The Australian superannuation industry has grown and evolved at lightning speed over the last two years. Rachel Alembakis looks at the impact of change and the effect of Simpler Super
The Australian superannuation industry is huge. Assets under management have topped A$1.2trn, which is larger than the country's GDP and also makes it the fourth largest managed funds industry in the world. It is more flexible than at any point in its 20-year history - members can change their superannuation provider at any time.
Legislative changes in 2007 have made it easier for people to leave their funds actively invested for longer into retirement while drawing down income as necessary, meaning the industry is looking at having more assets under management for potentially decades longer than previously assumed. It is more consolidated, due to licensing regimes that also thrust new responsibilities on boards of trustees - only around 300 superannuation funds remain, and consolidation has brought economies of scale, increased numbers and professionalisation of internal investment staff, and opportunities for more complex investment allocations. Most of these changes to the superannuation industry have only come in the last two years, but they have profoundly affected how superannuation funds, investment managers and consultants operate and will operate in years to come.
The remaining superannuation funds are building their internal management resources and demanding different services and investments from their external providers. Meanwhile, superannuation funds are looking to capitalise on the so-called Simpler Super legislation by developing products that capture members when they first open accounts, with the intention of keeping their superannuation assets into retirement and long past that. This has led to a number of product launches, with more to come, and innovation in terms of branding, marketing and communication designed to retain members and educate them as they reach investment milestones.
A shift in external relations
As superannuation funds have attracted ever larger assets under management, a number of larger institutions have responded by building their internal resources, particularly chief investment officers and increased investment staff. "A number of super fund clients have appointed reasonable sized teams," noted David Holston, executive director of JANA Investment Advisers. "In those cases, it's a matter of working with the teams within the funds. Asset consulting takes a complementary role rather than one that excludes one or the other, but it is a different working relationship."
Simon Eagleton, head of asset consulting for Australia and New Zealand for Mercer, agreed, saying asset consultants had been forced to become more specialised in the research and services they offer. This trend has also seen a rise in the uptake of Mercer's subscriptionaccess research database, Global Investment Manager Database (GIMD), which allows subscribers to access Mercer's investment manager research and formulate manager search shortlists. Mercer will also be rolling out its Portfolio Structuring Toolkit, a similarly structured webbased capital market and alpha modelling tool that will allow pension fund clients to self-analyse strategic asset allocations and construct theoretical portfolios.
"Our clients are importing investment expertise to their internal management teams," Eagleton said. "It's good for our business because we think we have deep technical knowledge. We've been hiring people to meet the expected demand for specialist services and that demand has been there. I think this is definitely a trend that's here to stay. We're a complement to a superfund's large internal team, which is now increasingly staffed by experienced generalists. We're the ones called in on specific issues to do the heavy lifting." As internal teams grow and superannuation funds branch into new assets and strategies, external fund managers are being called upon to implement strategies beyond investment management.
"It's not just about products, it's also about capabilities," said Lochiel Crafter, chief investment officer, Asia Pacific, for State Street Global Advisors. "We can help a client with research, tax implementation, currency. We can help a client implement a portfolio which is a multi-manager portfolio but with a different implementation. Part is about product, which products should they buy, but part is also about customising services to meet particular needs. [It] comes off a capability base of client services, management and operational support."
At JPMorgan, which provides custody as well as administration services to superannuation clients, this means drawing on services previously only available to larger asset managers outside of Australia. Bradley Kelly, vice president, worldwide securities services at JPMorgan, said JPMorgan had launched a private equity funds service in Australia to help "asset gatherers" like superannuation funds, investment managers and insurance companies to monitor and oversee their private equity allocations.
Australia is the first country in the Asia Pacific in which this service has been launched, Kelly pointed out. "We're moving away from core custody, and are now in the business of broad-based asset servicing - particularly in the alpha generating space," Kelly said. "We covet a close partnership with the client, which means providing the right products and infrastructure to allow asset managers and trustees to invest in a broad range of instruments, while letting them focus on their core capability of making investment decisions."
Additionally, services that increase implementation efficiency and minimise transaction costs are starting to rise to the fore, Crafter said. He pointed to a multi-manager service within SSgA that reorganises the way multi-manager mandates are structured to reduce the likelihood of occurrence of activities such as one manager selling an amount of stock and a second manager buying the same stock. "We've seen a few clients in Australia start to do this," Crafter said. "They're saying, 'do I want to have two active managers that are selling stock between each other and using the market as a warehouse and paying the costs associated with it?' I think they're thinking about how to employ other managers to implement the portfolio. What happens in this case is [there's] two active managers and there's a third manager implementing the aggregate portfolio. It's about where are the leakages in the portfolio and how do I plug them? They represent real performance."
