The front page of todays Australian Financial Review (AFR) includes an article titled “Unlisted assets drag down super fund returns”. In it, the returns of ‘Industry Funds’* is suggested as showing falling returns into a recovering market.
This is entirely expected, and should not be a reason to argue against the ‘Industry Fund’ attraction to unlisted assets. Many assets are actually more suited to the unlisted structure, and their use remains valid. What it does show, however is that either:
- Trustees were dealing with assets and structures that they did not understand or
- Those responsible for marketing of the funds was not updated with the actual characteristics of the underlying assets.
In other words, ‘Industry Funds’ should not have been marketing their majority-unlisted asset funds into the falling markets on the basis of returns or some poorly-argued “compare the pair” marketing hyperbole, as it was extremely likely that the prices would have to be marked down to reflect changing valuations at some stage in the future.
In any event, it is a sad example of how mismanaged the operation of public super funds is in Australia. The mismanagement is in the idea that default funds can be anything other than either cash or guaranteed accounts. And that is not a criticism that is levied only at ‘Industry Funds’. A Trustee should not be able to make a risky asset decision on behalf of a member. Simple as that. Any argument for this to be possible makes a mockery of standard financial market knowledge. Trustees should not be placed in that position, as it places both super fund members and Trustees at risk of substantial loss.
Unlisted assets are usually things like large property or infrastructure assets (water, energy or transport businesses underpinned by strong regulation of prices aimed at stability). These are quite sensible long term assets for the growth portfolio of a superannuation fund as they provide for regular, high-certainty income and a reasonable expectation of long term capital growth. If those assets are listed on the sharemarket then their price is subject to very high day-to-day volatility, which is often not even related to the specific businesses. Holding those assets in a private company can help moderate the impact of non-business related issues. This is also clearly good for super fund members. However, if the listed markets are being impacted by global issues such as interest rates, currency changes and credit availability then those issues will HAVE TO flow through to unlisted assets when they are next up for valuation (which a super fund needs to do regularly to make sure the members leaving and entering the fund are receiving and paying a fair price). In other words, the unlisted structure can help reduce volatility in the short term but it is likely to reflect the listed asset values in the longer term. All it does is to provide a timing differential that can be useful in a total portfolio risk strategy arrangement.
Some ‘Industry Funds’ had very high levels of unlisted assets in their ‘default’ funds. This is a sensible strategy for the long term in a very large, low turnover fund with regular cashflows and a relatively young average member age. However, it is a very questionable practice for a ‘default’ fund.
How can a simple little financial planner make such a grand claim? I can make that claim because it is a known fact in the superannuation industry that the average super fund member pays very little attention to their super until their fund is at least equal to a years’ income. The average member will not pay to obtain advice on their superannuation (partly a result of the campaign to discredit financial planners that has been waged by ‘Industry Funds’, consumer groups and poorly briefed regulators and legislators), nor will they pay more than a scant level of attention at how their fund is operated. In most cases, they will assume that someone, somewhere is looking after their interests. On the basis of this lack of understanding of the respective risks being taken within their fund, the ‘default’ fund into which they will fall should be one that takes the minimum of risk. Using unlisted assets helps reduce volatility but it does NOT take away risk.
My guess is that the default options of ‘Industry Funds’ are attempting to keep themselves competitive with retail and corporate funds by retaining a higher exposure to growth assets to make sure that long term returns do not fall too far ‘below the pack’. As a by-the-by, it is also my proposition that ANY fund that offers a ‘default’ strategy should have to jump over hoops for each and every member before that default strategy should be allowed to include growth assets.
As it stands, a person who was not aware of the composition of funds could have seen their (predominantly) listed super fund drop in value and decide to move to a predominantly unlisted-assets fund, just in time to see their account balance take yet another ‘hit’, right in the middle of a major recovery in the market. To be specific, this could have seen people with 20% drops in value move to funds where they get another 20% drop in value and become completely lost as to what to do from there.
And so we return to the title of this post. The reason that any discussion on the current return of ‘Industry Funds’ should be taken with a grain of salt is that this issue is not news, and shouting about the returns misses the more important point on how ‘default’ funds should be invested and marketed. It is clear that many Trustees were not aware (or not made aware) of the position of unlisted assets or they would not have allowed their funds to continue marketing strategies that were difficult to explain. If there is a lesson to be taken from this it is that we should not expect Trustees to be miracle workers – somehow able to magically conjure up the perfect mix of high returns with low risk that has eluded market participants for millenia.
“Not for profit” type funds (like the so-called ‘Industry Funds’) play a valuable part in the superannuation industry in Australia, and they should be encouraged to continue to refine their offerings. However, they should not be held immune from the glare of public scrutiny for flawed processes and poorly thought out marketing strategies.
* i have used the term ‘Industry Funds’ in this way to reflect my views that this marketing strategy – whereby a diverse range of super funds are labelled as if they are identical – is misrepresentative of the facts. Feel free to argue that point with me at any time.