Funds face enforced consolidation

Funds in the Australian pension industry will face enforced consolidation if they do not do a better job at managing the compulsory contributions of millions of workers, the Federal Government’s chief superannuation advisor has warned.

“All of us have some blood on our hands for what happened to those people (who) were near retirement over the last five years,” said Paul Costello, the chair of Stronger Super – the Australian Government’s peak industry consultation body.

“Collectively we have to ask: ‘why was our system not better able to deal with those people’s needs?’ ”

Costello said Australia’s compulsory defined contribution system, which is now in its 20th year, had been too focused on short-term returns, exposing members to undue risk when markets crashed.

In the wake of the financial crisis, the Australian Government committed to wide-ranging reforms to the way $1.25 trillion of funds in the world’s fourth largest pool of pension assets would be managed.

These reforms included restructuring the system to slash fees and lifting compulsory contributions from 9 to 12 per cent.

Unlike systems in Canada and Sweden that still have strong government involvement, the Australian system is more open to market forces.

This has led to concerns that funds were overly focused on competition for members and short-term performance rather than long-term investments strategies.

Under proposed changes, trustees would be required to better communicate both risk and return targets to members, including rolling 10-year return targets.

Costello said that the government regulator would formulate performance tables that balanced both the returns funds achieved and their risk exposure.

“We will strongly counsel the government that any reporting must be two dimensional, where they (funds) must report against a performance target and a risk target,” Costello said.

“I think there will be a lot of work that APRA (Australian Prudential Regulation Authority) will do with the industry around how risk can be optimally defined.”

While not supporting a mandatory life-cycle planning regime for funds, Costello said trustees should tell both regulators and members how they would manage risk levels as members approached retirement.

Costello warned that there would be funds that failed to meet these new standards and that consolidation in the industry would occur.

“There should be a high standard on people who run businesses, even if some of those businesses are not-for-profit, to manage the mandatory contributions of other people,” he said.

“So, we would support the view: set the bar clearly, set the bar high, hold people more accountable for meeting that standard than is currently the case. If people are struggling to attain these standards, then there is absolutely an appropriate conversation to be had between the regulator and that business.”

The Australian superannuation system has already seen extensive consolidation, primarily in industry and corporate funds.

Over the last 14 years the industry has shrunk from 4,447 funds to 442 funds as of June 2010. Of this number, only 77 funds have assets of more than $500 million.

Consolidation in the industry has slowed since 2006.

Stronger Super has recently completed a three-month consultative process with the Australian superannuation industry.

Legislation was expected to be finalised in the second half of the year.

The reforms were primarily targeted at bolstering regulatory protection for more than $600 billion in so-called default funds.

These savings were typically managed for members who did not take an active interest in their investments.

Under the proposed changes workers who did not nominate a specific fund would go into a “MySuper” default fund that was designed to minimise fees.

But this proposal had been criticised by some in the industry because it could lock members into less-expensive passive-investment strategies and potentially lower returns.

MySuper proponents have argued that up to 80 per cent of workers did not take an active interest in the management of their funds and this could cut their ongoing fees by up to 40 per cent.