Super funds risk handing back their gains from pursuing fee reductions – and more – by ignoring a far bigger source of erosion of returns: tax and implementation inefficiency.
There has been a lot of industry debate around the latest Grattan Institute’s report, which says there is not enough competition in the $1.95 trillion superannuation sector to drive down fees despite years of debates and reforms.
This once again puts the Australian retirement savings system in the spotlight, in line with various inquiries including the Stronger Super reforms and the more recent Financial System Inquiry.
The Grattan Institute report rightly reminds us that there is more to superannuation than investment returns.
If current practices force super funds to give back hard-won investment returns in areas like fees, taxes, excessive brokerage and FX commissions, then these practices need to be brought to light and addressed.
There is an underlying premise in the Grattan Report that policy and regulatory settings need to change further to compel better practices within funds.
However, Parametric’s experience says that funds themselves recognise the need to evolve, and they are delving deeper into new areas like implementation efficiency to return value to members.
In fact, many funds are seeing implementation efficiency, including a focus on post-tax investment returns, as a ‘third dimension’ to manage alongside investment risks and returns, to improve outcomes for superannuation members.
The self-propelled implementation efficiency drive is a good example of how the super industry can evolve and innovate organically without the need for regulatory interference.
The Grattan Report’s focus specifically on fees might be misleading by suggesting that fees are the biggest investment costs to super funds, when, in fact, it is investment taxes.
Based on the most recent published APRA statistics, APRA-regulated funds are paying $2.611 billion in taxes on investment earnings each year versus $1.535 billion in investment management fees.
If Grattan wants to sponsor a discussion on the ‘fat’ in super investment fees, let’s also have a discussion on the ‘fat’ in super investment taxes (ie. taxes which fund trustees need not have paid), both of which could be returned to member accounts.
Grattan Institute queries the value of actively managing Australian equities, based on an analysis of Australian equity manager cohorts versus peers through time.
We appreciate Grattan’s initiative – it is good for the super industry to subject itself to scrutiny of this kind, given how much is at stake.
However, as it is not clear from the report, we ask whether Grattan, like others, has fallen into the common trap of relying on a pre-tax analysis, which ignores the current trend for super funds to move their Australian equity managers to after-tax management and measurement mandates.
Thoughtful use of franking credits, in particular, can significantly impact equity return results, outperformance-against-benchmark and peer rankings through time (particularly in high yield and/or low growth environments).
The Grattan Report also refers to “the scale test” as “perhaps the most important new duty” of super trustees.
Trustees are not viewing this test simplistically or one-dimensionally as just about size, but are thinking about how to innovate so that so-called ‘sub-scale’ funds can stay nimble and close to their members but nonetheless ‘act big’.
This is a much more sophisticated response to the scale challenge than Grattan appears to contemplate or credit trustees for.
A demonstration of this is the growing interest in approaches like centralised portfolio management which seeks to provide scale and efficiency benefits to funds regardless of size.
Raewyn Williams is the director of research and after-tax solutions at Parametric Portfolio Associates.
