New APRA analysis suggests big retail superannuation funds are missing out on economies of scale that their size should give them, unlike large not-for-profit funds.

Not-for-profit superannuation funds’ clean structures and ways of lowering investment costs mean they benefit more from consolidation than their bank-owned competitors, analysis by the prudential regulator shows.

Multi-billion-dollar not-for-profit funds show a “size-related advantage” by achieving better net investment returns at lower costs than their smaller peers, states the Australian Prudential Regulation Authority (APRA) in a recent working paper analysing the returns of 280 funds.

However, such economies of scale are not evident among the largest bank-owned retail funds, which exhibit marginally higher investment costs while delivering lower returns, Effect of fund size on the performance of Australian superannuation funds, released March 26, reports.

From September 2004 to June 2010, members of the largest not-for-profit funds gained a net investment return of 112 basis points more than members with similar balances in the smallest funds. Not-for-profit funds include industry, public sector and some corporate schemes.

The average difference in net returns between the largest and smallest not-for-profit funds was 75 basis points each year. The largest retail funds, however, have “lower and more volatile returns” and were beaten by their smallest peers by an average of net 80 basis points each year.

“Fund members are likely to benefit from further consolidation in the not-for-profit sector,” the report, written by James Cummings of APRA’s policy research and statistics division, states.

Scale benefits accrue when not-for-profit funds grow to a multi-billion-dollar size and are not exhausted by Australia’s largest funds, the paper states.


Platform problems


The platform structures of many retail funds can explain their lagging performance, the paper says. Platforms are used to sell and administer “hundreds” of investment choices blended by investors. Retail funds offer an average of 248 investment strategies to members. In contrast, not-for-profit funds provide an average of 11 options because they manage portfolios with asset allocations controlled by trustees, not individual investors.

“The outcome of this approach is that a retail fund is often simply an aggregation of many separate investment choices, rather than a coherent investment strategy for a pooled set of assets,” the paper states. “There is limited opportunity for the trustees of the fund to shift resources towards asset classes for which scale and negotiating power matter.”

Not-for-profit funds can combine assets to invest in a broader range of investments, such as property and private equity, to improve investment returns, according to APRA. The low investment-expense ratios paid by the largest not-for-profit funds also suggests they use the weight of pooled assets to negotiate cheaper fees and better contractual protections.

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