Superannuation: Susan Hely Picking winners
Funds rely on highly paid experts to select the best investments. But members don’t always enjoy the rewards
An advantage of having your super with a large fund is the expert team who pick the investments. They are highly qualified, experienced and do it full time. But how much extra value these experts bring to a fund’s performance is debatable.
In addition to their internal investment staff, most funds also employ external asset consultants who recommend which outside investment managers should be hired or fired. The consultants are in constant contact with investment managers, reviewing their processes and performance, and know when there are key personnel changes. Asset consultants have a huge influence, as they are the gatekeepers for billions of dollars of assets.
There is a high degree of concentration in the Australian super system, with four main consulting groups: JANA, Frontier Advisors, Towers Watson and Mercer.
As asset bases grow, super funds have expanded their in-house capabilities, employing asset consultants as chief investment officers or members of the investment committee or investment team.
One way to see how successful the asset consultants are at picking good managers is to look at individual asset classes such as Australian or international shares. Super members can often choose to put their retirement savings in individual asset classes and make up their own portfolio, or they can invest in the diversified options such as balanced, growth or conservative. Members of many funds can increasingly choose to put their money into direct options including shares, term deposits and exchange traded funds that cover broadbased indexes such as the S&P/ASX 300 (Vanguard Australian Shares Index) or the S&P/ASX 200 (State Street Global Advisors).
When it comes to performance, the Australian shares investment option of the typical large super fund has returned 7.3%pa over three years, after fees and tax, based on SuperRatings numbers, compared with the S&P/ASX 300 after-tax benchmark of 7.2%pa – virtually in line. Worth noting is that super funds report performance after fees and tax, and so it needs to be compared with a benchmark that is also after tax. The fund’s fees include what it pays its investment managers as well as asset consultants, plus the cost of its own investment staff. The overall fee at the fund level is about 0.7% on average, around double the investment manager’s fees. Australian equities are unique in that the after-tax index performance is above the pre-tax result because of franking credits.
If investment options aren’t outperforming, what about the underlying managers? The typical Australian shares manager over the three years to June 2017 (the median manager in Mercer’s investment manager survey) returned 7.8%pa on average compared with 6.6%pa for the S&P/ASX300 index before tax and fees. So the typical Australian shares manager is ahead by 1.2%pa over that period. Even with fees of 0.3%-0.4% that still leaves a good slice of active return. Australian shares managers do tend to outperform the index, in contrast to what happens in the US. But the fund member choosing the Australian shares option isn’t seeing this outperformance. Somehow the fund’s hiring and firing process seems to allow performance to leak away.
A recent study in the US looked at how expert the asset consultants are. There, big pension funds’ investment managers also underperform non-recommended managers by about 1%pa, according to a study published in The Journal of Finance in the US in 2016. While past performance was a factor, the researchers found that the manager recommendations were also biased to how well managers presented themselves. This was characterised by the skills of their salespeople, the slickness of their presentations and the quality of their investment reports. Investment managers often say their best opportunities are under-researched companies that their competitors have ignored. But it seems that consultants in this study were biased to obvious choices.
The performance problem occurs when funds, acting on the advice of their consultants, try to choose the best managers. The Australian and US figures show that the manager selection process is tricky and can shred whatever advantage the managers would have been expected to achieve. It could be just as effective, and cheaper, to have invested in an index fund in the first place.