If internal teams are now covering administrative functions like performance reporting, mandate compliance, performance attribution and transaction cost analysis - all activities that traditionally used to be in the realm of the asset consultant, the flip side to this is that asset consultants are being used to perform research and product development.
"We're definitely seeing a trend towards more specialisation. Internal teams will do many of the functions that investment consultants have done, and quite rightly so," said Graeme Miller, head of investment consulting at Watson Wyatt. "But they'll never be able to have 400 people on the ground all over the world researching investment strategies, opportunities and managers.
"Increasingly our business is seen as an ideas pipeline business. What our clients are looking to us to provide them with is a pipeline of great investment ideas and opportunities drawn from the global opportunity set, which is rigorously investigated and allows them to be one step ahead of their competitors in an increasingly competitive environment."
Holston of JANA reported that clients with large direct investment programmes would use their consultants now to research opportunities in highly specialised asset spaces, such as private equity, direct property and infrastructure - and are happy to pay for that research on a retainer basis. "Large funds realise they can't do it. They know that in terms of a direct investment research function, for every one investment there might be 20 they've researched that haven't gone anywhere," he said.
"Those funds have been happy for their retainer fee to be increased because it's a better way than just doing it on a case by case basis. For us, it means bringing more highly skilled people in to respond to the needs of the funds, and the response is they're willing to pay for that advice."
The deciding factor in choosing to bring a function in-house is whether it makes financial sense to do so. Brad Holzberger, general manager of strategy for QIC, which wholly manages the assets of the more than $20bn QSuper superannuation fund, noted several examples of how this works in practice. "One thing we've decided not to do is run vanilla equity passive portfolios and the reason is we can find that so cheaply it's not worth our trouble doing it," he said.
"On the other hand, at the moment we are running reasonably large portfolios of commodity portfolios through a series of investment banks. The [internal] portfolio manager responsible for that is continually assessing whether to put that trading in-house rather than using the investment banks. We may well see that at some point. It's a search for efficiency - we have no philosophical bias for this. It's just rational."
Super for life?
On 1 July this year, a new legislative regime that dramatically loosens taxation rules regarding the use of superannuation was brought into force. The biggest impact of Simpler Super, officially known as the government's Tax Laws Amendment (Simplified Superannuation) Act 2007, has been to make income from superannuation funds tax-free for those over 60, so long as a minimum amount of money is removed from superannuation funds each year.
These changes are intended to entice members to increase contributions pre-retirement, encourage those past 60 to leave their money in superannuation funds to continue earning tax free revenue, and make it easier for people to tailor their retirement stages to continue working while supplementing income with their superannuation funds. Taken in conjunction with the so-called choice of funds legislation implemented in 2005, which permits members to choose their own vehicle for superannuation savings rather than being automatically enrolled with their employer's default provider, this means that in theory all superannuation members are up for grabs for upwards of 60 years - from the time of their first employment to actuarially determined longevity rates.
It is apparent this fact is very much on superannuation providers' collective minds as they battle to enrol members in their superannuation fund - preferably at the start of their working lives - and retain them in actively invested arrangements beyond retirement. This goal is being effectuated through product design, brand awareness and communication that applies sophisticated techniques to deliver an appropriately simplified, audience specific message designed to reassure and educate. In late July of this year, the more than $28bn industry superannuation fund AustralianSuper announced it would roll out a so-called "account based" pension, allowing members to take regular payments from superannuation savings while giving access to investment options.
The product will commence in January 2008. AustralianSuper's new option permits "regular pension payments credited to a nominated bank account", according to fund information. In November, BT Financial Group launched its own product, BT Super for Life, which - according to the publicity - features "online accessibility, flexibility and portability in one super solution", and proclaims functions aimed specifically at providing easy-to-access services and investment options, including the ability to contribute to the superannuation fund through credit cards issued by BT Financial's parent, Westpac bank. Additionally, BT Super for Life has three lifestyling investment choices, "savings", "transition to retirement", and "retirement", designed with pre-selected asset allocations.
"We are spending a lot more time communicating with our members," said Melanie Evans, head of BT Super for Life. "We're no longer primarily going via the employer. In a situation or in an environment where customers are going to be making choices, communicating directly with ordinary Australians is becoming a lot more important." Part of this branding and marketing is educating members - and potential members - as to the value of superannuation and what owning a superannuation fund means over the lifetime of communication. Making this shift in focus of communication to the member or consumer further blurs the line between institutional and retail provider or, in fact, renders it moot.
"I think when we're talking branding and marketing, you're looking at it from a customer perspective - not what you're supplying," Evans noted. "If you're taking the customer focus, if you're starting with the customer and building something from scratch, that could be a retail or a wholesale solution depending on the customer need."
