Euroweek Australia report: superannuation

Euroweek, August 2013

Standfirst: Australia’s A$1.58 trillion superannuation industry is one of the biggest pension systems in the world – so why isn’t it supporting the development of the local debt market? Several subtle changes at work may be about to change that. Chris Wright

Australia’s pension fund industry, known locally as superannuation, shows the country punching vastly above its weight. Despite a population of just 22 million, Australia’s superannuation pool stood at A$1.58 trillion at March 31, one of the largest in the world.

The figures are only going to get bigger, and the rate of growth itself can be expected to increase too. The reason the sector has become so big is because of the Superannuation Guarantee which then-prime minister Paul Keating put in place in 1992, requiring employers to put in a mandatory 9% of each employee’s salary into their superannuation. That rate of contribution increased to 9.25% on July 1 and will continue to step up incrementally until it hits 12% in 2019.

This has led to some very large predictions for the future scale of the industry: Deloitte has suggested $3 trillion by 2018 and $7 trillion by 2028, while the Australian Treasury itself has predicted a more conservative $6 trillion by 2037. The precise figure will depend on investment returns, voluntary contributions to super beyond the mandatory figure, and in particular the degree to which funds are withdrawn from superannuation in retirement; but whatever the outcome, there is, and is going to be, an enormous amount of capital to be deployed.

One frustration in the investment bank and fund management sector is that that deep pool of investable wealth has not been turned into a driver of the domestic debt capital markets. The reasons for this have been debated endlessly in various Australian forums and conferences for years: do Australian super funds, and their mandated external managers, not buy a wide range of Australian debt because they don’t want to, or because it’s not there to buy? If you build it, will they come?

“The super fund wholesale investor base does support the Australian market in most forms,” argues Rod Everitt, head of global risk syndicate at Deutsche Bank. “It has always been quite active. But it has been a chicken and egg situation with it not always getting the supply it has wanted, so it has had to source other forms of fixed income.”

Generally, though, super funds – in common with the nature of Australian investment generally – have tended to favour stocks over bonds anyway. “Super funds are still very equity-biased,” says Steve Lambert, executive general manager, global capital markets at National Australia Bank. “Of the OECD countries, we have among the lowest amount managed in fixed income.”

However, there are five trends underway in superannuation which should have an impact both on debt markets and the intermediaries who serve them. They are self-managed super funds, industry funds, the trend towards direct investment, MySuper, and post-retirement annuities.

Self-managed super funds are a growing community of individuals who have decided to go it alone and manage their super funds themselves. Despite the fact that, for several years, the compliance and reporting burdens upon them have become steadily more onerous – an attempt by the regulators to ensure that people know what they’re doing – there are more of these funds than ever, and collectively they have become an enormous force. According to the Australian Prudential and Regulatory Authority, by March 2013 there were 503,320 individual SMSFs with A$496.2 billion in assets between them – 31.5% of the entire superannuation industry, the biggest single chunk.

The relevance of this group is that they have a tendency towards assets that provide safe and stable income. Many bankers report this group as being steady buyers of the hybrid securities that are sold to retail: ASX-listed securities that pay a steady rate of income, such as tier one securities from banks (see separate chapter).

Their relevance to the debt markets may grow as other, vanilla bonds are increasingly listed on the ASX as well. Commonwealth government securities have been available through the ASX since May, and it is expected that more and more financial institution and corporate bonds will be listed too. The SMSF constituency may well be the group that makes or breaks this as a successful pocket of the market, and there is a lot to suggest they will be enthusiastic buyers: the ability to buy and sell like a share, combined with the certainty of income from a bond, is exactly what SMSF buyers tend to want. Until recently, they have largely ignored government bonds, because the yields are not attractive in comparison to bank deposits. But as bank rates fall alongside Reserve Bank interest rates, more and more money is likely to leave bank deposits and go into debt. And with half a trillion dollars between them, only a small percentage of assets needs to start looking at local bonds to have a pronounced impact. “The search for yield and certainty of income, with less volatility and strong capital preservation, is a theme that is likely to continue,” says Allan O’Sullivan, director, retail syndicate at Westpac, “particularly given the low interest rate environment and aggressive repricing of deposits.”

The second interesting theme is the other segment of the superannuation industry that is consistently growing: industry funds.

Until 2005, industry funds were largely confined to the particular industry they represented: so MTAA was for the automotive industry, for example, and Unisuper for employees of universities. They were non-for-profit funds that had grown out of the unions.

