Are super's mega funds getting too big to perform?

Australia is rapidly approaching a new era in its superannuation landscape, with five funds now classified as "megafunds," according to a new report.

The country's two largest super funds, Australian Super and Australian Retirement Trust (ART), now command a quarter of the APRA-regulated market, collectively managing more than $620 billion in assets, research from Morningstar has revealed.

After a wave of mergers, strong performance, and high inflows, the megafund club has expanded to include Aware Super, UniSuper, and Hostplus. Meanwhile, three additional funds—Cbus, Rest, and HESTA—are on the verge of joining this elite group.

While this concentration of assets enables these massive funds to leverage economies of scale, Morningstar cautioned that this size is a “double-edged sword,” bringing with it potential challenges in investment processes and governance.

“Active listed equity strategies with stronger potential for outperformance often have capacity constraints,” the research firm noted, meaning they can only absorb a limited portion of a large fund’s equity allocation.

Namely, of the $2.7 trillion market capitalisation of the Australian Securities Exchange, as of 31 March, $646 billion, or 24 per cent, was held by APRA-regulated superannuation funds - half of it by the big eight profit-to-member funds.

Morningstar analysts explained that when a megafund attempts to make an active shift in its stock holdings, it struggles to transact at scale without influencing share prices. This limitation can affect both asset allocation and investment style.

"A megafund may have no choice but to focus on passive, enhanced index, or systematic strategies within certain listed asset classes,” Morningstar stated. “It may also need to limit its allocation to those classes, even if its capital market assumptions and asset allocation process suggest otherwise.”

In contrast, smaller funds, though less able to compete on fees, have an advantage in agility.

Morningstar highlighted that some smaller funds, which are performing “very well,” can pursue higher-return active strategies without the capacity issues facing their larger counterparts.

To mitigate these challenges, many large funds are increasingly looking abroad, reducing the traditional “home bias” that has defined the sector. Yet, despite this shift, Australia’s largest funds still dominate key local asset classes, particularly Australian equities.

With Australian Super setting its sights on $1 trillion in assets over the next decade, Morningstar raised the prospect of a future resembling the banking sector—dominated by a few colossal funds alongside a smaller number of niche players.

However, the firm is cautious in its outlook, suggesting that further consolidation and regulation may not be the “cure-all panacea” some might hope for.

“New potential concerns with large funds are emerging,” it said. “Ultimately, there is unlikely to be a one-size-fits-all solution when it comes to super funds, and it is imperative that members be discerning in evaluating a fund in the future”.