Unlisted assets can’t explain success of industry funds

Australian Financial Review

June 13, 2018

Joanna Mather

A propensity to invest in unlisted assets accounts for only a tiny proportion of the outsized returns achieved by non-profit superannuation funds, according to Industry Super Australia.

ISA public affairs director Matthew Linden said additional returns generated by holding unlisted assets – the so-called illiquidity premium – accounted for less than one-10th of the performance gap, or 15 basis points compared to retail funds.

“The most obvious explanation for profit-making funds underperforming their benchmarks is the multiple layers of profit margins built into the investment ‘value’ chain between the member and the underlying assets,” he said.

Mr Linden was responding to claims by some in the industry that the illiquidity premium is worth 140 basis points.

As part of its inquiry into competition and efficiency in the super system, the Productivity Commission sought to shed light on a bitterly contested performance gap between bank-owned retail funds and union-aligned industry funds.

It found non-profit funds had delivered realised rates of return, on average, of 6.8 per cent over the past 12 years compared to 4.9 per cent for retail funds. That’s a difference of 190 basis points.

“The difference in the Productivity Commission’s two benchmarks for non-profit funds shows a small uplift of 15 basis points going from a purely listed portfolio compared to a portfolio of the same asset allocation with exposure to unlisted assets,” Mr Linden said.

“Accordingly this captures the premium for holding unlisted illiquid assets compared to listed equivalents.”

Decisions about which listed assets to invest in, and at what proportions, accounted for about 58 basis points, Mr Linden added.

Superior investment model

“In other words, just under half of the difference is due to industry and other not-for-profit funds having a superior investment model, including asset allocation and investment acumen, and half is due to the retail funds unexplained sub-standard net returns,” he said.

“The unfortunate reality is most for-profit retail super funds destroy member value wherever you look. Complicated and opaque product structures, higher fees, sub-optimal asset allocation and related-party gouging are geared to deliver to shareholders rather than the actual members of their funds.”

The commission’s draft report noted “significant variation in performance within and across segments of the system which is not fully explained by differences in asset allocation”. Nor could the performance differences be explained by factors such as fund size or reported administration fees, the report said.

The commission has written to retail funds requesting more information about returns by asset class so it can “investigate sources of underperformance”.

Chant West senior investment research manager Mano Mohankumar has told The Australian Financial Review that greater exposure to unlisted assets by industry funds is what accounts for most of the performance divide. These are assets such as unlisted property, infrastructure and private equity. Mr Mohankumar said estimates of a 140 basis point illiquidity premium were “fair”.

More exposed to traditional assets

On the flip side, retail funds are more exposed to traditional assets such as cash, bonds and stocks. They had members who were more likely to use financial advisers, which meant they were more likely to switch between funds, Mr Mohankumar said. They needed to be more ready to give members their money back, which meant they had a greater focus on liquidity, he said.

So while industry funds in what Chant West calls the “growth universe” (funds with between 61 per cent and 80 per cent of members’ savings invested in growth assets, which is where the bulk of Australians would sit) have exposure to unlisted assets of around 20 per cent, comparable retail funds have exposure of around 5 per cent.

Strong cash flow through the default super system and a more “sticky” membership base made it easier for industry funds to invest in unlisted assets, Mr Mohankumar said.

But Mr Linden said the reasons for underperformance flowed from the commercial structure of retail funds.

“To suggest the reason why industry funds outperform is because of their default status is deeply misleading,” he said.

“The reason lies in the fact that non-profit funds have structured themselves in ways to try to maximise returns for members.

“They do that by maximising scale and investment horizon. They also try to disintermediate the investment process by holding unlisted assets and by bringing investment management in house.”