In 2005, a new choice of super regime was introduced in Australia, allowing individuals to choose what super fund they went in to. This opened many industry funds up to wider application for the first time – and, since they were low-fee, certainly compared to the super funds offered by the country’s big commercial fund managers, they proved extremely popular. Today, industry funds represent 19.8% of the industry and have $311.4 billion under management between 54 active funds (a number that is gradually shrinking as industry funds merge to achieve economies of scale. AustralianSuper, for example, the biggest industry fund in Australia, has absorbed AGEST Super, IBM Super and Queensland’s AUST(Q) Super in the last two years. “We believe in growing the fund and using our increasing scale to achieve sustainable results for members,” says AustralianSuper chief executive Ian Silk.)

What difference does this make to the debt markets? Chiefly the fact that industry funds have tended to invest in quite a different way to the equity-heavy retail funds. Many industry funds, MTAA and Westscheme being prominent examples, have far higher allocations than is typical in alternative assets, although they have pulled back a little since the global financial crisis following concerns over liquidity. For example, Westscheme’s balanced option (the default option into which most investors put their funds) features a 14% allocation to infrastructure; among other things, it holds stakes in Melbourne, Brisbane and Perth airports, Anglian Water, the Port of Brisbane and the Polish energy utility Dalkia Polska. MTAA has 15% in infrastructure, and a separate 3% allocation to a class it calls ‘alternatives credit’, which includes “infrequently traded debt securities (such as corporate bonds and loans) that exhibit greater credit risk and higher expected returns relative to sovereign government debt.” Until recently, Westscheme had a separate allocation to subordinated debt.

So if industry funds continue to gain traction, it is reasonable to expect more and more assets being deployed into infrastructure, which ought in turn to help create a fixed income market that matches infrastructure by being longer tenor.

The third theme involves some funds – industry funds in particular – doing more and more investment in-house and directly than through third-party external managers. “Consolidation in the superannuation industry is creating funds with critical mass,” says Will Farrant, head of debt capital markets for Australia at Credit Suisse. “If you are dealing with one of the in-house teams, they have a much broader view of what they want to do and achieve. They can be more flexible and if they see a good opportunity that doesn’t quite fit the mandate they have given to a third party manager, it is easier for them to say: we should be doing this. That is positive.” Perhaps that is the prompt to create the beginnings of a high yield market in Australia, as individual super funds can make a call on one-off deals that the managers they mandate would not be permitted to do. Or perhaps it means taking on longer-dated bonds – which would, after all, be a better fit for funds that are meant to invest for the long, long term. Again, this has possible consequences for infrastructure.

The fourth theme is MySuper, a new measure coming into effect in Australia this year following a lengthy review of the entire industry. Bill Shorten, speaking to Euroweek shortly before leaving his portfolio as Minister for Superannuation and Financial Services to go to another ministerial role, describes MySuper as “a new, simple and cost-effective default superannuation product. The creation of MySuper is intended to put downward pressure on fees and charges, meaning Australians will retire with more.” It’s designed, chiefly, for those who don’t take an active interest in their superannuation, so that the set-and-forget option is cheap, simple and transparent.

This, too, could perhaps have an impact on the debt markets. In order to keep fees low, fund managers are going to have to put a lot of their assets into passive products. Local debt – which pays pretty well compared to international fixed income – is a logical way to do so, although as Lambert says: “It’s not obvious what MySuper means for more fixed income. There will be more passive investments, but one doesn’t necessarily lead to the other.”

Finally, there’s the fact that Australians are retiring. The baby boomer generation is hitting its mid-60s and is starting to draw on that vast mass of superannuation. What will retirees want? Chiefly income – and this is perhaps the biggest potential boon for local debt. “As we see a demographic shift towards an ageing population, it’s only natural we are going to see a greater allocation to fixed income products,” says Luke Gersbach, director, debt securities at Westpac. “There will be more liability asset matching requirements, leading to demand for longer tenors. That should create more demand in the 10 year part of the curve over time, without doubt.”

The mechanism through which this will be done may well be through a more vibrant annuities industry than the somewhat infant one that exists today. “There has been a lot of discussion about how superannuation is regulated up until retirement, and that there is little regulation of investment upon retirement,” says Steve Black, head of bank capital at Credit Suisse. “One school of thought is that there should be a requirement to invest some part of retirement savings into income generating products, such as annuities.

“A more developed annuities market would create greater demand for fixed income instruments, including corporate credit, as annuities providers sought to match cash flow and return requirements.

“The introduction of a requirement to invest in long-dated annuities,” Black says, “would be a game changer for the domestic bond market.”