One interesting observation regarding the current round of merger discussions is that many of the funds publicly mentioned are in good health – generally these funds are experiencing positive net inflow. In contrast, there appears far less activity amongst funds in a less healthy position.
Why would this be?
The attractiveness of a merger is that it increases scale. This provides operational benefits, including the ability to raise larger operational reserves to fund future projects. It also creates some potential for investment scale benefits (lower investment fees) which needs to be weighed against a loss of flexibility which may or may not be valued in a world which feels more peer-relative than ever.
A merger creates a one-off tangible cost. However, there are additional factors to consider such as the impact on culture and the post-merger operational environment (the number of legacy systems and products the merged fund is left with).
A merger can sometimes absorb a huge amount of focus, though there are some examples of a merger not being all-consuming – usually where small funds roll into larger funds on a clearly defined basis. There is also the issue of prioritisation: if implementing a merger becomes the top priority, then what activities are put aside e.g. developing a better investment model, greater personalisation, retirement strategies, engagement etc.? Good trustee discipline would be to state clearly what is being de-prioritised.
The net inflow positions of merging funds should also be considered. If a fund in net inflow merges with a fund in net outflow then, all else equal, the fund dilutes its net inflow position. If net inflow is valued from both a sustainability and an investment perspective, then to incur cost and bandwidth implementing a merger which ultimately reduces the net inflow position would be a difficult decision for a trustee to justify.
Similarly, if two funds in net outflow merge you simply end up with a larger fund in net outflow. The sustainability metric of scale may improve but the net inflow metric would not. Indeed, it arguably impairs the prospect of improving future net inflows as a fund focuses on implementing a merger rather than enhancing their organic growth strategy.
Are we left with a situation where there is no rational reason to merge with a fund in net outflow? This creates the risk of super fund orphans – funds that no one wants to merge with.
Yet, undoubtedly, it feels like the merger squeeze is on. The regulatory pressure is focussed on cost reduction and greater scale. SPS 515 (Strategic Planning and Member Outcomes), the APRA heatmap, and additional regulatory requirements will maintain this pressure. Funds need to justify themselves and their activities like never before. At some point the focus will spread further to retirement outcomes, thereby increasing cost, complexity, and in turn, the merger squeeze perpetuates.
Is there a need for something like a national consolidation fund? In concept, this would be a fund dedicated to merging with any fund seeking a partner. It would be an operational specialist (to deal with all the legacy product and system issues. Presumably it would face its own net inflow challenges, and these would need to be worked through. It would provide a benchmark for a fund looking to merge to use as a comparison against other alternatives. It would represent a hurdle to be used by the trustee of a fund when justifying their choice of merger partner. It could be used as a hard benchmark in SPS 515 outcomes assessment tests.
It appears that there is a policy / regulatory desire for consolidation, but one not supported by the necessary infrastructure. The duty of a trustee to their members makes it potentially difficult to merge with a fund in net outflow. A national consolidation fund could be a pragmatic solution and would reduce one lottery issue (to use a term coined by the Productivity Commission) creating large dispersion amongst the retirement outcomes experienced by Australians.
David Bell, a former chief investment officer of Mine Super is the executive director of The Conexus Institute