Be gentle on ‘Industry Funds’ – they know not what they do.

Property is often 'unlisted'

Property is often 'unlisted'

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:

  1. Trustees were dealing with assets and structures that they did not understand or
  2. 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.


  2 comments for “Be gentle on ‘Industry Funds’ – they know not what they do.

  1. alan pierce
    December 20, 2009 at 11:30 am

    Sorry for this late comment, but I really enjoyed (if that is the right word) your musings on industry funds and the heavy weighting to unlisted assets in their default funds. I wrote a long submission to the Cooper review on my sad experience with one of the very worst offenders. My particular gripe was that my industry fund (and industry fund financial planners) marketed extremely high risk (as it turned out) balanced and conservative fund options to retirees looking for secure allocated pensions-with disastrous results as retirees do not have the luxury of being able to recoup their losses over while still at work. Since then I have been scouring the web for articles that further my case(there are quite a few) with a view to making a supplementary submission in the third phase of the review now under way.
    The two focal points that you make are also at the core of my original submission: that those responsible (but sadly, in no way accountable) did not understand what they were selling and, once the slide began, they failed to inform fund members about what was happening as fund balances continued to collapse even after listed assets stabilised. Their own publications and frantic reassuring letters to members are quite sufficient to condemn them.

  2. December 21, 2009 at 4:37 pm

    Hi Alan,

    Yes, it is a very difficult scenario all-round. The unlisted asset percentage is a difficult one for a Trustee to have to deal with in a public offer superannuation fund. Large retail funds (such as MLC, AXA and the like) generally avoid too high an exposure in their flagship “balanced” funds as the lack of liquidity would add too much risk to the overall portfolio, and in rare circumstances it could result in the fund being unable to meet member requests – something that super funds aim to avoid for obvious reasons.

    ‘Industry Funds’ have relied on the stability of their award-based legislated cashflows to help them moderate that possibility while including unlisted assets for all of the previously mentioned reasons (lower volatility, hopefully higher returns). However, some major funds have had well over 50% of their default fund assets in this area – a huge amount of risk that is incredibly difficult to explain in anything less than a series of intense discussions or a very thick booklet.

    i have noticed that most industry funds now allow different options and the funds containing high levels of unlisted funds are not necessarily the default funds any more. This is a very good thing.

    The primary conundrum in all of this is that the Trustees are trying to make decisions on the portfolio profile for a default fund that has to cater to the needs of ALL members in that fund – and if it is the default then clearly it will be very difficult to ensure that everyone in the fund will find that strategy appropriate.

    This is where i believe that Trustees have over-stepped the line of prudent management. It is especially galling that the marketing campaigns simply switched to a “long term view” even when the effect of the unlisted assets position was really impacting returns. The long term view is all well and good but there is a timing issue that is inherently dangerous and without full advice, most people will come unstuck.

    The arguments against this position will generally be :

    1. The fund adopts a long term view.
    2. The long-term ‘value’ inherent in the underlying assets will eventually return.
    3. The unlisted assets allow exposure to solid and reliable income investments with that income often partially or fully mandated through legislation. Hence, they remain suitable assets for a long term portfolio.
    4. The assets held do not include the same level of leverage as most listed infrastructure and it is therefore one of the few ways of reducing risk while accessing that asset class. – this particular argument is one that i have seen raised a few times. As true as the fundamental premise may be, it doesn’t stop a severe mauling in values when the issue is availability of funds globally, as whether your asset uses debt or not isn’t really as important as how others will access funds to purchase your asset. In this case, your lack of debt simply gives you a bit more leeway… it doesn’t necessarily improve the asset value.

    As you can see, these are arguments helpful to a Trustee to defend inclusion of unlisted assets but that isn’t the real point, is it? The point is that funds with high (and someone clever can define exactly what “high” means) exposure to unlisted assets should include a warning on timing and valuation issues. Trustees who fail to understand that are either uninformed or misinformed.

    i like the idea of submissions to the Cooper review – so far, the bulk of the comment and media debate on the issues has been pandering to the “anti-financial planners” campaigns and signally failing to address the real issues facing superannuation today.

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