Under the Corporations Act, a managed investment scheme that holds 20 per cent or more in illiquid (or unlisted) assets is deemed an illiquid scheme and is restricted from providing frequent liquidity. Meanwhile, there is no formal limit on how much super funds can allocate to unlisted assets. Regardless of how much they hold in such assets they can – and are required to – offer frequent liquidity by accepting applications, redemptions and option switching.
Super funds thus have special privileges in how they can include unlisted assets in their portfolios. No other savings vehicle in Australia has this benefit.
A common view is super funds are entitled to these privileges due to the secure cashflows resulting from the Superannuation Guarantee, preservation rules and the long-horizon nature of super savings. Yet more than a third of APRA-regulated super funds are experiencing net negative member flows due to factors such as aging membership demographics, competition, and changes in underlying employment sectors.
Many espouse the benefits of unlisted assets, noting access to ‘alternative return sources’ including long-dated investments, management opportunities in an unlisted setting, diversification and supressed volatility. Each of these contentions is heavily disputed.
Nevertheless, we are not challenging the investment case for unlisted assets. At a minimum, unlisted assets expand the investment opportunity set for super funds. Most funds seem to be adding to rather than reducing their unlisted holdings.
With privilege comes responsibility. In this case, the responsibility of super funds is to expertly manage liquidity risk and value these assets appropriately, while carefully presiding over any implications for member equity such as fairness around the unit prices at which members enter and leave the fund. APRA has made this clear in its regulations and guidance. Excellence in governance is the key to super funds effectively utilising unlisted assets.
It is hence disappointing that APRA’s recent review of governance practices around unlisted assets uncovered shortcomings. APRA found many funds do not have best practice valuation processes and could improve their risk management. Every fund needs to do more to formalise frameworks relating to member equity.
Some funds are doing many things well. It must be frustrating for these funds to have peers that lag and bring negative attention to their sector.
Use of unlisted assets by a large and fast-growing super system has given rise to concerns over systemic risk. For instance, the International Monetary Fund has raised this issue. We caution against overstating the systemic risks due to a lack of clear mechanisms to propagate liquidity strains in super across the financial system. Super funds are not leveraged and may sell their ample liquid assets to satisfy cash calls, which in turn shuffles the ownership of the assets around the system.
Nevertheless, a super fund under liquidity stress may harm its own members as it struggles to sell assets at reasonable prices, grapples with a potentially ‘out-of-shape’ remaining portfolio and responds to any redemption requests. Advanced risk management practices are required to manage these risks, especially as portfolios increase in complexity and funds carry a larger footprint. This is where some super funds are struggling.
APRA has set clear expectations. Portfolios with unlisted assets require well-resourced, sophisticated frameworks for valuation, managing risk and overseeing member equity. Following peers and applying rules-of-thumb is inadequate. For instance, a fund’s maximum allocation to unlisted assets should be informed by its own net inflow position, not by the allocations of peers that may be experiencing different inflows. If funds aren’t reaching the required standards, then their governance models need to be reviewed.
When it comes to unlisted assets, super funds have special privileges. But not all funds are respecting this privilege, with some failing to appropriately manage risks to member outcomes. Significant portions of the industry need to raise their game.
David Bell is executive director of The Conexus Institute. Geoff Warren is a research fellow at The Conexus Institute and an honorary associate professor at the Australian National University.
