Jonathon Shapiro from the Australian Financial Review wrote a great article last week about 4 big decisions super funds are going to have to make and it highlights some of the big complexities that super fund trustees must be grappling with. My attempt here is to make that info more digestible for those less familiar with running a super fund.
The first point in his article is that our super system now has $3.4 trillion dollars in it, the 4th largest in the world. For a population our size, that is a staggering amount of money and only getting bigger. However, it’s too much to invest in our own domestic markets and already if a large super fund decides to change its investments, small changes can affect all Australians. The tail ends up wagging the dog so super funds will need to invest more overseas in the future where there is more opportunity to grow.
Big Decision 1: Passive vs Active investing
This is simply do super funds use active investment managers who strive to beat the market returns (but might not) or just copy what the market is doing itself (passive). Passive is cheaper because there really isn’t many investment decisions to make other than invest the same way others are. The downside is that opportunities can be missed and when markets fall, passive investors will fall by the same amount. The challenge is that the government are setting new rules around market benchmarks (Your future, Your super) and the risk of not meeting that requirement means trustees of funds may be more inclined to simply hug the benchmark and not seek to exceed it. The outcome is everyone ends up just getting the average.
Big Decision 2: In house Fund Managers or Outsource
In theory it makes sense to keep your Fund Managers as employees but what if the good ones’ leave? What if there are better fund managers elsewhere but to lure them, you have to pay more which increases the cost to the super fund? If the trend is to hug the index or a benchmark, then really (as per decision 1), a super fund can employ an average fund manager to get an average return. Essentially, an in house fund manager with certain skill sets can’t just be good at investing in all asset classes so when a super fund needs to change investment directions, they may be stuck employing staff who have the wrong skillset or simply aren’t good at their job.
Big Decision 3: Hedging currency
If we invest overseas, we need to convert AUD to that country’s currency. If the currency exchange moves the wrong way, it can wipe out returns on an investment that is otherwise doing well. So fund managers can hedge the currency, meaning they pay a small amount extra to minimise the impact of any changes in the value of the AUD. Or they don’t hedge, take the risk, save the extra cost and hope it works out. In recent years, the risks for our currency have been more favourable, but due to changing economic conditions, the need for that hedge may well increase. Meaning the cost of investing overseas goes up and return (and risk) goes down.
Big Decision 4: Listed or Unlisted (private) assets
This one is the big sleeper issue and there has been plenty written about it in the media. Listed assets are traded on an open market where the price is transparent. For instance, BHP is listed on the stock exchange and every day, the value of 1 BHP stock is determined by the market (public). Unlisted assets are privately owned and their value is not determined every day. For example, an investor can buy shares in a listed company that owns a shopping centre or buy a shopping centre directly themselves (unlisted). The listed shares are valued everyday and can be quickly sold, whereas unlisted assets are valued only when a valuer is paid to assess the asset and generally far less liquid to sell. As unlisted are less regularly valued, the value and therefore return is assumed but may not actually be accurate. It’s a sleeper issue because super funds have been increasing their exposure to unlisted assets and have been accused of smoothing returns and gaming the system. If the regulators change the rules about unlisted assets, there could be a shock to the system.
The summary is that super trustees have some difficult decisions to make about how they run their funds in the future.
Industry trends, market forces and government regulation are all creating competing pressures that may not actually be in the best interests of all superannuants.
Ironically, whilst the above points appear to suggest that all super funds could become homogenous, in fact the opposite may be true. Points of difference often overlooked become more elevated: service, the investment menu, disclosure of fees, management of risk, compliance process etc.