The controversial proposal to create a shortlist of the nation’s top 10 super funds has been labelled an “iterative improvement” by a high-profile UK pension expert who also warned policymakers against being blind to the dangers of such a scheme.

While the ‘best in show’ proposal has already been lambasted by major players who say it would concentrate the market and undermine competition, professor David Blake, director of the Pensions Institute at Cass Business School in London, says it’s a solid step, in principle, towards boosting returns for some fund members.

He warns, however, that there is a danger of regulatory capture – that the industry will pressure the regulator into promoting the selected funds for the wrong reasons.

Still, broadly speaking, Blake supports the proposal and further argues that the financial regulator should play the role of the ‘intelligent consumer’ and remove individuals from high-cost funds that perform badly.

In his view, Australia needs a new approach, since the current super system assumes competition that doesn’t exist.

“A whole range of behavioural biases and inertia dominate behaviour, which means consumers don’t behave in a way that a simple competitive model would predict,” Blake explains. “This is why so many people keep their money in poor-performing funds.”

Things are no better in the UK or the US.

“Competition only works when consumers understand the products they’re buying, and the problem is they don’t, anywhere,” Blake says. “So, applying a competitive model to super is faulty. Even when you have a lot of apparently competing providers, there is an implicit oligopoly.

“Providers almost collude in not competing, so you do need a different model to ensure the customer is getting value.”

As for Blake’s concerns about the best-in-show proposal, they range from spotty performance to how well the process is monitored and whether the policy encourages innovation.

The danger is that as more money piles into the winning default funds, the manager will simply scale up the investment, which will bid up the price of stock already held, which will lower returns.

“If you have default funds investing in best-performing local equities, they will soon become the least-preforming equities, because you are still scaling up the investment,” Blake explains. “Australia will end up with a diseconomies of scale problem sooner or later.”

He notes that Australia’s home bias in asset allocation remains an issue for the savings industry.

Current figures show that in a typical portfolio split 70/30 between equities and bonds, half of that equities allocation will be in local stocks. In a globally diversified portfolio, only 4 per cent of funds should be invested in Australia.

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