Welcome back. I’ve missed you. [i3] Insights has kindly invited me to once again take up my keyboard to write the Market Fox column. First up is Your Future, Your Super (“YFYS”).
I’m not going to go over the new rules introduced by YFYS in detail. Nor am I going to debate its fairness. In my opinion, the legislation has little to do with fairness. It is a blunt tool designed to rationalise the superannuation industry, reduce duplicate accounts and prevent fund trustees from engaging in certain activities.
These issues have all been dealt with elsewhere, in great detail and with much hand-wringing. Instead, I’m going to highlight a few nuances that other commentators may not have considered.
YFYS will have far-reaching consequences for jobs in superannuation. It is important to be clear about why YFYS is so scary for trustees of funds at risk of underperforming. How YFYS might change the incentives for fund managers to seek superannuation funds as clients. And why administration fees will be a key battleground for the survival.
Recruitment and Retention
I’m guessing that the staff at superannuation funds are looking at the APRA heatmap in great detail. I certainly would. This raises a few questions for recruitment, retention and the job market in superannuation.
- Would staff stay with a fund at risk of having to notify members of under-performance?
- And if they leave, how will the fund replace them? Will anyone want to join a fund at risk of being suspended from accepting member contributions?
- What will this mean for the superannuation job market?
Members or Employers?
Much of the YSYF commentary is focused on member communication and activity. Underperforming funds are required to notify their members. Underperformance over two consecutive years results in a fund being prohibited from accepting further contributions.
Naturally this has created a lot of anxiety around the risk of members rolling out of underperforming funds. I would argue that employer rollovers are the real risk.
Here’s why. Member rollovers rates across the superannuation system were around 4.4 per cent in the 2020 financial year. Even in a year as volatile as 2020, rollovers were less than 5 per cent.
I know what you’re thinking. System-wide averages are one thing. Surely the rollovers out of underperforming funds are significantly higher. As it turns out, they aren’t.
The Table below shows the 10 biggest underperformers (single strategy funds only) on the APRA June 2020 MySuper Heatmap. The performance numbers are for the 2019 financial year. I compared these numbers with rollover data from the 2020 financial year. If members really were concerned about long-term underperformance, they would have done something about it in the next financial year.
I excluded two funds from my calculations. Fund #6, with rollovers in excess of 100 per cent, was likely to be in wind down or closed. I couldn’t find data on net assets and rollovers for fund #8.
Even for the worst performing funds, rollovers barely nudged above 5 per cent.
One could argue that this statistic alone justifies the intent behind YFYS. Maybe members in underperforming funds need to be shaken out of their complacency? That debate sits outside the scope of this column.
Even if members receive a letter advising them of their fund’s underperformance, how many members will roll out? Will it be a terminal blow for the fund? The average fund on the list manages just over $3 billion. Several funds could probably survive a significantly higher rollout rate for a year or two.
What these funds can’t survive is a roll out of employers. Many smaller funds depend almost solely on two channels for acquiring new members:
- Employers who nominate the fund as their default super fund
- Enterprise bargaining agreements
What employer or union will take the legal risk of mandating that their staff contribute to an underperforming fund?
Even if a fund survives a performance strike, it is unlikely to survive the disintegration of its primary sales pipeline. It may be impossible to rebuild. Many funds don’t have large marketing budgets. Other provisions of YFYS specifically prohibit offering employers certain types of incentives. YFYS also makes it harder to justify marketing expenses as being in the ‘financial’ interests of members.
When I first read the YFYS legislation, I thought that it offered an opportunity for forward thinking active managers to offer innovative performance fee structures. For example, they could share their client’s underperformance risk by charging base fees at or below the assumptions used in the APRA Heatmap, coupled with a performance fee. In this way, they share some of the YSYF risk with their clients. This would make it easier for clients to stick with them.
One could argue that fund managers aren’t really taking on much extra risk. They are likely to suffer redemptions and terminations anyway from these underperforming funds.
Chatting with industry colleagues helped me to understand why this is unlikely to happen. Many established fund managers have current fee arrangements, such as most favoured nations clauses, that make innovation on fees difficult. Any change would mean cannibalising a large chunk of their current revenue.
It is possible that fund managers will start looking elsewhere for new business. It would be rational to look for markets where there is less transparency on performance and fees. Private wealth management comes to mind.
Superannuation funds could be priced out of active management. Not only is active management challenging under a YFYS framework. The risk/reward from the fund manager’s perspective may deteriorate to a point where superannuation funds become unattractive clients.
YFYS compares the performance of each fund to its Simple Reference Portfolio. This performance benchmark is net of investment management fees and administration fees. APRA assumptions for investment management fees are based on the cost of passive management (or indexing) for asset classes where that is an option.
The administration fee assumption is based on the median administration fee across funds. What will happen once underperforming funds are eliminated? The median administration fee will fall. In other words, it will get progressively tougher to beat the APRA heatmap for funds without the benefits of scale. The ground that smaller funds lose on administration fees will have to be made up on investment management fees.
 Outward rollovers are those monies which are transferred from the superannuation entity to another superannuation entity: https://www.apra.gov.au/sites/default/files/qsp_glossary.pdf
 Rollovers as a per cent of assets is calculated as Outward Rollovers divided by Net Assets at Beginning of Period. Source: APRA Annual Fund-Level Superannuation Statistics June 2020.
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.