The superannuation industry faces its demons

The year has produced its challenges, but the Australian superannuation industry more than met them, writes Damon Taylor.

If 2008 was a year characterised by financial crisis, then 2009 has been one of both consolidation and improvement for Australia’s super industry. But that is not to say that the volatility and uncertainty of 2008 disappeared, or even lessened to any significant extent.

For Russell Mason, worldwide partner and national business leader for industry/multi-employer superannuation at Mercer, it was a case of the industry, and perhaps more importantly its members, coming to terms with the challenges set before them and acting accordingly.

“By and large, the industry and its membership dealt with the financial crisis very well,” Mason said. “Funds have gone out of their way to communicate with their members and, in the main, members seem to have understood the messages being delivered.

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“Most have realised that if world equities markets have dropped then it’s highly likely that their super is going to have dropped as well,” he continued. “Fortunately, despite that realisation, mass switching to cash and other conservative investment options hasn’t happened.

“Reactions have been measured rather than panicked, and hopefully that means members can ride investment markets up as they continue to improve.”

Pauline Vamos, chief executive of the Association of Superannuation Funds of Australia (ASFA), said between the Henry Tax Review, the Cooper Review and the tail end of the global financial crisis, 2009 has been a triple bunger year for superannuation.

“It’s all tested the industry but it has also reconfirmed that with respect to retirement income, the Australian system remains one of the best in the world,” she said. “It’s very clear, when looking at investment market falls and average super returns, just how well the industry has done.

“We’ve learnt a lot about stress testing, about liquidity and about how particular assets work, but most importantly our research shows that member confidence is still very high, and that’s vital.”

For Tony Lally, chief executive officer of Queensland-based fund SunSuper, the events of 2009 reminded many in the industry that markets work in cycles.

“Significant downturns tend to be different every time,” he said. “In 2008, everyone was asking where the bottom of the investment market drop would be and when markets would be coming out of their decline, and I think the answers to those questions are clearer now.

“We’re not out of the woods yet, but people know that market cycles are a reality, they know that predictions are all but impossible and they’re starting to see that recovery does eventually come.”

Performance

Yet when talking of the consequences of this global financial crisis, the super industry needs to look no further than the performance differential between industry funds and retail master trusts.

For many years prior to 2008 industry super funds enjoyed performance ascendancy, but in more recent and more turbulent times that status quo seems to have changed.

However, according to Lally, there are fundamental reasons for the performance gap that traditionally exists between industry super funds and their retail counterparts.

“A lot of the work done by Chant West recently has shown that industry funds have outperformed in nine out of the past 10 years,” he said. “And there are fundamental reasons for that outperformance.

“In the first place, the cost of an industry fund is lower, but it’s also about what they do,” Lally continued. “Where a retail fund might have up to 15,000 financial planners underneath them, an industry fund’s primary focus is their default fund.”

Lally said despite moves on the part of retail funds towards unlisted assets and dynamic asset allocation, he expected some sort of performance differential would always exist.

“By their nature, retail funds are more vulnerable to switching between products,” he said. “Liquidity is a more pressing issue because there can be massive amounts of money walking around from manager to manager throughout any given year.

“That doesn’t happen within industry funds, but it means retail funds have to be very careful about their allocation to unlisted assets,” Lally added. “It’s a very different type of business.”

Referring to the fact that retail funds outperformed industry funds through the 2009 calendar year, Damian Hill, chief executive of large industry fund REST, said it was always dangerous to look at short-term numbers.

“You have to look at the longer term,” he said. “And over that longer term I think there will be significant differences in performance for some time to come.

“It comes back to asset allocation, because any increased use of alternatives is going to give you a different return profile and different return characteristics,” Hill continued.

“Retail funds may close the gap a little as time progresses, but I still believe there will be an enduring performance difference.”

With the ability to comment from a more neutral standpoint, Vamos said her view had been that the industry versus retail debate had been much ado about nothing.

“Both sectors of superannuation have clear reasons for investing in their chosen asset classes,” she said. “And I think those differences, coming from each sector’s own history and individual drivers, will continue to be there.

“Industry funds, for example, have much grittier members and have strong relationships with unions and employers,” Vamos continued. “Whereas retail funds are able to offer members more choice and flexibility in their investments.”

The point, according to Vamos, is that in the face of a global financial crisis, no fund has failed.

“At the end of the day, both sectors are long-term investors and that’s the name of the game,” Vamos said. “The important thing is that wherever members are invested, it’s the right place for them.”

