The Australian Government released its report of the review into the governance, efficiency, structure and operation of the superannuation system, last week. Some of the recommendations have been met with controversy by industry participants, with continued support of innovative and alternative investments at risk.
The Australian Super System Review, chaired by Jeremy Cooper, and known locally as the Cooper Review, has handed down its final report to Government with recommendations aimed at improving the regulation, efficiency and integrity of the superannuation (pension) system.
While many of the recommendations, such as the SuperStream – a recommendation to modernise the backoffice operations of pension funds including the use of electronic commerce and the compulsory use of tax file numbers – have been generally well accepted by the local industry, some aspects of the review will attract extensive debate.
Underpinning the recommendations, of which there are 177 across 10 broad categories, is the concept of MySuper: a universal default fund with low fees and limited investment options.
But many local consultants believe there is an over-emphasis on cost, at the expense of innovation and value.
Worldwide partner at Mercer, David Knox, says MySuper, which might facilitate a push for all funds to gain scale and have one investment strategy, is being driven by costs rather than value for members, and an unintended consequence could be a move away from alternative investments.
Australian superannuation funds have been early adopters of private equity and infrastructure, and continue to support these asset classes.
“With the MySuper route it advocates a single investment strategy, so then investment options become less popular. Investments (such as ) infrastructure and private equity may appear to be more expensive, and I emphasise appear,” Knox says.
Similarly, local consultant Warren Chant from ChantWest, says MySuper is a mistake and an unnecessary distraction from the real goal of developing efficient, high-quality superannuation products.
He says retail funds are likely to interpret ‘simple, low-cost product’ as equalling passively managed investment with little or no exposure to alternative assets, which will be cheaper than industry funds which generally favour active management and significant investment in alternative assets.
“But there is ample evidence that, over the long-term, industry funds, with their higher investment costs, have provided better returns than retail funds – net of investment fees and tax,” he says.
“Not only that, they have also produced better net returns than funds which are 100 per cent passively managed. Cooper does not understand this. He quotes US research showing that higher-priced retail funds do not on average deliver higher returns. We do not argue with this US data, but the Australian experience is different. In Australia, higher-priced industry fund investment options have more than justified their higher costs. MySuper will only put pressure on industry funds to lower their costs by dismantling the very elements that have led to their superior long-term performance. Let’s hope they resist this,” he says.
Similarly Towers Watson is cautious to ensure the strong focus on reducing costs does not discourage funds from investing in higher-cost investment vehicles that can provide members with significant diversification benefits.
“It would be disappointing if an unintended consequence of MySuper was to stifle innovation and discourage trustees from seeking the best risk-adjusted investment returns for their members,” managing director of Towers Watson Australia, Andrew Boal, says.
The review also recommends a high level of disclosure, which some consultants have said is onerous and unnecessary, and Mercer’s Knox says could add costs to funds.
“There is a suggestion that every fund has to disclose their full portfolio on their website, down to the stock level, and that is a very complicated thing to do. This is an area where there will be added costs because the level of detail is unnecessary,” he says.
“There is a desire in the review overall for greater transparency which is great, but there are costs that come with that. There is a debate to be had about the cost benefit.”
However in other recommendations there are projected cost-savings. Mercer estimates with the introduction of SuperStream for example, there is potential to reduce the administration fee by up to 20-30 per cent.
Cooper also found funds should provide a new operational risk reserve, which Mercer recommends as about 0.5 per cent of assets held in cash or short-term securities.
This, together, with the effect of another recommendation – that funds provide retirement income products – could see Australian funds move more of their assets into fixed-income.
“When you move into retirement income products, annuities and risk protection, you are promising certain payments in certain years, and cash and liquidity becomes an issue. We would expect there could be funds moving into fixed income marketable securities. There are a number of reasons Australian funds have had higher allocations to equities – the system is relatively new and the funds are predominantly defined-contribution,” Knox says. “We’ve also been in accumulation so there has been a higher allocation to equities, in the retirement years that will change.”
Other recommendations, particularly those relating to liquidity management and investment governance, have been well-received.
With regard to investment governance, one of the key recommendations involves requiring trustees to consider the costs involved, taxation consequences and the availability of independent valuation information when setting their investment strategy.
It also recommends new enforceable performance-based fee standards, to be developed by the regulator, APRA
“We believe the recommendations made will enhance the investment governance of super funds, and look forward to the industry consultation in developing the performance-based fee standards to be developed by APRA,” Boal says.
With regard to investment governance it also recommends a focus on managing investments for after-tax returns and establishing a requirement for funds to have a proxy voting policy and to disclose voting behaviour on the fund website.
At this stage the recommendations form a report only to Government, with the Government yet to respond.
The Federal Minister for Finance, Chris Bowen (pictured), has indicated the response will take between six and eight weeks, but there is likely to be an election in Australia within that time, which could derail those plans. Nevertheless a lengthy consultation process is likely.
Summary of Cooper review recommendations
*Introduction of operational risk reserves
*A retirement income stream offering
*Maintain the trust structure – but eliminate compulsion to have equal representation