What big Aussie super funds can learn from the US

Many Australian super funds outsource their investment management, with consequences for brokerage and tax costs. But there's a way to vastly improve their performance.

For some time there has been much suspicion regarding self-managed superannuation funds and how they have been been able to match or outperform a large number of the big-pooled super funds. But I can reveal the hidden reason why so many SMSFs have fared exceptionally well in recent years.

At the same time, I have also discovered why Treasury thinks self-managed funds are tax avoiders, even though the Australian Taxation Office has confirmed they obey the rules -- and those tax rules are the same as for pooled funds (The ATO reveals the truth about SMSFs, September 12).

Over the weekend I was yarning to the people from Seattle-based US investment advice house Parametric, led by its managing director of research, Paul Bouchey.

The big-pooled Australian superannuation funds outsource much of their investment management to a series of managers. In many cases, these managers operate independently of each other and rarely have an understanding of the tax implications of their transactions to the overall fund because they don't know what the other managers are doing. Of course, that does not apply to all big pooled funds.

Parametric has developed a system where the managers retain their basic independence but delegate the execution of buy and sell orders to Parametric. That way if manager 'A' wants to buy, say, BHP and manager 'B' wants to sell BHP  (and that happens), the orders can be crossed, which saves on brokerage. And because Parametric does not make the decisions, it does not need broker research, so there are much lower brokerage rates.  

In Australian superannuation, if you hold a stock for a year, you are taxed at just 10 per cent, whereas if it is held for less than a year there is a full 15 per cent tax.

Managers can be made aware of the tax implications of their decisions and can review those decisions in the light of the tax bills they create.

In the US there are several groups like Parametric, but to date no one has adapted the US system for Australian superannuation because Australia is one of the few countries in the world that taxes superannuation funds in the accumulation phase. The US taxes the pensions as income, but not the funds.

Parametric applied the US system to Australian superannuation, in which high-net worth individuals and insurance companies pay tax on transactions. To test this application, Parametric did a test run on the Qantas superannuation fund and found that over more than a year, substantial tax and brokerage reductions could be achieved, which lifted the overall Qantas fund performance. And Qantas is telling the world.

Of course self-managed super funds have always understood the cost of taxation and brokerage and so took legal steps to save tax and brokerage, including holding stock for at least a year and often undertaking far less trading than the big funds.   

This has given them a great advantage over those big funds. When the boffins in Treasury found that self-managed funds paid less tax than big funds, they incorrectly thought there was some form of racket going on in SMSFs. But if Parametric’s systems become widely used among the big-pooled funds, those funds will pay a lot less tax and brokerage. As a result, members will gain better returns. Treasury will not be happy. 

If the Parametric system takes off, it also will put enormous pressure on the broking industry. Brokers currently receive their commissions from the managers who pay two or times the bulk rate to gain access to broker research. Suddenly that automatic business will not be there. Managers may have to pay for research separately. There is a second arm to the Parametric business: risk diversification. Bouchey says that because of ageing populations, a larger proportion of superannuation fund members are becoming more risk averse, so many funds are looking to the ultimate in diversification strategies.

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