If we are to believe everything in the news these days, the superannuation industry appears to be facing an existential crisis; that is except the industry, or union super funds. The union funds were somehow able to avoid the wrath of the Royal Commission, even though they continue to replicate many of the models that are coming under question. With the Australian Labor Party seemingly nudges more and more investors towards the union super fund sector, we thought it worth undertaking the analysis that the Royal Commission failed to cover to provide readers with some insight into their approach.
What triggered this article was the seemingly constant bickering that has been occurring between the union funds and both SMSF and corporate or retail superannuation accounts; we’ve all seen the advertisements. Yet both SMSF and union super fund member numbers continue to grow. It’s interesting, I think, that the most commonly cited issue with SMSF’s is the fact that they do not exist anywhere else in the world; but are superannuation accounts that allow unions, rather than the State, to control both the employment terms and wealth of their members (and non-members) all that common either?
In our view, there are six real areas that concern us with the union super fund sector, which we will seek to address in the sections that follow:
- Experience; and
Only a few weeks ago, the Industry Super Alliance, which appears to be a marketing body for the union fund sector, were outspoken in their view that the Future Fund should not be considered as an alternative superannuation option. The primary reason for their view? The fact that the best (not all) industry super funds had outperformed the Future Fund over various reporting periods. Yet this comparison brings to the fore the most important and misunderstood fact about the union fund sector; they do not offer their members access to risk-adjusted returns.
Risk-adjusted returns are incredibly important when it comes to measuring the performance of people in or nearing retirement. It is all well and good to produce market leading returns, exceeding 10%, but when these returns have been delivered by taking substantially more risk than the alternative, is a major cause for concern. We all know that future returns are not guaranteed, yet many of the union funds seem to be investing as if they were; in some cases up to 90% of so called ‘balanced’ funds is investing into highly risky assets like private equity, listed shares and smaller companies. Some may say that the union funds are simply great at understanding the market, however, if they are wrong, those ‘balanced funds’ and the life savings of their many million members, are at substantial risk of an extended fall in markets. Take for instance the weak performance of these options in the December quarter of 2018, with many down at least 5%. This problem with this focus on
retirement. It is all well and good to produce market leading returns, exceeding 10%, but when these returns have been delivered by taking substantially more risk than the alternative, is a major cause for concern. We all know that future returns are not guaranteed, yet many of the union funds seem to be investing as if they were; in some cases up to 90% of so called ‘balanced’ funds is investing into highly risky assets like private equity, listed shares and smaller companies. Some may say that the union funds are simply great at understanding the market, however, if they are wrong, those ‘balanced funds’ and the life savings of their many million members, are at substantial risk of an extended fall in markets. Take for instance the weak performance of these options in the December quarter of 2018, with many down at least 5%. This problem with this focus on topping the performance tables every quarter is that it doesn’t factor in the fact that retirees need to draw capital at inopportune times, such a high risk approach requires an endless investment horizon, which suits the fund, but unfortunately not the retired investor.
The scoreboard for union back funds came out in early February, and unsurprisingly the spread of returns is highly volatile. Of the so- called ‘growth funds’ which include about 15 different option names for investors to decipher, the best performing fund was 2.8% and the worst 2.5%. That may not sound like much, but when applied to $100’s of billions, of dollars, it means a lot to investors. There is very little consistency in those who outperform in any given year and the asset allocations vary so much in the ‘growth’ option alone, some holding large amounts of bonds and others equities, that it is effectively a lucky dip in picking the right fund.
Rather than focusing too closely on the underlying investment approach of the sector, which is inherently over-exposed to interest rate sensitive assets including utilities, property, bonds, infrastructure assets and airports, it was interesting to see the report released by Stock Spot. The report outlined that the some two thirds of growth funds in the sector underperformed the index after fees; this is no better than the active versus passive debate?
Whilst transparency has been increasingly demanded of the private sector, from CEO’s pay to where loans are being made by the major banks, the union fund sector has seemingly dodged a bullet. Where Australian share funds are benchmark against the ASX 200, industry funds do not offer up any such index, nor do they report their performance or asset allocation in a consistent way. This is where we believe the biggest issues lie, which are thankfully finally being addressed by the research sector. An investor in one of these funds would likely have no idea that they are actually allocating private equity, mezzanine finance, or direct lending to the low-risk component of their portfolio, rather than the risk portion where it belongs. Some progress is being made in reporting this to members, however, a ‘balanced fund’ at one institution could mean 90% is at risk, but another may actually be ‘balanced’ with 50% in risky assets as the name suggests. There seems to be no way to truly understand where your life savings are being invested. The theme of transparency continues into the underlying investments held by the funds, with little more than a token list of the top 20 shareholdings on offer and a list of their primary external fund managers.
What may actually be the biggest risk for investors, and a ticking time bomb for the sector, is the underlying discount rate used by these funds. What’s a discount rate? The discount rate is used to value unlisted or non-market tradeable assets like property, infrastructure, utilities, toll roads and the like. It is typically set based on prevailing interest rates, or the ‘risk- free’ rate plus an additional margin for risk.
Due to the reliance on unlisted assets for their returns, the discount rate has become one of the biggest risks for the sector, as it determines the price of a huge amount of their assets. Yet it is incredibly difficult to actually identify what this rate is from any investment reports.
