Super funds must get better at global investing

As Australian superannuation funds outgrow the local pool of assets, their only option is to look for investing opportunities offshore.

Australia’s superannuation funds are going to have to become much more global in their outlook and expertise because they are rapidly outgrowing the local pool of assets.

Australians’ savings in super now total about $1.85 trillion; in ten years’ time it will be double that.

There’s no way very much of the inflow over the next decade can be invested in Australian assets without inflating their prices beyond true value and therefore lowering returns.

It might be good for Australian companies, which would find themselves swimming in capital, but it would be a bad outcome for investors.

It’s not as if this is a surprise: the problem of getting sufficient liquidity in the Australian sharemarket has been obviously coming for a while.

The problem is that no one has done much about it. Super funds and their fund management contractors should have been building knowledge and expertise in global investing for years already; instead they are scrambling to do it now.

Super funds and investment managers have to rapidly build their global investing expertise if they’re going to maintain any semblance of a decent return for their clients.

In fact the investment business is at an interesting inflexion point. This is an industry in which, because of the super guarantee legislation 22 years ago, Australia could already have built global leadership.

Politicians and business leaders often agonise about what, if any, industries Australia can become a world leader in. We are world leaders in extracting minerals from the ground and loading it onto boats, and we are world leaders in repairing footballers’ knees because AFL players pop their ligaments so often.

But world leadership in investing has so far eluded us. It shouldn’t have.

Apart from mining (and knees) investing is an industry in which Australia punches far above its weight thanks to the establishment of mandatory super 22 years ago -- but only in terms of size.

From a standing start, in two decades the pension fund savings pool has grown to be larger than the total capitalisation of the sharemarket. In another ten years, the amount in self-managed super funds alone will be bigger than the sharemarket.

The average investment return of Australia’s super funds over the past 22 years (that is, from inception) has been 7.1 per cent, while the average annual total return from the Australian sharemarket over the same period has been 10.4 per cent. That’s not great, but it’s OK, given the asset allocation imperatives of large-scale investing.

Unless the super funds start investing a lot of their money offshore, that return will decline because they will push the prices of domestic shares to levels that the companies themselves can’t sustain with profits.

But given how the world has shrunk due to the internet and technology, there is no excuse any more for investment funds to remain rooted at home.

It’s true that super funds can, in theory, be used to improve domestic infrastructure, but only if the risk and reward equation works. But there should definitely be no government intervention to direct super into domestic investments of any sort, including infrastructure.

The sole purpose of a super fund is to provide for its members’ retirement.

At 7.1 per cent compound growth per annum over 40 years, a worker on the average wage paying 9.5 per cent of salary into super would end up with about $1.2 million.

That might seem like a lot, but it’s barely acceptable to fund a long retirement, given expanding life expectancy these days.

If super fund returns were to fall because they had become too big for the local market, retirement savings in Australia would be clearly inadequate, which would be a tragic irony given the opportunity that mandatory super has provided this country.

At 10 per cent compound (the average total return from the sharemarket over the past 22 years), the worker on average earnings saving 9.5 per cent of salary over 40 years would end up with $3m -- enough to fund a long and comfortable retirement (plus a cruise or two).

Surely 10 per cent per annum compound should be the industry’s aim for its customers -- not 7 per cent; 15 per cent ($14m over 40 years) would be even better, but 10 per cent should be a minimum benchmark.

It’s a matter of expertise. Anyone can hug the index, pay themselves a fee and then give the index return minus the fee.

The only way to achieve global leadership in any industry is to be good at it. In the business of investing that means valuing companies, and other assets, accurately, buying them at the right price and then owning them with discipline.

In my view the way to achieve global leadership in investing is to skew the fees towards paying for performance.

Paying a simple base fee produces base performance: people will always do what their salary tells them to do.

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