contractual pension fund fees are high by global standards. Fees average over 1% in Australia, compared to the Nest scheme in the UK, for example, where the average is 0.5%.

The government has also said it is happy for the super industry to conduct more passive investing, which fits with the desire of super funds to lower fees. They are already pushing for transparent fixed-fee charges from asset managers, while building up internal investment teams.

Yoon Ng of global fintech firm Broadridge believes the rule changes will likely bolster the Australian exchanged-traded fund market; “it’s a fertile market for ETFs," she said.

Russell Clarke, VFMC

US fund giant Vanguard appears to agree. It has announced its intention to launch a retail super fund in mid-2021, which is almost certain to undercut the fees currently charged by rival issuers. It also plans to relinquish as much as $100 billion worth of existing mandates with super funds to compete directly in the retail funds space. That would open the door to other providers, particularly competitor ETF providers such as iShares and State Street.

Fee pressure extends well beyond passive products, with hedge funds finding themselves at the sharp end of the trend. Russell Clarke, chief investment officer at super fund VFMC, told AsianInvestor he expects to see “a continued slow reduction” in fees.

UNINTENDED CONSEQUENCES

While lower fees sound like a good outcome for members, industry associations warn the new rules could have unintended consequences.

Carruthers cautions that introducing a single, prescriptive test could distract from what should be the funds’ the primary focus of maximising long-term investment returns. 

“The new test ignores the CPI+ objectives of funds that reflect long term member outcomes. The test measures how well a fund has implemented their chosen strategy, but not whether it is a good strategy.”

He also feels the methodology could discourage funds from focusing on the specific competitive investment advantages they enjoy. “It devalues the benefit of risk diversifying assets, particularly any investment which will perform well when equity markets are negative.”

Industry observers add that another unintended consequences could be that closing a fund to new members creates further problems.

“With decreased cash flows, expense ratios may rise. Engaged members exit, whilst remaining members may experience even poorer outcomes in a legacy product,” said Carruthers. “Furthermore, a fund which fails the test may become short term-focused and take excessive risk to recoup the underperformance.”

In addition, Martin Fahy, chief executive of the Association of Superannuation Funds of Australia (ASFA), argues that the proposed measure of investment performance could encourage super funds to adopt a herd approach to asset allocation, increasing risk aversion and encouraging short termism.

The could include funds feeling compelled to cut the flow of super capital into alternative investments such as infrastructure, private equity, venture capital, hedge funds, fintech start-ups and credit, and instead hug the index.

ASFA proposes a fund assessment system where, if a fund’s fees and costs exceed 130 basis points, net investment returns would be benchmarked and those in the bottom quantile of risk-adjusted returns deemed to be underperforming.

This proposal has been described as “self-serving” by Grattan Institute director Brendan Coates, who also said applying a hurdle of 130 basis points (bp) in fees to super funds was “an absurdly low bar”.

According to the Australian Prudential Regulation Authority's heatmap on super fund fees and performance, only five super funds would fail the 130bp hurdle.