The outlook is outlined in a new report from Willis Towers Watson’s Thinking Ahead Institute, based on interviews with a number of senior investment professionals on the Your Future, Your Super reforms.
Aware Super chief investment officer Damian Graham, AustralianSuper CIO Mark Delaney, Hostplus CIO Sam Sicilia and QIC CIO Jim Christensen were among the individuals consulted for the paper.
It claimed that “members will suffer” because under the changes, aggregate costs are set to rise, long-term returns will be lower and systemic risk is likely to increase.
“The short answer is that we believe the reforms (if not modified) will eventually be counterproductive,” the report stated.
Your Future, Your Super proposed account stapling – tying each member to one account to avoid account duplication when they move jobs.
By doing that, industry funds will need to compete for new members as if they were retail funds, the Thinking Ahead Institute argued, no longer being able to rely on being the underlying fund for an employer.
The move would increase costs, reflecting that it is more expensive to recruit individual members than to sign on a new business with underlying employee members. Retail funds have had higher costs traditionally for this reason, as well as having to provide a profit margin to shareholders.
“This reform shifts the industry funds from being a business-to-business operating model to a business-to-consumer model with the associated increase in cost of acquiring new business,” the paper stated.
Higher costs also is expected to reduce the net return to members. But returns are also anticipated to be lower because of the performance benchmarks proposed by the government’s changes, which would see APRA conduct tests on the net investment performance on MySuper products.
Funds that record returns under the benchmark for two consecutive years will be blocked from receiving new members, and products that underperform their net investment return benchmark by 0.5 percentage points over an eight-year period will be classified as underperforming.
The Thinking Ahead Institute has projected that the benchmarking will “divert skill and attention away from maximising absolute returns towards the management of career risk”.
The severe consequences could mean that teams could change their investment behaviour to manage their career risk.
“Underperform the benchmark by 0.49 per cent per annum and ‘nothing happens’, but underperform by 0.5 per cent per annum and you likely have to exit the business,” the report noted.
“Faced with those consequences, how would you manage the portfolio? To maximise the long-term absolute returns or to not fail the performance test?”
The chiefs of IFM Investors and Mercer have made similar warnings, having previously said that investment managers will feel the need to manage their risk relative to the benchmark rather than focusing on making money over the long term.
The behaviour of super funds may become less predictable also, as their businesses will be contingent on the path of returns. If a fund is behind the benchmark at the six-year mark, the report questions, their time horizons will be shortened – which may negatively impact on any collaborations it may wish to pursue.
Teams are also expected to game the rules – with the performance test only accounting for investment costs, but not administration costs. What’s to say super funds would not find ways of reallocating costs between the two categories, the report asked.
“The Your Future, Your Super reforms seem to take us backwards,” the institute noted.
“The performance test clearly communicates the Australian DC [defined contributions] system will be an asset management system where the return over the latest eight-year period is all that matters. Rather, it should be a system that accumulates funds to meet future (de facto) liabilities.”
The benchmarking is also forecast to compress the range of investment outcomes – with the herding behaviour expected to rise and further narrow the range of returns.
“This, in turn, increases the correlation of member outcomes, meaning that when the system fails to deliver the expected, or hoped-for, returns, it fails to deliver them for all members at the same time,” the report cautioned.
That fallout would have implications for the first pillar of the retirement income system (the age pension) and taxpayers.
