This article is drawn from a State Street paper, ‘Evolving superannuation funds for the future’, which explores the challenges facing the industry today and how it is evolving in response.
To download a copy of the full report, see here.
Robert Goodlad, Senior Managing Director, State Street Global Advisors, Australia
Lachlan Baird, Chief Executive Officer, Prime Super
Alistair Barker, Investment Manager, AustralianSuper
Ross Martin, Former Chief Executive Officer, Media Super
The super fund industry is experiencing a growing number of mergers — a shift that will have permanent effects on the industry. We set out to learn the factors that funds consider when deciding to merge, what they see as the pros and cons of merging, and what the long-term implications could be. We discovered that the reasons for — and results of — mergers vary. Some funds see the benefits of scale and others mention challenges associated with the lack of scale. Meanwhile, there are warnings that the cost benefits of merging don’t actually materialise the way funds expect them to. Our panellists discuss these issues, as well as their tips for success and their thoughts on the future of the industry. Highlights of our discussion are shared here.
Robert Goodlad: What is driving the recent trend of super fund mergers? What role does scale play?
Alistair Barker: We believe that adding to the scale of our fund and operation will deliver tangible benefits to our members. The motivations for merging with us vary for each merger partner, but it comes back to being in the members’ best interest. One of the benefits that we are working through is internalising a substantial part of our portfolio for significant cost savings. It will enable us to operate the fund and continue to add value in our lower-cost environment — which is particularly relevant with the upcoming start of MySuper.
Ross Martin: We don’t have any problems doing what we want to do for our members. My feeling is that if you are struggling to meet your business plan, then you aren’t big enough. If you can accomplish what you want to do, you are big enough. We currently have a number of new business opportunities, but do not want to merge with funds outside of the media industry, which is our strategic focus. You shouldn’t override the particular business plan of the fund to any merger strategy.
Lachlan Baird: A big driver is the new regulation and its increasing complexities at the smaller end of the market. This creates a need to expand existing resources, which comes at a cost. The only way that you can achieve cost efficiency is to merge with another fund. Broadly, there hasn’t been significant growth in super member numbers, as most of the real growth is coming through mergers. This is important to be aware of. If you look to where you want to be in five to 10 years, you will need more scale to add and deliver the complexity that members will be requesting — which will cost money.
Robert: Are cost savings and member value tangible benefits of mergers, both at a fund and member level?
Alistair: These are two major benefits of mergers, but they also touch on service delivery to members. This is true particularly in the post-retirement phase, but also with other products. It is difficult to strike a balance between having too many products and not enough. We do hope that we will have the scale to expand our offering as needed.
One of the tangible benefits with mergers is around the comfort that members can receive. A lot of smaller funds do a fantastic job for their members and have very good returns. However, the reality is that almost all of the larger funds within the industry have delivered at or above median returns over the longer term, and many smaller funds have not.
Ross: Four years ago Print Super and JUST Super merged to form Media Super. The JUST members received reduced administration fees, but the Print Super members didn’t. So, to say that costs will always go down isn’t true. The benefit of a merger is that it defers the potential to increase costs, but it doesn’t necessarily reduce costs.
With a number of mergers, you also take over illiquid assets, which may be the worst performing assets in the portfolio. You can’t do anything about it if they are private equity or similarly illiquid investments.
The compliance and accounting costs should be lower for the post-merged entities. I remember explaining the benefits to our board post-merger at the same time our audit costs were going up by 30 percent. I told them that was good — for the combined group, the audit costs per pre-merged entity were now down by 40 percent. It may not look like the situation has improved, but in terms of costs, there’s a need to view the new percentage of that in AUM.
The idea that you can provide more services is possible. But generally with bigger mergers, most funds are already offering the services that they want and members may not want new services.
Lachlan: On the investment side, you might see a marginal change, but I don’t feel that there are significant savings. You can share out the costs across a larger membership so that maybe you defer some of those increases for a little bit longer. With MySuper and Stronger Super, we are seeing a lot of new costs. If we can defer those to a much later date before passing them on, then we do actually get something out of it.
One of the tangible benefits for members is that with greater scale, it is easier to have more people. Super funds are very complicated and people generally don’t understand the details. If they can engage with people and employers, they can better understand their super. This is not necessarily a cost savings, but it is the ability to get more from the fund.
Alistair: Insurance is another benefit. Certainly members who have merged in from other funds have seen significant changes in their insurance cost, or in items such as automatic acceptance limits, because of having a greater pool of members for spreading the insurance risk. The insurers are a little bit more willing to take a broader view.
Lachlan: I agree. One of the concerns I have over the longer term is if the number of super funds reduces to a handful of big funds, like the government wants, will this create an even bigger risk, particularly on the insurance side? If you have four or five funds and they all have the insurance risk in those four places, does it make it more expensive in the long term?
Robert: What are the barriers to a successful merger?
Alistair: One is certainly around investment portfolios and whether or not there is a difference in investment philosophy between the merging partners. Sometimes the portfolios can have difficult investments, and unless they are priced appropriately at a merger date, it can be difficult to counter terms there.
The other barrier is around whether it is appropriate to — and whether people want to — stay focused in a particular niche area, which is an entirely relevant thing for a lot of funds to do.
Lachlan: It is critical to make sure that you have the two boards in agreement over the philosophy of the fund going forward, who is going to be on the board and the structure of it. It’s about making sure that you get the two boards, the investments, administration and insurance together to make sure that it is something that will function. At that time you put out the tender to get the best deal for the new fund going forward.
Robert: Will there still be a role for niche funds in the future? What can they do to justify their independence?
Ross: I do feel there is a future for niche funds. Since we are focused on growing from within the media industries, we have a lot of exposure to companies like Fairfax and News Ltd. They are roughly 10 percent of our fund, but they have their own corporate funds. They are the kind of targets that we want to break into.
We feel that if we are successful in growing the fund, then there will be a great loyalty factor involved with our members and being part of the media industry. It is not a super fund so much as a fund for our industry. The loyalty factor is the way to justify the operation within each fund.
Lachlan: Of course there is a place for niche funds. If we make a comparison to the banking sector, we have the big four. Then there are other parties out there. I don’t mean to bash the banks, but if we didn’t have the smaller funds or banks, then there would be too much power consolidated within a small group. You would end up paying more for it over the longer term. When they opened up the home loan market to have more flexibility in where you get your home lines from, we saw a reduction in the costs. One risk is that if we keep merging to create a small number of mega funds, in the longer term that will result in less competition, higher costs and other problems.
Robert: What are the key attributes of a fund that you would consider as a merger partner?
Alistair: The main one is if the two funds are complementary and if there is an underlying imperative for both funds to want to merge. For example, we were quite keen to grow our retirement division because we wanted to have the scale to offer a product within the post-retirement area. AGEST merged with us this year, and fit with this idea quite well. They gave us some reasonable scale to think creatively about what we can do for members in this area. Ideally, both parties share a philosophy around how members’ assets should be managed.
Ross: There also has to be some commonality of investment philosophy around not only how the fund should be run, but also in getting its staff talking to members. One of our prime attributes is that we do talk to our members and have managers all over Australia. We’d want to merge with someone who shared this philosophy.
Lachlan: It is basically a marriage. If you both have the same vision, then it can work. But if you are coming from different angles, then it won’t work. There are many hurdles along the way, so both parties have got to be willing to get over them together and not just give up. You both have to want the same final result.
* Ross Martin is no longer employed by Media Super.