Challenger retirement income chairman and former Super System Review chair Jeremy Cooper is known to indulge on occasions in a bit of philosophising. Sometimes this happens out loud and in the presence of a large audience, as was the case earlier this month at the Morningstar Investment Conference.
On being asked a question about why he did not use after-tax equities returns instead of pre-tax returns on a slide in his presentation, Cooper pondered the viability of dividend imputation.
"I guess you always need to remember good old franking, and one of the questions is how long franking credits are going to last," he said.
"We all hope they will last forever, but there is probably a whole seminar worth in looking at whether it is time to wind back some of these things which we've got in place."
He argued franking credits had contributed to the high equity exposures in Australian super fund portfolios compared with portfolios of other pension systems around the world, and the abolition of franking credits could help in addressing that situation.
"We are way out of line with our fixed income exposure and you can wonder whether that can continue, and you have to look at what policy would change that," he said.
Cooper is not the only one who has questioned dividend imputation in its current form. The most recent government initiative to deal with this issue was the Henry review, and in its final paper it also emphasised that franking credits strengthen the home bias of investors.
"The bias for domestic savings to be invested in the shares of Australian companies will increase, limiting opportunities and increasing risk to households from poorly-diversified savings portfolios," the report concluded.
Although review chair Ken Henry did not recommend any changes in the near future, he said in the longer term an alternative to the imputation system would be required.
But superannuation fund executives do not support a move away from dividend imputation, saying it would create more problems than solutions.
"Lack of franking credits in other parts of the world, such as the United States, has led to lower dividend yields as companies try to minimise the inherent double taxation of company earnings," SunSuper chief investment officer David Hartley said.
"In turn this has also been mixed up with bad remuneration practices that emphasise capital growth over dividends, which has encouraged very creative accounting. This is not good for the economy and not good for investors."
AMIST chief executive John Livanas agreed the absence of dividend imputation would likely affect companies' dividend policies. "It would be a pity to see a progressive system like franking credits being scrapped. The system has served us well, avoiding double taxation and encouraging companies to pay out earnings as dividends," Livanas said.
"Without franking credits you may have companies choosing to pay less as dividends and investors may start relying more on capital gains. I can't understand how such a change benefits anyone."
He also said investments in equities should be based on the risk profile of investors and not on concerns over tax policies. "Ultimately, investment in equities is a portfolio decision and creating tax uncertainty may just dampen risk appetite for all the wrong reasons," he said.
Hostplus chief investment officer Sam Sicilia also questioned to what degree a change to the dividend imputation system would eradicate a home bias, as exposure to domestic stocks had many more benefits, including exposure to the local currency.
"It is true that Australian investors have an overexposure to Australia, however, the home country bias is a feature everywhere in the world and they don't have franking credits," Sicilia said.
"If you switched off the franking credits tomorrow, it doesn't necessarily mean that we would go underweight Australia to 2 per cent of the index. It would not change one dollar."
About 94 per cent of Hostplus's 1 million members were in the balanced option, he said.
This option allocated 26 per cent to defensive assets, of which just 7 per cent is fixed income. "We know that equities win in the long run," Sicilia said.
