$30bn down the drain: not much change

PORTFOLIO POINT: The funds management industry remains heavily weighted in equities. A lack of investment alternatives makes DIY super the most attractive option.

Last week (click here), Alan Kohler wrote about the underperformance of the superannuation industry and noted the heavy reliance or allocation into equities as one reason underpinning this underperformance.  

Readers may remember a piece I wrote last quarter showing by just how much the funds management industry was investing, and had invested, into equities, although I was more looking at what this allocation implied for risk appetite.

The data set I looked at then has recently been updated, and so I think it’s worth having another look this week at whether there has been any change in behaviour since the last time I wrote on the subject.

There is plenty of reason to think there would be. The underperformance that Alan highlighted is one aspect, but, in addition to that, the investing environment deteriorated sharply over the June quarter – it certainly wasn’t pretty. The election stalemate in Greece sparked a market rout that lasted the whole quarter and, if you recall, over that time US stocks fell over 10% to the trough, ending the quarter only 3% lower.

The All Ords ended the quarter almost 6.5% lower, but that again was up from a 10% fall at the trough. The mood was grim and it has since barely recovered. Surely all of that would have sparked some reaction, some change or shift in investor behaviour?

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Against that backdrop we shouldn’t be surprised that over the last quarter total funds under management have actually declined somewhat (see chart 1 above), although overall the fall has been modest. We’re only talking about $4 million, which is nothing in the grand scheme of things and, for the superannuation industry in particular, funds under management actually rose about $1.6 million.

However APRA advises that in the June quarter there was about $30 billion in new super contributions, so when you net everything out, the funds management industry, excluding those contributions, actually lost just below $30 billion of funds – in one quarter.

That is certainly a dismal tale of woe, driven by valuation changes or market moves more broadly. Alan certainly has a point then, and it’s not incorrect to argue that if there wasn’t such a high weighting toward equities then these losses wouldn’t be so significant.

I mean cash yields about 3.8% on average and Aussie bonds surged over the quarter – three-year futures were up over 120 points. At $30 roughly per point, one contract ($100,000 face value) would have given you $3,600, or a return of 14.4% annualised (these figurings are very rough and not exact).

With that in mind, the recent data shows the allocation to equities is still nearly double that of cash, and many multiples of short-term securities or bonds.

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Moreover, and over the last quarter, recent data shows that has barely changed, with allocations moving little as you can see in Chart 2 above. The longer-term trends I mentioned last quarter still remain – a sharp lift in deposits at the expense of debt securities, unit trusts and investments overseas.

Indeed, we can gather that funds managers look to have almost barbelled their investments this quarter and are still keeping well clear of debt securities. So cash deposits surged almost $16 billion, or $14 billion assuming interest received is reinvested. Similarly, when we look at equities under management, they should have fallen by about $28 or $29 billion if we take the fall of 6.5% in the All Ords as a guide to valuation.

Yet the fact that funds under management in this sector are down a smaller $12 billion suggests there were inflows of approximately $16 billion.

When we look just at the superannuation industry it’s the same pattern. Indeed there doesn’t look to have been any inflows into bonds and short-term debt securities over the quarter, and while funds under management in these components increased (by $1 or $2 billion only), this appears to be mainly due to valuation changes following the significant rally in debt securities over that period. But the bond rally has been going on for some time, so why, in a period of so much consternation, have fund managers not aggressively switched into bonds or even shorter-term debt securities?

The simple answer is one I have mentioned before – that there is no real economic rationale to do so. Indeed, many of the advanced economy sovereign yields offer you no return after inflation. In other words, you are paying the sovereign to buy their bonds and so there is no incentive to take the income or the yield here. In addition to that, investors expose themselves to considerable capital risk.

The ECB, the Fed, the BoE and the BoJ are all printing money to either directly or indirectly buy sovereign bonds. This is what is behind the global rally, not investor perceptions or any qualitative or quantitative assessment of worth – or risk. Just central bank printing.

The Fed, for instance, is the largest single holder of US Treasuries, and at various stages had bought all new treasury issuance for a given period. US Treasuries are in turn the benchmark for all other sovereign yields.

In the Australian context, we have to contend, not only with the global problem of a central bank induced bond bubble, but there is a more practical matter to think about. The market is simply too small. If you want the ‘safety’ of a government bond and you want to get in on that huge rally we’ve seen over the last quarter, then good luck! The bottom line is that the Australian government bond market – Commonwealth and states – has only $400 billion (or so) outstanding, with 70-80% of our Commonwealth bonds held by foreigners. That’s a very small pool of bonds left over for retail investors.  

I think Alan’s point more broadly about the super industry is spot on. The Australian retirement savings industry is indeed a “dismal tale of woe”. But I don’t think that we can reasonably criticise the industry’s asset allocation. Bonds and short-term debt just simply aren’t a viable alternative in this environment.

There’s not a lot of choice between cash and equities to be honest. It’s more the cost and fee structure that Alan alluded to. That’s the leakage from your savings into bloated salaries for some super/fund managers and especially the brokers who service them. That is, the excessive brokerage fees charged by global investment banks and asset managers, which does nothing other than boost their bonuses and salaries.

This is ultimately what makes DIY super so attractive. We need to be wary though. I suspect the most likely course of action is that governments will try to stymie the flow into SMSFs via a higher burden of regulation and a more onerous cost structure. Certainly that is the pressure. Watch that space.