Cerulli Global Edge: Australia’s superannuation industry enters a new phase

Cerulli Global Edge, May 2013

Australia’s A$1.5 trillion superannuation industry is fast approaching one of the most transformative moments in its recent history: the arrival of a new default investment product called MySuper. Years in the development, it will begin to replace default investment options in superannuation funds on July 1 – at the time of writing, barely 75 days away. Yet, also at the time of writing, there were just 14 MySuper products registered with the regulator, the Australian Prudential Regulatory Authority – and not one of them was from a major commercial fund manager or bank. What’s going on?

First, some context. Australia’s superannuation sector has in recent years become one of the largest in the world despite the country’s relatively small population, underpinned by the Superannuation Guarantee, which obliges Australian employers to make a contribution of 9% of any employee’s salary into a super fund. By the end of 2012 assets stood at A$1.507 trillion, and as the superannuation guarantee is to rise from 9% to 12% in phases between now and July 2019, the pool is rapidly going to become considerably bigger. (Its scale has become particularly visible in global terms because of the rapid ascent of the Australian dollar since the financial crisis; it is now worth more than the US dollar.)

Consequently the government has set about a detailed series of reviews of the superannuation sector, covering tax, back office streamlining, and product. MySuper is the biggest outcome on the product side, and it comes from a sense that many Australians have been paying relatively high fees for little benefit. Most Australians make no active choice in their super, simply going with a default option, and so MySuper replaces these default options with a low-fee product (typically around 1% of AUM or less) with an emphasis on simplicity. These products will start to appear from July 1, and by January 1 2014 it will be mandatory for employers to make employee contributions to a fund offering a MySuper product.

Industry funds, which in some cases have looked a lot like a MySuper product anyway, have been relatively quick to launch compliant products. Examples include equipsuper, Health Employees Superannuation Trust Australia, Media Super, Sunsuper, Victorian Superannuation Fund, Australian Catholic Superannuation and Retirement Fund, and the Construction & Building Unions Superannuation Fund.

Industry funds started out as union-backed products that handled the retirement needs of a particular industry: automotive, health, education. Ten years ago, though, under the ‘choice of super’ initiative, they became open to the wider population, and so ended up in head-on competition with commercial or retail funds backed by the likes of Colonial First State (part of Commonwealth Bank of Australia), BT (backed by Westpac) or MLC (backed by National Australia Bank). From the outset of this competition, industry funds have touted themselves as being low-fee, not-for-profit enterprises, and have done so with some success, taking market share from commercial funds. So it is perhaps natural that they should be quick to offer MySuper products, since their existing default options have been fairly close to that model anyway.

For example, the Queensland-based industry fund SunSuper has put forward a version of its existing SunSuper for Life product as its MySuper option, and this appears to have been accepted by APRA. The SunSuper for Life prospectus shows that management fees on SunSuper investment options typically come out at around 0.67% and 0.72%, well within the level that MySuper envisages.

But why no product from the big commercial houses? Aren’t they leaving it late? Well, it’s worth noting that the date for the mandatory offering of MySuper funds was pushed back from October 1 2013 (which would have meant needing to have a product authorised by July 1) to January 1 2014, and was done so mainly at the behest of the retail/commercial sector. Additionally, a few design changes have been made to the MySuper model as it has inched its way through Australia’s legislative process, and this has slowed the finalising of new product design. “The retail sector was strongly involved in lobbying for the design changes, so those funds were more likely to defer making their authorisation applications,” says someone close to the process.

Still, an initial batch of authorisations made from one part of the industry with none whatsoever from the other gives a clear indication of who is enthusiastic about MySuper and who is not. Somewhat begrudgingly, commercial/retail managers are preparing the ground for their new products, but they know they stand little chance of making much money out of them.

In order to comply with the low-fee and simple themes of MySuper, products are likely to have a heavy reliance on passive investment approaches, with a few active methods around the edges for differentiation. Many are also likely to offer life cycle fund characteristics, in which the investment mix varies through a person’s life as they get closer to retirement, in order to foster growth in early years and preservation later; this is, for example, known to be a characteristic of the SunSuper offering, and the ability to offer life cycle was a relatively late amendment to the MySuper legislation.

What does this mean for fund managers serving the Australian pension sector? Clearly it’s good news for the Vanguards and State Streets of the world who focus on passive product. But for active managers, it is going to make life harder.  Fewer super funds are going to offer active mandates for their default funds; correspondingly, investors who want a more active approach in their super will have to make the effort to seek it out and to move away from their default fund.

Nevertheless, in April and May the atmosphere in the fund management community in Sydney and Melbourne was not especially negative. “MySuper serves a segment we don’t chase anyway”, was a common response, in that MySuper serves people who don’t make a choice or take any particular interest in their superannuation, and who therefore would have been unlikely to seek out a top new fund anyway. For fund managers, they are far more concerned about the relentless growth in go-it-alone self-managed super funds, which now represent the single largest part of the industry (see chart), and within which investors typically make their own investment decisions without going through a third party fund manager.

There are other, more subtle changes at work. One consequence of the push to low fees is a corresponding push for scale, particularly among industry funds, many of whom have merged with one another in recent years. AustralianSuper, for example, the biggest super fund in the country, has been bolstered by mergers with AGEST and Westscheme.

As they have become bigger, a trend has developed for some of these super funds to do some of their investment directly: buying their own equities and bonds, rather than asking a fund manager to do it. It’s likely that this in-house management of mainstream assets is going to continue. And perhaps not just the mainstream: at the Future Fund, for example, the closest thing Australia has to a sovereign wealth fund, the early years were spent building in-house expertise in infrastructure, forestry, property and other non-liquid assets, most of which are now handled in-house. Several industry fund have sought to buy their own private equity capability rather than having to go third-party for it. This, too, is not particularly good news for external fund managers.

Alongside this is the fact that tweaking of the superannuation industry simply never seems to end. In April, the government introduced a new tax on post-retirement superannuation for people with high post-retirement income (drawing more than $100,000 of income per year from super); they will, from July 2014, be taxed 15% of that. The Treasury estimates that only about 16,000 people will be affected by the change, but still, there are two issues: one, these people saved in good faith believing the tax they’d already paid on their income was sufficient and that there would be no further tax; and, more broadly, a mounting frustration that there is little point committing to super when the regime will be constantly, endlessly changed at some unknown later date. This does not help the popularity of retirement saving.

But it has to be remembered that no matter how much tweaking, no matter how much low-fee pressure, and no matter how much onerous compliance is lumped onto superannuation, the sheer volumes – and the cast-iron guarantee of their continuing growth – makes it impossible and unhelpful to step away from the super industry. The key to successful fund management around the super industry is twofold: building a scale business that works on low margins; and having the best active product for those remaining active mandates. That will continue to be the case under MySuper.