International pensions expert Keith Ambachtsheer thinks most Australian superannuation funds lack the scale and sophistication to deliver in their members’ best interests, and the local regulator should step-up its efforts to drive fund mergers.
Ambachtsheer put a few noses out of joint when he told a recent gathering of Australian superannuation executives that “about $50 billion” in funds under management was the level at which funds are large enough realise “real economies of scale”.
He tipped the ability to bring some investment mandates in-house to be managed by an internal investment team, rather than relying solely on external funds management firms, was set to become a defining characteristic of best-practice funds.
“Scale allows funds to hire expensive people with a specific skill set who understand infrastructure investing and can source, originate and syndicate deals. In other words, people who can act like investment bankers,” Ambachtsheer told the Conexus Financial Fiduciary Investors’ Symposium in Healesville, Victoria on November 15.
The idea that funds need to be big enough to insource sophisticated investment teams is an unsettling one for most industry participants. According to the latest available Australian Prudential Regulation Authority (APRA) fund level statistics, only seven of the 231 registered super funds in the market had $50 billion under management at June 30, 2015.
Insourcing the way of the future
Ambachtsheer said $50 billion in assets was the level at which the “economics of insourcing started to really add up”.
Funds with less than $50 billion under management are also disadvantaged by a limited ability to invest directly in private markets, he said.
The so-called “Canadian Model” of insourced investment teams, as pioneered by The Ontario Teachers’ Pension Plan, is already catching on.
Some of the largest local super funds – notably $100 billion AustralianSuper, $60 billion QSuper, $55 billion UniSuper, and $34 billion Cbus – are already well advanced on strategies to insource more of their investment management.
All of these funds are also directing more capital to into unlisted assets, such as property and infrastructure.
Governance matters
Speaking to Investment Magazine on the sidelines of the event, Ambachtsheer said scale was a “tremendously important” factor in a super fund’s capacity to meet its governance obligations, while acknowledging that scale was no guarantee of good performance.
“Of course a large fund can have bad governance, but with sufficient scale comes the opportunity to do some amazing things if you do have the right governance.”
APRA deputy chair Helen Rowell has made numerous public statements over the past two years warning super fund trustees they must do more to shore up their fund’s ability to continue to meet the prudential regulator’s “scale test”, or pursue a merger with another fund to protect their members’ best interests.
However, Rowell has been much more circumspect than Ambachtsheer about the ability of small and mid-size funds, with appropriate outsourcing arrangements, to deliver value for members. Speaking at a conference in 2015 she indicated APRA was concerned about the ability of many funds with “less than $1 billion or even $2 billion” to continue delivering sufficient economies of scale without a viable growth strategy.
APRA staff have participated in a board effectiveness program for pension funds and other long-horizon investment managers that Ambachtsheer runs out of the Rotman International Centre for Pension Management at the University of Toronto, Canada.
Merger push
Ambachtsheer said APRA was “clearly very serious about governance” but urged the regulator to be more transparent with the public when it has concerns about a particular fund.
“My expectation is that the first notice might be a quiet one. But if the board doesn’t shape up there has to be some kind of public notice so the public knows the regulator has deemed the board to be ineffective,” he said.
“Change will require a push. These directors aren’t going to just wake up one morning and suddenly decide to merge because it is in the best interest of their members”.
Pension fund regulators in The Netherlands have recently pursued this style of name and shame approach, which has proven effective at improving outcomes and driving mergers.
Sceptics argue the reason there have not been more mergers is that some fund directors and executives are motivated by vested interests, in instances where a merger would put half of them out of a job.
Ambachtsheer said the international experience indicated there was likely some truth to this assertion and that lifting the professionalism of boards was part of the solution.
Following a backlash from the industry fund lobby, the Turnbull government was this year forced to put on ice its plans to force all super funds to allocate one third of boards seats, including the chair, to independent directors.
Ambachtsheer said his preferred model was to maintain the representative nature of the industry fund model by allowing unions and employers to each nominate an equal number of directors, but forcing them to select these individuals from a suitably qualified pool of candidates rather than from within their own ranks.
An alternative for small funds that do not wish to merge is to pursue an ultra-low fee strategy.
“If a small fund can run at 5 basis points then you could make a case for doing that, but understand that probably takes away the possibility of generating an extra 100 to 200 basis points for members in the long term.”
Ambachtsheer’s latest book is The Future of Pension Management: Integrating Design, Governance, and Investing. He is also the founding director of KPA Advisory Services and a co-founder of CEM Benchmarking, which benchmarks the organisational performance of 400 plus major pension funds around the world.
