This may sound like headline grabbing but I’m not being flippant: AustralianSuper’s decision to conduct an out-of-cycle valuation of its private assets creates a raft of issues for the superannuation industry. Hopefully, it leads to stronger internal and prudential policies, and a more robust industry, providing better outcomes and greater consumer confidence.
When we think superannuation liquidity risk, it’s natural to think cashflow liquidity. However, this is just one point of a trident of liquidity issues. Cashflow liquidity, quality of the remaining portfolio, and the equity of the unit price are each important.
Cashflow liquidity accounts for the ability to meet obligations as they fall due. Obligations could be member-driven (redemptions and switching) and portfolio-driven (settlement of currency forwards and other derivative positions). This is all reasonably well understood by the industry. Historically funds have been caught when all the bad things happen at once during a crisis: members redeem and switch, the Aussie dollar falls generating settlement demands, and perceived liquid assets become illiquid (such as credit and hedge funds during the global financial crisis). Funds, under the review of APRA, have been refining their approaches to managing this risk for a number of years.
Quality of remaining portfolio relates to the portfolio in which remaining investors find themselves. Does it represent good investment ideas, is it appropriately diversified, and does it contain sufficient liquidity? This was a big issue for hedge funds during the GFC: many funds sold their liquid assets to fund redemptions and left their remaining (loyal, such as naïve me) investors with poor quality, unbalanced portfolios.
The assessment of this issue can be quite subjective (unless the portfolio sits outside published portfolio guidelines) and sits with a trustee. Simply put, should a trustee allow redemptions if it leaves remaining members in a portfolio of insufficient quality?
The third liquidity-related issue is equity in the unit price. Private assets typically utilise appraisal-based valuations conducted periodically but not frequently. In between valuations, assets are typically held at their most recent valuation. Yet we allow daily (high frequency) transactions. In stressed environments it may become clear that an asset is worth less than its last valuation. This means the unit price of the portfolio is effectively overstated. Redeeming investors are effectively subsidised by remaining investors.
It is this third liquidity-related issue which appears to have motivated Australian Super’s decision to review (out-of-cycle) the valuations of their private assets. The trustee of AustralianSuper should be acknowledged for making this decision. It goes to the heart of fair treatment of remaining members who have taken the guidance (provided by most funds) to remain invested for the long run. Why should those remaining members subsidise exiting / switching members in this environment?
There are many questions and related issues. Proverbially, the can of worms is now open.
Unit price equity
First, let’s think about the concept of unit price equity and industry practice. How many funds consider the issue and have an internal policy? How many funds have conducted out-of-cycle valuations? Should there be industry guidelines or should the issue be left to individual funds to decide? How well is this issue monitored by the prudential regulator? Indeed, issues of unit price equity are probably the domain of both APRA (prudential) and ASIC (conduct).
Is there potential for claims relating to inequitable treatment and damages? After all, in Australian Super’s case the unit price was probably 2 per cent off the mark the week prior to the revaluation. If we consider the extreme case of a 10 per cent redemption, the impact on remaining members is around 20 basis points (i.e. the sizable benefit to a small number of redeemers is borne by a small detriment to a much larger group of remaining investors). This number should be comforting to those worried about a scare campaign inducing a contagion scenario.
Hopefully, this doesn’t lead to the retail funds sector launching a scare campaign. Retail funds have often felt unfairly treated as many have watched industry funds invest in private assets. Often these assets are self-assessed to be less than 100 per cent growth, and this has contributed to peer group outperformance.
In a way, this line of thought misses the point: it is important to be cautious when investing in private assets. But the issue is not investment risk (in my research the risk of private assets does appear to be less than their listed equivalents). Rather private assets create other issues such as liquidity risk and unit price equity issues. It is these issues that require sound policies.
Ultimately let’s reflect on the structure of this industry. Superannuation is for the long-term, and in that sense, private assets make a lot of sense. Yet we allow, and in some cases promote, daily liquidity and switching capabilities. That’s a bad mix.
AustralianSuper’s case study has directed a floodlight onto some of the more nuanced risks which come with investing in unlisted assets. Let’s take the opportunity to get these issues clarified and actively monitored and managed sooner rather than later so that we can invest for the long-term and not lose the confidence of members.
David Bell will be speaking at Investment Magazine & Professional Planner’s digitally live-streamed event: “Superannuation and retirement in crisis”.