Underpinning the current wave of Australian superannuation fund consolidation is the belief that bigger helps. Is this really so? Are there any benefits to being a member of a large superfund?
A recent paper here addresses the question of whether larger sizes benefit members. Our answer is “probably”. We believe that size is not as important as how you use it. When large funds are able to capitalize on their advantages and limit their size disadvantages, members can achieve better results. increase. Ultimately what matters is how well the management team works, regardless of the size of the fund.
Australia now has megafunds
Consolidation combined with member contributions and switching has created several large superannuation funds. Australia has 17 funds under management with over $50 billion in assets under management (AUM) as of June 2022 (see chart). Of these, 14 are superannuation funds. The largest is the $272 billion AustralianSuper, closely followed by the Australian Retirement Trust (ART) at $247 billion. The Australian superannuation industry has not only become systemically important, it will reach $3.3 trillion as of June 2022, roughly 1.4 times the GDP and ASX market capitalization. It now includes some very large financial institutions.
Advantages of large size
Size has two advantages. The first is that it can be used to lower the cost per member, or economies of scale. Second, large funds can do what smaller funds and retail investors cannot: economies of scope.
Larger fund sizes can lower unit prices in three ways.
beginning In-house asset management. The costs of running an internal team are somewhat fixed. In other words, the cost of managing a given asset mix decreases as AUM increases compared to paying a basis point fee to an external investment manager. AustralianSuper currently manages 53% of its assets internally, while Unisuper has 70% of his. The proportion managed internally is increasing for most large superannuation funds. This is intended to limit fees that are subject to regulation and public oversight.
number twoLower fees may be negotiated with external investment managers for larger mandates.
The thirdsome elements of administration costs are fixed and can be spread over a larger member base. Research confirms that size actually reduces the cost per unit of administration.
Lower investment costs and more efficient administration may reduce fees for fund members, but it may not work this way. Large funds may instead use their size to do things that may benefit members in other ways.
On the investment side, the scale makes it easier to invest directly in “high-priced” private assets such as infrastructure and commercial properties. This can help diversify and provide access to unique opportunities. However, due to the cost of investing in unlisted assets, the fee reduction potential is limited. The main advantage is finding additional revenue streams in private markets that are not available to smaller funds (or individuals).
Larger sizes may also be supported more and better customized Membership services that require significant resource commitments. Keep in mind that the ability to customize can be especially important in providing future retirement income strategies, and retirees’ needs vary widely. Adjusting to these different needs could be done more effectively under financial advice, but there are many retirees who do not accept advice and turn to superannuation funds to support them. A larger fund should be able to accommodate members who effectively rely on expensive systems and high levels of staff functionality.
Drawbacks and challenges
There are also disadvantages of being large. An important one is that the fund is constrained from making investments that cannot absorb the greater amount of AUM required to make the fund valuable. This is true for certain segments of the stock market, such as small- and mid-cap stocks. As the size of the fund grows, it becomes difficult to move the stock portfolio without incurring the cost of ‘price impact’. Limits on how much you can reasonably hold in a particular stock also narrows the investable universe.
For illustration purposes, the table below assumes that the fund is targeting a minimum holding ratio equivalent to a 25% weighting of Australian stocks ranked 50th, 75th and 100th by market capitalization at the time of writing. It shows the percentage required to own 3 ASX shares. 2% of the stock portfolio. For example, to hold a 2% position in Pro Medicus, a $100 billion fund would need to acquire his 7.4% of the company, and a $250 billion fund would need to acquire his 18.4%. . Once the fund reaches ‘megafund’ status, it is questionable whether it can prudently invest in sufficient quantities in mid-cap Australian stocks to make a meaningful difference, much less in small-cap stocks.
Such investment constraints are significant when these small areas offer the best opportunities. This is often the case as they may not be well researched or offer an illiquidity premium. Smaller funds and individuals do not face such size constraints. Instead, their challenge is to have the ability to identify and access good opportunities.
Additionally, larger organizations can be more complex, less flexible, bureaucratic, and difficult to coordinate staff and work toward a common purpose. These factors can easily lead to functional impairments that can impair performance.Research also shows that large funds can provide a positive and personal experience to the members involved. I’m not good at it.
Large funds can have difficulty finding attractive enough assets to fill their large portfolios. AustralianSuper, for example, received an average weekly inflow of about $500 million over 2021-2022. A lack of attractive assets leads to poor performance. Whether this is the case depends on the pricing of the big-ticket assets and may fluctuate due to competition and market cycles in those assets.
For a large fund to succeed at scale, it needs to build an operational structure. Note that this will likely require building an internal team with the ability to invest in non-listed assets, and this area is somewhat specialized. Members only benefit when internal teams perform well, so cost savings aren’t lost to lower revenues. An overseas office may eventually be required. AustralianSuper and Aware Super are taking this step. This only increases the difficulty. Attracting and retaining skilled staff is especially important, but tricky. Strong governance and a positive culture are also important.
Providing enhanced member services can be difficult. Projects typically run on time and over budget, sometimes requiring you to build systems that are prone to failure. You can’t win easily.
In short, large size comes with a mix of pros and cons, along with many challenges. No profit is guaranteed. Management must run well.
Potential Systemic Effects
It’s also worth noting that the expansion and consolidation of retirement plans can have systemic implications. These are less likely to be serious, but more likely to be harmful. Our concerns fall into two groups.
beginningWith retirement funds of varying sizes, the financial system would be stronger and more vibrant. Concentrating assets in a few large funds can undermine market resilience and competition, which is enhanced by participant diversity. Institutional investors’ presence can hollow out in markets where large funds are often overlooked, such as those providing capital to smaller companies. This is important as it helps the institution enrich the market environment through research, price discipline, surveillance and liquidity.
number two That’s what happens when a large fund gets into trouble. Larger funds have more members and a larger footprint. Rifts can cause damage on broad fronts. Execution of the fund seems improbable, but not impossible given that member selection allows members to switch at the time of the call. The Your-Future-Your-Super test only increases the risk on this front. Losers are likely to be members within the fund.
Function is more important than size
In some parts of the retirement industry, the slogan ‘size is good’ is circulating. However, size is not an automatic win. One consideration for members is whether the superannuation fund offers valuable capabilities and services, ideally at competitive rates.
Larger funds may offer aspects such as lower fees, greater exposure to unlisted assets, and richer services such as retirement strategies. But a more important consideration is whether the fund will materialize. Ultimately, its manageability is perhaps the most important.
Geoff Warren is Associate Professor at the Australian National University and Director of Research at the Conexus Institute. This research was conducted with Scott Lawrence of Lawrence Investment Consulting. This article is general information and not personal financial advice.