A little known fact is that it is generally a select group of ‘asset consultants’ that control the investment of union or industry fund account. These asset consultants undertake research on appropriate investments, determine asset allocation and in many cases make the final decision on investments. In many cases they are poorly funded, at least compared to the $1.4m being paid to one union fund Chief Investment Officer. Interestingly, Australian Super owns 30% of Frontier Consultants, which it employs, but which also advises a number of other union backed funds in Australia.
Without sounding like a conspiracy theorist, it was thought provoking to look back at the stated purpose of the ACTU upon it’s founding. The original objective was to socialise industry in Australia, by putting ownership of assets, business and plants in the hands of its members. A worthy cause no doubt, however, somewhat questionable when in light of the falling levels of union membership, from 40% some 20 years ago, to just 15% today. Yet it seems that the union backed funds may actually be more powerful than ever and having more success in achieving this objective. In just the last few weeks, they have made several plays at purchasing private hospital operator Healthscope, with a view to taking the business private. Do they intend to offer medical services directly to their members? Or is it just an investment play?
At this point, the union backed funds own a massive swathe of key Australian
infrastructure assets. They have shares in energy distribution networks, domestic and international airports, seaports, toll roads and train stations, not to mention major shopping centres. Interestingly, if this were a foreign investor, they would have little hope of gathering even a portion of these assets in their hands. The union backed sector is gathering more clout and power by the month, with Australian Super representing some 10% of the entire value of the ASX by assets under management. Their investment teams are becoming increasingly active in voting down executive pay and other resolutions, yet their own members have no say in the salaries they pay themselves.
One of the biggest issues in the superannuation sector at the current time, is the lack of options for those drawing an income in retirement; in this area the union sector is as bad as the rest. We have replaced defined benefit pensions, with defined contribution schemes, but given investors no option for a consistent and guaranteed income; like an annuity. Interestingly, the SMSF sector is one of the few that allows you to build a portfolio more suited to this need.
The most interesting announcement in the union sector in recent years, was the announcement that CBUS and Australian Super launched their own news service, the New Daily, seemingly in an attempt to influence the views of their 2.2m members.
When researching this article, it came to my attention that there is a lack of real investment or private sector experience on the boards of many of these funds. Unfortunately, as is the case on both sides of politics, the boards are filled with people of similar experience, be it as union stewards, economists, retired politicians or lawyers. Now, I’m not saying the entire board should have experience in the institutional investment sector, but there seems to be an under representation across the industry. The same could likely be said of the likes of Colonial First State, MLC or AMP.
It is with concern, then, that we saw the industry funds pushing back heavily against a Coalition proposal to require the inclusion of at least two independent trustees on the boards of each of these funds. Any other board in Australia is required to have independent trustees, yet the boards continue to be made up of the same group of people. In our view, this simply places huge amounts of pressure and responsibility on the CIO, who is generally very well paid, and the external consultants that contribute to the investment decisions. The majority of these board members have less experience than a first year stock broker, or bank financial planner. This may be fine when times are good, however, we only need to look back at the risks that having inexperienced people in positions of power with a lack of oversight, can be to markets. Statewide Super is an interesting case study, in that the fund moved so heavily into unlisted and alternative assets that it was nearly deemed insolvent due to the inability to pay pensions to its members during the GFC.
The final concern relates to experience, and it is the overall governance of the sector and the wishes of its members. The construction of boards for most of these funds remains enshrined in legislation or the trust deeds of the fund, limiting the quality and diversify of potential board members. Yet the membership of these funds is increasingly diverse; Australian Super has some 2.2m individual members. Are these members interests, with such diverse backgrounds, really being appropriately represented by members of the ACTU alone? This is particularly questionable in light of the fact that the likes of HOST PLUS continue to entertain employers at major corporate and sporting events, using member funds.
Of increasing concern, is the lack of regulation in the sector. There is seemingly no question from the ACCC when the sector purchases another airport, partners with a builder to construct a new toll road, or increases the cost of using these assets. In light of the Royal Commission, it is interesting that the vertical integration implemented by the banks that is now being broken down, is actually being implemented by the union funds in the form of employing their own advisers, outsourcing to ‘independents’ and only offer advice on their own products. Without naming names, we have experienced first-hand the inappropriate advice of some of these institutions, in some cases recommending clients give up defined benefit pensions.
Where to from here?
It’s difficult to comprehend how the major union backed funds are still advertising the fact that they are non-profit, or only for the benefit of members, yet their actions seem like they are seeking to be more profitable than their competitors. It’s seems like the same idea of a bank claiming to be an independent adviser. Whether it’s the expensive corporate tickets for employer partners to attend the Australian Open or AFL Grand Final, the sponsorship of major sporting events like the Melbourne Cup, their substantial TV and outdoor marketing budget or even the idea of running their own news website; surely these funds would be better put to use in reducing the fees to members rather than in an attempt to gather further political clout.
With all this in mind, there is little wonder that SMSF’s remain so popular in Australia. People are simply sick of the poor options, for differing reasons, available in both the retail and union backed sectors. I’m sure if other countries began offering similar options to an SMSF, they would grow as quickly as they have in Australia. Finally, the idea of ‘generational theft’ where younger people will pay higher taxes to fund the retirement of their parents, is alive and well in the industry fund sector, where it is actually those with larger balances (typically older) who are subsidising the young.