‘Narrow’ ASX universe spurs funds to mull overseas opportunities

The scarcity of domestic investment opportunities for Australia’s superannuation funds has come to the forefront recently, as the Australian Securities Exchange (ASX) continues to shrink in size.

The ASX contracted by $55 billion last year due to shifting market dynamics, including declining IPO activity and a growing preference for private markets, which is also driving capital into other areas of opportunity.

In a new report from June, Macquarie analysts highlighted that while Australia’s superannuation pool continues to grow and desperately seeks investment opportunities, there is a shortage of ASX equities due to several factors, including an IPO drought.

“Keep in mind, there has been an IPO drought for the past two years, so there has been little new supply,” Macquiarie analysts said. 

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Speaking to Super Review, Andrew Fisher, head of investment strategy at Australian Retirement Trust (ART), highlighted an "inherent capacity constraint" in Australia’s listed equity space.

“The super industry is growing faster than the ASX and has been for a long time, and it's as consolidation is happening as well,” he observed.

“Increasingly, we’re reaching a steady state point where our appetite for having a larger ownership of the ASX as a super fund, as a single investor, is starting to diminish.”

However, this doesn’t imply that the fund is avoiding Australian markets, as "earnings are increasing and stock markets tend to rise over time". Fisher acknowledged that while inventory levels will "inevitably" expand offshore, this is due to ART's growing concentration and ownership in the ASX.

Previously, the investment executive outlined how it is "not going to be practical" for mega funds like ART to sustain the current level of domestic allocations as they continue to grow in scale.

“I’d be lying if I said $280 billion of assets to invest is not a challenging task at times,” he said at an investment conference in May, adding that internal growth projections suggest the fund will reach $500 billion in size by the end of the decade. 

In conversation with Super Review, Fisher explained the ASX is a “relatively narrow universe of stocks” for mega funds to navigate.

“There's 400 stocks in the ASX, about 100 ends up being most of your holdings, compared to a global index where you have 3,000 stocks [and] you get a lot more diversification moving offshore as well,” he said. 

Previously, Macquarie’s report found ASX securities comprise a quarter (25.7 per cent) of the super industry’s allocations as of September 2023, compared with 26.9 per cent two years prior. 

This decline, the analysts said, is likely explained by the fact that the super industry is outgrowing the domestic equity market.

In the case of industry funds specifically, which comprise almost half of super assets (excluding SMSFs) with an average of $59 billion in assets, Macquarie noted that, in line with the sector trend, they too reduced their exposure to the ASX by 3ppt over the last three years to 22.7 per cent.

Pursuing other opportunities

Interestingly, Fisher elaborated that the “stranglehold” of Australia’s big banks on direct lending is pushing super funds to look to global markets for private debt opportunities.

“With private debt, the domestic banks here have a pretty good stranglehold on the direct lending market, which is why we really like them as equity investments in our listed shares portfolio, but it does make it challenging, I think, for super funds to do a lot of direct lending and private debt in Australia,” he explained, adding that a lot of ART’s opportunities in the private debt space have instead been offshore, such as in Europe.

Moreover, he said that the fund also ends up with "almost all" of its private equity investments offshore due to more rewarding opportunities overseas, although it does maintain some allocations in Australia.

“The opportunity set, particularly in the US, is just so much larger in terms of small to medium size businesses in the private market space,” Fisher explained.

“There’s just a lot more people and a lot more businesses offshore than there is domestically.”

When considering the deployment of capital domestically versus overseas, he highlighted an "easy example" of the dilemma in infrastructure, noting that it has matured as an asset class in Australia compared to overseas markets.

“There are a lot of markets where it's quite immature asset class from an institutional investment point of view, and so, it's a good opportunity for funds of our size and scale to take all the learnings we have from investing really successfully in infrastructure in Australia and applying those learnings offshore,” Fisher said, though he conceded that with the maturity of Australia’s infrastructure market, “innovation in the sector is likely to be domestic”.

“If we're moving into new things like digital infrastructure, there's a tendency for that to be domestic. If you want to move into the more traditional sectors, then the opportunity to innovate is perhaps [to] take what you know or how to invest in infrastructure here, and take it to an offshore market that has a capability.”

He mused: “As you get larger, it becomes more episodic, and the opportunities will become more episodic to have real impact on the portfolio.

“I think we'd have to be more diverse in our universe of thinking. You’ve just got to look harder and look more broadly for opportunities, and that will see us moving more offshore.”