Watering down super fund tests risks lower returns

Dud super products have closed and members have moved to better performing products.

Since the performance test was first administered in 2021, 17 MySuper products have exited the market, which collectively accounted for $75.5 billion of assets and 1.4 million member accounts, the Australian Prudential Regulation Authority says.

Labor needs to tread carefully and make an evidenced-based case for changes.

The move to corral super funds to invest in the energy transition and housing reflects broader policy failures.

The benchmarks were recommended by the Productivity Commission and implemented by APRA after extensive consultation.

They may not be perfect, but any benchmarking system is inevitably going to throw up winners and losers.

Some will reasonably ask why the performance of super funds needs to be regulated.

The answer is because the government compels working Australians to pass on about $1 in every $10 they earn to super funds to manage for about 40 years. There is a lot of ticket clipping by money managers in the default system and consumers are complacent about choosing good super options.

Treasurer Jim Chalmers says he wants to find “win-win” ways for the government and super funds to invest in “national economic priorities”, including the net-zero transition, housing and defence.

“It’s all about trying to align what’s good for investors and superannuation fund members, with what’s good for our communities and what’s good for our country more broadly,” Chalmers said after hosting a roundtable of executives from super funds, banks and other investment funds on Tuesday.

The great irony is that AustralianSuper just blocked Canada’s Brookfield from investing a pledged $20 billion to $30 billion in renewables at Origin Energy.

The government’s national economic priority ambitions are perhaps understandable, as it struggles to fund the 2050 net-zero energy transition that is estimated it will cost $225 billion above business-as-usual levels.

But adjusting performance benchmarks could also pose risks for super fund members.

A Labor government co-ordinating with Labor-dominated industry super funds led by the likes of former ministers Wayne Swan (Cbus) and Nicola Roxon (HESTA) will raise questions about whose interest funds are working for and whose money it is.

The Australian Council of Trade Unions said on Wednesday the performance test needs to enable investments in advanced manufacturing. The political pressure is building on big super to co-invest with the government’s $15 billion National Reconstruction Fund.

One of the hurdles to investing in renewable energy assets for super funds is the long-term time horizon and the uncertainty over returns.

Hence, the trepidation among super funds about making big bets on renewable energy generation, storage and transmission.

Adjusting the performance test methodology could make green investments more viable, at least at the margin.

But it could also lower the performance bar for super funds and lead to suboptimal returns for members in retirement.

Moreover, capital markets are already pricing in climate risk and energy transition for various listed and unlisted assets.

Arguably the existing benchmarks super funds are being measured against should already reflect the impact of climate change and the energy transition. It is not clear they are an unreasonable benchmark.

The move to corral super funds to invest in the energy transition and housing reflects broader policy failures.

The lack of an economy-wide carbon price to reduce emissions and failure to impose a housing supply strategy by governments for more than a decade have robbed private capital of the necessary investment signals.

As AustralianSuper chief executive Paul Schroder said on Tuesday: “The challenge we face is not a lack of capital, but a shortage of good quality investment opportunities.”

Without broader policy reforms, even if Labor loosens the performance methodology for super funds, there is no guarantee extra money will go into its priority areas of the energy transition, housing and defence.

Financial Services Minister Stephen Jones already committed in April to add more performance benchmarks such as for emerging market equities and extending the measurement timeline to 10 years, up from eight years.

The flagged tweaks responded to complaints from super funds that the existing system encourages short-term investments and benchmark hugging.

This view is that the benchmarks have become so prescriptive for each asset class that it is leading to too little diversification by funds and may be fuelling systemic risk due to concentration. Super funds with their long-term investment horizons should be acting more like venture capital funds by spreading their bets on a range of higher-risk, higher-reward investments.

Benchmark hugging is regrettable, but it is also natural evolution of active managers as they become bigger.

This is explored in a research paper by Paul Woolley of the Centre for the Study of Capital Market Dysfunctionality at the University of Technology Sydney.

The financial incentive for managers of new investment funds – not just superannuation funds – is to take risks and invest aggressively in the early years to build up a track-record of higher returns.

If they beat the market, they will attract new members. If relatively new funds perform poorly, they have little to lose.

But once funds become bigger like the big super funds, the incentive is to take less risk and retain their funds under management (FUM) by not underperforming the market. That’s because investment fund fees are typically a percentage of fees under management.

Hence, the incentive to hug the index.

Labor and industry funds also need to be wary that if the government becomes more involved in nudging super investments, the grand bargain for industry super will be undermined.

If people’s retirement income capital is used for “nation building” while super funds charge active management fees, the case for a low-fee government-administered index fund will look more appealing.