I attended the inaugural ASFA Asia-Pacific Pensions Forum in Hong Kong earlier this week. It was quite refreshing to attend a conference and not hear the words “peer risk” uttered. It did make me think more about the topic and the conditions in Australia that lead to an obsession with peer risk. That is, the reluctance of superannuation funds to pursue investment performance that is “materially” different from peers. And I might add that the word “materially” is an overstatement!
Whilst there are likely to be many behavioural and other factors that I have discussed previously, there are two issues worthy of brief comment before I get to the survey results. The two issues are the concentration of investment consulting advice amongst four providers and the lack of differentiation across superannuation funds.
Investment consulting oligopoly – they wish!
The Australian investment consulting market is dominated by four consultants with a market share of over 90%. (click here for market share information as at 30 June 2011). This concentration is exacerbated by funds generally receiving similar advice on asset allocation as it is driven off similar market metrics and time horizons. But, of course, you still need me to help you select and manage your investment consultant!
The very nature of this concentration in advice will steer funds in very similar directions resulting in similar outcomes over the medium term. This brings me back to the point on “materiality”. I suspect that the net outcome of the concentration in advice is performance being clustered around a fairly tight band over the medium term. Consequently you don’t have to do a lot wrong or right, to look materially different, even though you may only be 1% better or worse than your peers.
Business and investment strategy lacking alignment?
This brings me to the second point, the lack of differentiation across funds. Despite funds having different member cohorts and (in theory!) different member financial circumstances on average, most funds still end up with common published objectives and very similar strategies. From a business strategy viewpoint, there is not clear alignment between business strategy (driven by member needs) and investment strategy. Net result, most funds are not differentiated, at least in regard to investments. And you wonder why consolidation is such a big agenda item in the industry (or maybe you don’t)!
Peer risk is alive and well
OK, back to the survey results. The first question was “How important is exceeding CPI+ objectives versus outperforming peers?” The average outcome was half way between “It is equally important (i.e. to outperform peers and exceed CPI+)” and “CPI+ more important, but peers still relevant”. This result reflects the tension between published CPI+ objectives and the reality that most funds are extremely sensitive to outcomes relative to peers.
The second set of questions focused on investment performance outcomes which are 1% per annum below that of peers, and at what point you would “raise concerns” and at what point you would “push for a material change to strategy”. In terms of raising concerns, the most common (median) result was 3 years. That is, if our 3 year performance was 1% per annum below that of peers, then I would “raise concerns”. However, more importantly, the time period was 3 years or less for 3 out of 4 respondents. So the majority would be raising concerns at or before there was 3 years of 1% per annum of under-performance.
Whilst “raising concerns” will influence strategy and behaviour, the “pushing for material change” may result in making bad decisions and costs to members (e.g. selling out at the bottom). Half of respondents said they would “push for a material change to strategy” if performance was 1% below median over 2 or 3 years; rising to 4 out of 5 if you include those whose tolerance stretched to 5 year performance.
The next set of questions focused on member switching activity as a result of weak performance relative to peers. Interestingly, respondents seemed less sensitive to member switching activity. For instance, less than 1 in 4 respondents would ‘push for a material change in strategy” if 2% or 5% of additional members switched during a 6 month period. At 10% additional switching, half of respondents would be pushing for “material change”, and 2 in 3 respondents at 15% additional switching. Perhaps this is a reflection on the global financial crisis experience. I suggest that if it was only your fund (or a few funds) that were experiencing this additional switching; your behaviour may be quite different.
Front page news!
The final set of questions was, “on a quarterly basis the main State newspaper publishes an investment performance table on the front page of the newspaper listing the top and bottom performing default superannuation funds based on the last 12 months performance. How many consecutive quarters would your default fund be in the bottom decile of funds and therefore on the front page of the newspaper before you would either raise concerns or push for material change?”
In terms of raising concerns, 1 in 4 would raise concerns “the first time we appeared on the front page of the newspaper”. However, 3 in 4 would have raised concerns if bottom decile performance persisted for four quarters.
In terms of “pushing for a material change to strategy”, 4 out of 9 would be “pushing for a material change” after 4 quarters of bottom decile performance. Around 3 in 4 would have “pushed for a material change” once 8 quarters of publicity was experienced.
Tolerance for a turn-around in fortunes is short
When analysing this sub-set of results in further detail, it is evident that the time period between “raising concerns” and “pushing for material change” is quite short. Ideally, this time difference would be far greater. Of those that had some sensitivity to bottom decile results, around 2 in 3 would have been pushing for a material change in strategy within 6 months of first raising concerns, and most would have pushed for material change within 12 months of raising concerns.
So what does all this mean
The key point is that our human conditioning is to be conscious of and concerned with differences, particularly those viewed as negative. So despite our best intentions, our tolerance for being different will be tested, and therefore, it is important to understand your tolerance and limit the chances of making reactionary bad decisions. The more you explore and discuss issues of “peer risk” within your fund, the better equipped you will be to ward off bad decisions.