The reliability of super funds’ status as the so-called shadow banks in the Australian economy has been called into question, as new research finds as funds’ appetite for certain assets rise and fall in different stages of the investment cycle, it could create a “feast or famine” for sectors relying on their investments as a funding source.
The research, conducted by the Conexus Institute* and launched at the Investment Magazine Chair Forum on Thursday, outlined eight potential types of systemic risks related to modern super fund operations and investments.
“We hold some concern over the potential for ‘feast or famine’ cycles in the funding provided by super as assets fall in and out of favour,” wrote the institute’s executive director David Bell and research fellow Geoff Warren.
“Of concern from a systemic perspective is where a sector is relying on super for funding that is then subsequently withdrawn, causing the sector to retrench.”
Bell and Warren pointed to private debt as a recent example of where substantial superannuation capital has flowed, chasing a “hot asset class” in an environment with elevated interest rates.
This makes the prospect of the private debt market continuing to expand then contract “concerning”, said Bell and Warren. “A future scenario is imaginable where private debt falls out of favour with super funds, removing a key funding source for some businesses.”
But more broadly, Bell and Warren said asset allocation trends could most impact funding in two ways. One relates to the increase of funds’ overseas investment which could lead to a reduction in funding for Australian assets generally.
“Each 1 per cent reallocation to overseas assets amounts to around $40 billion in a $4 trillion system. This is a significant amount relative to our baseline estimate of $65-$70 billion of new cash available to invest in Australian assets,” the research said.
“If the pace of reallocation to overseas assets quickens or the flow of new funding available from super funds within Australia declines, then the super sector could move from a state of providing new funding to a state of either reallocating existing Australian assets (‘shuffling the deckchairs’) or even withdrawing funds.”
The second concern is that as funds grow in size, they are less likely to invest in small businesses or start-ups as it will be harder for assets of that size to have an impact on funds’ portfolio.
“With super becoming an increasingly significant conduit for equity funding within the Australian economy, and overseas investors tending to favour investing in larger companies, some reduction in available funding to small companies seems likely,” the report said.
However, Bell and Warren concluded that the real magnitude of effects that super funds’ asset allocation trends will have on funding flows will depend on whether other funding sources can effectively help fill the gap.
“Here effects would be limited to the extent other participants can take up the slack. This could include any remaining small-medium super funds, investment managers offering pooled funds that address sectors vacated by larger super funds, or direct investment by private investors.”
The report also myth busted some popular systemic risks often cited in public discussions. For example, it concluded that super funds’ foreign exchange exposure is unlikely to be a source of systemic stress and any liquidity impacts should be manageable.
But it identified superannuation’s operational structure as an area to be improved, most prominently in member administration.
“Upgrading the operational infrastructure in the industry will be challenging and is likely to entail considerable cost, time and effort,” the report said.
“We would like to see greater recognition of the situation, rather than presuming the underlying problems can be easily addressed and that ‘super funds are failing their members’ simply because they are incompetent or uncaring.”
*The Conexus Institute is a not-for-profit organisation philanthropically funded by Conexus Financial, publisher of Investment Magazine.
