It’s time to rethink super

With contributions mandated by law and no price regulation, super fund managers are riding the best gravy train around. But focusing on liquid assets is not the best way to serve their customers.

Join the following dots:

  • Geoff Wilson of Wilson Asset Management has persuaded 13 fund managers to contribute their services for free to a new fund that will pay a 1 per cent “fee” to charity. The Future Generations Fund, as it’s called, is a great initiative made possible by the fact that that it costs no more for fund managers to add the extra money to their existing pools.

  • A chart in the Financial System Inquiry’s interim report shows that since 2009 the average super fund has increased in size from $1.5 billion to $3.5bn, while the average fee has fallen from 1.3 to 1.2 per cent. That means the average fees received by each fund have doubled from $20 million a year to $40m.

What better business can there be? Contributions are mandated by law so that about $100bn a year pours in; there are few variable costs (costs are mostly fixed); and there is no regulation of prices, so they are determined by competition alone.

And as the Murray inquiry observed, the fees they charge for this are among the highest in the world because “competition between funds for members has largely been conducted on a non-fee basis, which has led to feature-rich and more costly superannuation products”.

For these fees, and the tax break inherent in super, the funds and their contractors are meant to invest the money for the greatest long-term return to provide a comfortable retirement that reduces the pressure on the old age pension.

In fact, what they do is invest in liquid assets -- mainly companies -- in proportion to their size.

That’s because the industry is benchmarked against share indices, so that even active managers are ‘benchmark aware’ -- which is another way of saying they hug the index. They have to.

There are two results of this: first, Australia’s huge superannuation pool is not invested in venture capital or infrastructure because these tend to be illiquid assets; and second, the returns are lower than they should be because the money is churned, attracting high transaction costs and with large companies getting the most of the money.

In normal capitalism, higher prices are supposed to lead to lower demand. But in Australia’s superannuation system, the higher the price, the greater the demand -- because size is all that counts.

It means retirement savers are much more exposed to the swings of the markets than they should be, because as a company’s share price rises, they are forced to buy more of it -- no matter what the reason for the rise in price.

It is essentially a momentum-based investment strategy: as a stock -- and the market -- rises, the super funds chase it higher, buying more and more.

The result is an economy and financial system swinging wildly from boom to bust and back to boom, because the fund managers are shackled together by their index benchmarks and all buy and sell together.

The superannuation industry has defined ‘risk’ as deviation from the index against which managers are measured; for their customers the only risk that matters is not having enough to live on in retirement.

Whereas a fund manager’s life is measured in quarters, the customers’ time frames are measured in years, and decades.

To serve both their customers and the nation providing the tax break, super funds should invest more in long-term, illiquid assets such as infrastructure and venture capital.

And to cap it off, as the FSI interim report also observed that the “retirement phase … does not meet the risk management needs of many retirees”.

Superannuation is the only utility that you are required by law to buy and whose prices are not set by regulation (not that regulation has not prevented the price of electricity from doubling in recent years).

You could not invent a better gravy train, so it’s perhaps not surprising that it fails both its customers and the nation.