The latest instalment from the Cooper Review is now out providing further insights to the principles around the universal fund concept, now called MySuper. The good news is that there is acknowledgement of the benefits of pooling assets, and therefore support for the retention of the existing commingled investment operating models.
However, there are broader issues from the Report and related commentary that may have significant implications for the financial outcomes of members.
Obsession with fees, at the expense of member returns
The desire of the Panel to lower costs for members and improve returns is certainly supported by most in the industry. However, the obsession of the Panel with costs and its ongoing drive for consolidation in the industry has the potential to actually result in lower member returns. The Panel is essentially saying that disclosure combined with comparability will lead to greater competition and lower costs.
Conflicted obligations
Ideally, every investment and operational decision would be made to maximise the dollars available for members in retirement. The fiduciary obligation of trustees and the regulatory regime would then reinforce and encourage this obligation. The Report acknowledges the importance of trustees focusing on net returns for members, however it also strongly emphasises the desire to lower costs (well only 46 times!).
The Report also reinforces this emphasis on costs via the introduction of a new “duty on trustees to manage overall cost to members”. However, the core problem is that the objective of optimising net returns is bound to be in conflict with this “new duty”. If a fund is focused on the net return to members, including protecting members from GFC like experiences, then they are likely to be actively seeking to diversify their investments to improve long term after-tax, after-fees returns. However, moving away from traditional investments such as cash, bonds and equities is expensive and will increase the investment costs of funds, and thereby put the fund in conflict with its “new duty”.
The pendulum has swung
The increased focus on fees and charges via retail ratings, league tables and Panel jawboning, has seen fee budgets permeating the profit-for-members segment. The “new duty to manage overall costs” will now formally cement fee budgets into the superannuation management landscape.
The concept of fee budgets has been a reality across the commercial (for-profit) superannuation sector for many years. The beauty of industry, corporate and government funds has historically been a genuine focus on after-fees outcomes (dollars in the members pocket), given the absence of such budgets.
Having a budget may sound like a sensible approach; however it results in inefficient capital allocation and other undesirable behaviours. As mentioned earlier, investment strategies that provide better diversification from traditional asset classes are expensive. In a fee budget framework, to achieve better diversification (e.g. invest in nation building infrastructure projects!), the remaining assets need to be invested in lower cost, lower returning strategies to off-set the higher cost strategies. The result being an inefficient allocation of capital, market distortions and the prospect of lower returns for members.
Flawed disclosure regime
I have previously highlighted the flaws in the current disclosure regime
(October 2009 newsletter) and that there are at least 33 ways that funds knowingly or inadvertently enhance the presentation of their relative fee competitiveness
(September 2009 newsletter). A key part of the MySuper initiative centres around consistent disclosure across “MySuper” products.
Unfortunately, there is no mention of an overhaul to the current disclosure regime, which is absolutely essential (perhaps I should repeat this sentence 45 more times!).
The current disclosure regime encourages inefficient behaviours and investment decisions. The example that I have previously used is listed real estate investment trusts (REITs):
"The current disclosure regime encourages trustees to invest in REITs in favour of unlisted property vehicles. If you invest in REITs, the published fee is primarily the fee paid to the REIT investment manager. The costs of managing the individual REITs are not typically included in published fees. However, if you invest via an unlisted trust, the management costs of the unlisted trust are typically included in your published fee. Thus, investing in unlisted trusts could be easily 5, or even 10 times more expensive than investing via a REIT investment manager, yet only from a published fee viewpoint."
This is a clear example of an undesirable outcome of the disclosure regime, supported by a focus on costs rather than the net benefit to members. More controversially, the disclosure regime encouraged capital to flow into REITs and arguably contributed to the REIT bubble that spectacularly burst in 2008!
There is a solution to the fee disclosure mess, which focuses on the fiduciary. However, it is radically different to the current regime and was discussed in my
October 2009 newsletter.
Performance fees
Interestingly, the Panel has also flagged the establishment of Performance Fee Standards. Well, all I will say for now on this topic is...Good Luck!
I should end on a positive note
“The core of the problem is that so many activities and businesses are supported by indirect fees and subsidies. The net result is significant inefficiencies and costs, and enormous tension as the various parties try to preserve the status quo or improve on their position. If all of these indirect fees and subsidies were eliminated, then we could have a far more transparent system and an objective discussion around delivering better financial outcomes for retirees.”
The myriad of flows (fees) are often for mutual convenience and benefit, rather than a clean fee payment for an explicit service. So the elimination of such distortions is a move in the right direction.