There hasn’t been a good political stoush in the superannuation industry for some time. The main game in recent years has been adequacy, with debate involving not whether we should be saving more but, rather, how we go about it. Enter Jeremy Cooper, drawing the ire of new IFSA chief executive, John Brogden, for perhaps jumping to conclusions before he has completed his inquiry into the industry – not due until the middle of next year.
Cooper was expansive last month during his speech at the ASFA conference, suggesting the funds management industry was wagging the superannuation dog and that further massive consolidation among funds would be a good thing, for instance enabling more co-investments in big infrastructure projects. A total of 25 funds could be an aim.
It is difficult to argue with either point. According to figures from AIST, there are about 80 funds with more than $1 billion under management, out of a total of about 300 APRA-regulated trustee entities. The total money in not-for-profit-run super funds is about $350 billion, or roughly one-third of total super money.
Watson Wyatt Worldwide has a form of best practice manual based on the operations of 10 big pension funds and sovereign wealth funds, in which it categorises funds into three levels. Level one is a minimalist low-cost fund with mostly outsourced investments and level three is the full monty, with empowered internal investment staff overseeing a wide range of investment types. Level two is somewhere in between.
Watson Wyatt’s global head of investment content, Roger Urwin, who visited Australia last month and got a copy of Cooper’s hand-written speech notes, says that the minimum size for a level three fund is between US$2-3 billion. According to the Top1000Funds. com database (owned by Conexus Financial, publisher of this magazine), there are 30 Australian super funds with more than US$2.2 billion under management, which would have the capacity, therefore, to become level three funds for world’s best practice.
Most of the remaining Australian funds probably fit into the uncomfortable middle ground of level two – not being particularly low cost and not being particularly good at overseeing a sophisticated investment structure. That is not to say that these funds are not currently doing a good job. Certainly, compared with overseas counterparts of a similar size, they are streets ahead in sophistication. But in order to achieve and maintain a level commensurate with world’s best practice, the small Australian funds may well struggle in the future.
If the Watson Wyatt work is a good guide, though, Australia could support 80-100 funds with sufficient scale to aim for best practice, provided they were able to mop up the remainder of funds, which may need some help from the Government. Some in the industry go further than Cooper’s suggestion. Ron Bird, Professor of Finance at University of Technology Sydney and Jack Gray, fund manager and part-time academic with the Paul Woolley Centre for Capital Markets Dysfunctionality, believe the optimum number of super funds is about six or seven.
They believe that super funds compete with each other too much, as Cooper seems to believe, in the broad markets by all buying the same stocks using too many outsourced agents. They also agree with Cooper’s assessment that funds managers’ positions on pricing power are similar to the tail wagging the dog, as does Watson Wyatt’s Urwin. Most of the fee structures for funds management firms were established long ago, say 30-40 years, when the industry was smaller, yet they persist today.
Urwin says the fee structures are anachronistic and do not adequately reflect the scale which the aggregation of pension fund money has brought to the industry. “There is some change, but it’s not happening as quickly as you’d like to see it take place,” he says. Watson Wyatt, with between US$2-3 trillion under advice, has been urging client funds for some years to be more aggressive with their external managers on fees and charges. “Institutional funds should be managing their cost budgets more aggressively.
They’ve been looking at the opportunities and have probably been more keen to manage costs with their own staff.” Urwin says those funds with significant internal investment resources have tended to recognise the value proposition being presented by agents more accurately, and have therefore been more aggressive in negotiations. Competition is relatively weak among workplace pension markets across the world, he says. The two main symptoms of this are governance and cost structure.
“The point about governance,” Urwin says, “is that the pensions industry hasn’t shown its leadership mettle yet. It hasn’t acted as though it’s at the top of the food chain. It has the check book and it’s managing the expenses.” Most of Watson Wyatt’s research is set against the backdrop of fund governance. When asked what sort of investment strategies a particular fund could pursue, for instance, the firm needs to study the fund’s governance first.
Home-grown consultants such as Frontier and JANA have also been railing against manager fees for years. Frontier this year floated the idea of a dramatic change to most fee structures such that managers are paid a flat fee, calculated based on their overall costs, plus a performance fee. This would mean that managers would not lose out so badly when markets fall significantly, but of course they would not get a free kick either when markets rise. So far, the global financial crisis has not had that dramatic an effect on the way the funds management industry works – it’s just downsized for a while. Perhaps Jeremy Cooper will.