Unfortunately, if sector performance comes down in large part to asset allocation, recent history is more than adequate proof that no one in the super industry has access to a crystal ball. Hill said he was no exception and that he always loathed making investment market predictions.

“It’s still an uncertain world and certainly a lower growth environment when compared with what we’ve become used to,” he said. “But the important thing for investors is to remain focused on fundamentals.

“Maintaining that sort of focus will be vitally important for investors going forward.”

In terms of what 2010 might hold for investment markets, Lally said the United States would provide the lead.

“The world is still being held up by significant government support,” he said. “And until the private sector steps in and fills that void, we won’t see a complete recovery anywhere.

“US consumer confidence is likely to be another signal for that recovery,” Lally continued. “And when we see either of those it will have a knock on effect on the share market and flow on down the line to Australian markets as well.

“There’s no way the market will roar on ahead from here, but depending on the actions of the private sector, we may see some sort of steady recovery.”

Also steering clear of predictions, Vamos advised funds to look to what they could control about the future.

“The only thing you can say for sure is that provided super funds invest in a broad cross section of assets, provided they continue to invest for the long term and not year by year, then members’ retirement needs will be met,” she said.

“Provided that happens, funds will continue to deliver.”

Remuneration

There has been more to 2009 than market volatility and funds coming to grips with a financial crisis. Due perhaps in part to Australia’s current financial climate but also to a growing trend towards professionalism in the financial planning industry, adviser remuneration has been a topic stimulating significant debate.

Indications from the Financial Planning Association (FPA) have been that adviser commissions may soon be a thing of the past and yet, with Liberal Party Shadow Treasurer Joe Hockey expressing his opposition to such a move, it would seem the issue is by no means clear-cut.

For Mason, however, the remuneration debate’s key issue is transparency.

“How the adviser is being remunerated isn’t important so long as the individual understands how that payment is being made and, more importantly, how that payment is affecting the service that they’re getting,” he said. “It’s about disclosure.

“As long as people are going in to see a financial planner with their eyes wide open, the method of remuneration shouldn’t be an issue,” Mason continued. “The problem is, members don’t know.

“They need to know if they’re being encouraged to invest in a product because it’s the best option for them or if it’s based on adviser incentive and, as things stand right now, many don’t.”

Vamos said the “number one” achievement of financial planner remuneration discussions this year had been the connection of advice and product sale.

“If the only way advice can be given is by selling a product, there has to be a conflict,” she said. “Advice in the best interests of fund members has to be independent of a product.

“It’s that simple, but it’s something I think that has become clear this year.”

Yet transparency is only one side of the remuneration coin. Arguments abound within the financial planning industry that the removal of commissions may make financial advice less affordable and, by extension, less accessible. So to what extent does price become an issue in this debate?

According to Hill, concern over what people must pay for advice is somewhat inevitable.

“There will always be some degree of price sensitivity in terms of what people are willing to pay for advice,” he said.

“But it’s beholden upon all parties within the financial services community to educate people on the value of that advice.

“The challenge for the super industry lies in the fact that advice’s benefits are long term rather than immediate,” Hill continued.

“People forget that, so to encourage them to act and get advice we have to make it as cost effective to distribute as possible.”

Hill said the super industry was coming from a position where the majority of members were excluded from access to advice.

“But I am certain that there is a growing trend towards addressing that,” he said.

Mason also admitted that price would always be an issue.

“But I think the majority of people are looking for very straightforward advice,” he said. “Are they in the right fund? Are they making the right contributions? Have they got the right insurance cover?

“Those questions would cover 90 to 95 per cent of all enquiries,” Mason continued. “And it’s excellent to see a number of funds now offering advice in those areas.

“And at the end of the day, any removal of commissions is unlikely to impact on the price of those sorts of services.”

Alternatively, Vamos sees the price of advice question being answered by competition.

“For the first time ever I’m expecting the provision of financial advice to become incredibly competitive,” she said. “I’m expecting that advisers will be competing not only with each other but also for their customers.

“We should see more financial planners looking at different levels of service and that may lead to something the super industry has been looking for for a long time — scaled financial advice.”

Legislative reviews

No wrap-up of 2009 would be complete without a mention of the current legislative reviews in the form of Henry and Cooper.

Both are likely to have a fairly lasting impact on the Australian super industry, but in terms of specifics, the Henry Tax Review’s recommendation to leave the superannuation guarantee at 9 per cent is most certainly the focal point.

