Researchers Scott Lawrence and Geoff Warren say it is time to abandon ‘the size is good’ mantra that is helping drive a wave of merger activity among super funds in Australia.

The Australian superannuation industry is currently going through a wave of consolidation that is at least partly driven by a belief that larger scale is beneficial. But is this necessarily the case?

After examining this issue in a recent paper, we conclude that large fund size could be either beneficial or detrimental for super fund members. What matters is whether funds can execute effectively on their investment strategies and provision of services to members, whatever their size.

Large fund size has both advantages and disadvantages and gives rise to some significant challenges. It is not an automatic win.

We have no argument large size offers the potential to reduce cost ratios and hence fees. This occurs via replacing external investment managers with relatively less costly internal management teams, and economies of scale in some administration functions.

Expanded operational scope

Alternatively, large size might be used to expand the scope of operations. It hence may not appear in lower fees, but rather greater functionality that could benefit members through improved returns or services.

For instance, size can enhance the ability to invest in big-ticket private market assets such as unlisted infrastructure and property, which offer a range of benefits but tend to be higher cost. Being able to bring more resources to bear can enrich functions like portfolio and risk management.

Large size can assist in providing more and better customised services to members, to the extent that such services require significant resources in terms of systems and staff. Ability to customise may be particularly important in offering retirement income strategies.

The drawback of scale

Size also brings disadvantages and a raft of challenges.

A number of features could work to hamper investment returns. Large funds need to source assets in large volumes. They thus rely on the availability of attractive assets that can take enough investment to move the dial.

Large funds can also outgrow the ability to invest effectively in some public market segments like small-mid cap equities and various niche markets where there may be better opportunities. Big portfolios are harder to adjust quickly at low cost. Internal teams could struggle to perform.

Large organisations tend to suffer problems of internal coordination and bureaucracy. They are typically less flexible. And they find it harder to deliver a good experience to those members who engage.

Recipe for success

There is a long list of things that large funds have to get right to succeed. They need to focus the investment program on areas where scale is advantageous. This likely includes building internal teams and the capabilities required to invest successfully in private markets. Sourcing and retaining skilled staff are critical, as well as building a governance structure and culture that fosters a co-ordinated effort.

As funds grow to very large size, a direct overseas presence starts to become inevitable. AustralianSuper and Aware Super are currently establishing overseas offices, and others will probably follow. Becoming a true global investment organisation takes the game to a new level. It only heightens the challenges around staffing, coordination and culture.

Thus, while large size has the potential to benefit members through better returns and services, there is plenty that can go wrong. We anticipate a mix of successes and failures as the journey unfolds.

Systemic effects of consolidation  

There are also broader systemic effects of consolidation in the superannuation industry. Our conclusion is that impacts are unlikely to be major but are mainly detrimental. Our concerns fall into two groups.

First are impacts on market structures. The superannuation industry is becoming increasingly systemically important. Further concentrating assets in a handful of large funds could dent market resilience and competition, noting that both are enhanced when populated by participants that behave in a different manner.

Institutional presence could be hollowed out in markets that large funds tend to pass over, such as those providing capital to smaller companies. This matters as institutions enrich the market environment through bringing research, price discipline, monitoring and liquidity.

In short, the financial system would be stronger and more vibrant if populated by superannuation funds of various sizes.

Second is what happens if a large fund gets into trouble. Large funds have more members and a bigger footprint. Any ructions might cause damage on a broad front. While a run on a fund seems unlikely, it is not impossible under member choice. The main losers would be the members in the fund.

It is time that the size is good mantra was discarded. Focus should turn towards whether large and growing funds are adapting their operating models and building the capabilities to succeed at scale. We also suggest more thought be put into the broader systemic implications of consolidation in super.

Scott Lawrence is principal of Lawrence Investment Consulting and Geoff Warren is a research director at the Conexus Institute and an Associate Professor at the Australian National University.


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