In this environment, communication from superannuation funds has to follow legislation as well as cultural shifts, explained Linda Elkins, managing director of Russell Investment Group's superannuation business. "You've had this massively increasing responsibility that individuals have over superannuation. It's been necessary for the communications to make a similar transition," she said. "On the disclosure and consumer protection front, a lot of that is legislatively driven. If you're going to have choice and pass responsibility to individuals, you clearly need disclosure. On the other side, is the communication you need from a marketing perspective because they have the choice? The conversation that you have with them is one of the key determinants.
"Around superannuation, the big communication hurdle is around relevance. Members struggle to connect or feel that the fund is relevant - we in the business use jargon, the benefits are so far away, and because this is complex, consumers find it hard to make good consumer decisions." If this sounds as though it is a discussion purely for retail providers, it is not. "Ultimately what it means is that superannuation is becoming a commodity," Elkins said. "Brand and distribution will be premier in terms of who ultimately will have market share."
The dawn of the operation risk reserve
Even as superannuation fund managers take investment risk management on board, some professionals are sounding an alarm towards operational risk and its management - in other words, how superannuation funds protect members in the event of errors effectuated by operational errors, such as unit mispricing. Although the Australian Prudential Regulatory Agency (APRA) has not yet mandated funds to explicitly detail operational management risk mitigation, an increasing number of professionals are recommending - and implementing - strategies such as operational risk reserve budgets set aside to remunerate members in the event that operational error results in loss to members' assets. This is an area that represents particular risk to industry superannuation funds, because they do not have the explicit backing of a corporate sponsor or fund manager or banking entity.
"Many commercial operators have access to capital to support the operational risks they take," noted Simon Eagleton, head of asset consulting in Australia/New Zealand for Mercer. "But it's arguably a non-level playing field in terms of risk capital with industry funds, since they have no shareholder capital and in some cases minimal risk reserves. It will quickly become an issue if one of these funds should suffer a major unit pricing problem, which would have ramifications for the whole industry. In such a situation, it will be inevitable that industry funds will be required to hold a risk reserve."
Sunsuper, a A$13bn not-for-profit, multi-industry superannuation fund based in Brisbane, maintains an operational risk reserve fund equal to 1% of total assets under management, said CEO Tony Lally. Although the fund mitigates risk by having an outsourced administrative provider, CitiStreet, and outsources most of its investment management, the fund maintains the operational risk reserve to be able to cover losses in the event of an operational problem. "I believe that given the responsibilities superannuation funds have and the growing balances for which they're responsible, it is appropriate for some capital reserve requirements," Lally said.
"Industry superannuation funds in particular started out in such a way as to be seen as low risk, and as not-for-profit entities, a lot of the functions were outsourced. Twenty years later, we now have quite a large business and are responsible for many of the functions." Two other superannuation funds already maintain operational risk reserves - one of them is the $8.2bn Government Employees Superannuation Board (GESB), Western Australia's largest superannuation fund. GESB established an operational risk reserve in early 2006, upon advice from its actuary, David Knox of Mercer, a GESB official said. The reserve was $77.4m as of 30 June 2006.
AustralianSuper also maintains a reserve of 0.25% of its $28bn assets under management. "Unit pricing issues have impacted not just the commercial providers, but also industry funds," noted Eagleton. "While industry funds have insurance coverage, most don't maintain significant risk reserves, and without appropriate operational risk reserves their members are exposed."
The idea is catching on throughout the industry - even if implementation lags discussion at this point. "We are seeing an interest in operational risk reserves and how funds manage operational risks and how funds recognise that an operational risk event is a thing that will happen to them from time to time," said Knox of Mercer. "I've done a couple of recent presentations to boards where the trustees have cottoned on very quickly to what it is and, if such an event did happen, [how] it would affect them."
But David Holston, executive director of JANA Investment Advisers, said the regulatory regime in Australia was robust enough to mitigate against the risk of operational risks. "[The] compliance regime in Australia is reasonably robust in terms of entities. You can't say it'll never happen, but the regulatory regime is reasonably robust [so as] to decrease the operational risks," he said.
"There is a segregation of responsibilities. In terms of unit pricing errors - there's an argument that unit prices are never right because there's always something bobbling around - differences in timing, in taxation, etc . it's not a panacea. Notwithstanding that, there is an increased focus and awareness from trustees and boards as to what their expectations are. In an Australian environment, the underlying risk is concentrated in larger firms, which provides some solace to the investor, because it would assume they have substantial indemnity."
One of the major arguments against an operational risk reserve is that by ring fencing an amount of cash, a fund is ultimately shaving off performance from the overall fund. But QIC, manager for the $20bn QSuper superannuation fund, says it is possible to extract cash from a portfolio in such a way as to have a reserve without impacting on the portfolio's return. "We do think of risk management partly in terms of capital adequacy," noted Brad Holzberger, general manager of strategy at QIC. "If QSuper or one of our clients required a stringent capital adequacy control - for example along the lines of where banks are headed with Basel II - we could create that."
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