As to whether a 9 per cent superannuation guarantee was sufficient to provide an adequate retirement, Lally said the terms to keep in mind were ‘adequate’ and ‘comfortable’.

“There’s been quite a bit of modelling done on this subject,” he said. “And for middle income Australia, it’s found that 9 per cent really won’t deliver people what you’d call an adequate retirement.

“They’ll be able to get by, but there’s a significant difference between adequate and comfortable,” Lally continued. “If we want to reduce that difference then we really need to be pulling for 12 per cent.”

On the topic of adequacy, Vamos said ASFA’s position was that a 9 per cent superannuation guarantee would be insufficient for anyone entering retirement.

“People don’t work for 35 years anymore and they’re certainly not on a high enough salary for 35 years to make 9 per cent sufficient,” she said. “We need to be looking at a 70 per cent replacement rate.

“Australians want a comfortable retirement,” Vamos continued. “And as a super industry and as a nation we need to look after those consumers because they’re the ones out there supporting our economy.

“At the moment, Treasury is talking ‘adequate’. We’re talking ‘comfortable’.”

Mason said Mercer’s view on retirement income was also that a 9 per cent superannuation guarantee was not enough.

“That’s our view, it’s ASFA’s view, it’s the industry commentators’ view,” he said. “And the figure pointed to most often as the right level of retirement savings is 12 per cent.

“The only real debate is how we get to that.”

Of course that, if anything, seems to be where the retirement adequacy discussion is focused. In spite of the Henry Tax Review’s recommendations, the overwhelming industry consensus seems to be that retirement savings need to be lifted. The question yet to be answered is how.

Interestingly, Lally said while a higher level of retirement savings could be achieved in a number of different ways, he was of the opinion that soft compulsion could prove all too hard.

“It’s all very well putting soft compulsion in place within one company,” he said. “But when we’re talking about doing it across the whole system it gets too hard — there’s too much leakage.”

By contrast, Mason said of the mechanisms proposed, Mercer favoured soft compulsion.

“Our stance is that it gives people a little more flexibility,” he said. “Different people have different needs and soft compulsion caters to that.

“Having said that, the beauty of increasing the superannuation guarantee to 12 per cent is that it guarantees retirement safety,” Mason continued. “There’s no chance of people falling through cracks in the system.

“But as long as the mechanism chosen is equitable, it will be the right thing to do.”

Reflecting on the potential for change coming from each legislative review, Mason said the super industry would be hoping for this to be the last lot of significant change.

“The feedback we’re getting from research is that people are sick of constant super uncertainty,” he said. “They want to know what aspects of their super are tax free, what isn’t tax free and so on and so forth.

“The Government needs to finish its reviews and give people some degree of certainty,” Mason continued. “Whatever is put in place needs to still be there in 10 to 15 years’ time.

“This is policy that needs to stand the test of time or people will continue to have a severe lack of faith in super.”

Predictions

So with 2010 mere weeks away, a lingering financial crisis still affecting returns and significant legislative change almost certainly on its way, it seems Australia’s super industry has come to a crossroad.

Looking to the year ahead, Mason said he hoped for something simple for the super industry.

“I’m hoping for a positive return from this financial year,” he said. “Because that would be quite the novelty at the moment.

“But I think it’s also important to realise that there have been some positive outcomes from recent years,” Mason continued. “Funds have learnt a lot of lessons and have become a lot more professional.

“They’re in a good place to cope with anything the future might throw at them.”

Vamos predicted that 2010 would be enormous for the super industry.

“We’ll see taxation changes, we’ll see the industry competing with non-super investment options and we’ll have to become more efficient and more cognisant of the fact that we’re providing for peoples’ retirements as a consequence,” she said.

“It will be a year of challenge, but hopefully a year in which the industry comes together as well.

“If we can leave our vested interests behind and through our diversity meet these challenges, the result will be a better retirement system both now and in the future.”

Asked whether there was anything he’d advise superannuation executives and their trustees to take from 2009 and make use of in 2010, Lally advised funds not to be scared of going back to fundamentals.

“There’s a lot riding on the outcomes of Henry and Cooper,” he said. “I think the changes will be far beyond what people are expecting.

“Funds may have to go back to square one and ask themselves why they’re here, what they’re trying to achieve, how they’re going to keep their costs low and how they’re going to continue to deliver the best service possible to their members,” Lally added.

“The challenges of this year have been a positive, but I think these reviews are really shining the spotlight on areas in which our industry can improve.

“It’s time for the super industry to think hard about the future.”