Fund mergers: the good, the bad and the ugly

David Coogan, Ken Marshman, Michael Dundon and Naomi Edwards
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by Greg Bright

Ken Marshman, the independent chair of Rest, called them the ‘matchmaker’, ‘the fiancé’ and ‘Muriel’. They are three people who have been involved in no less than 13 super fund mergers. In the current climate, their experiences should be noted by all funds.

Marshman, also a former chief executive of JANA Investment Advisers, quizzed David Coogan, PwC partner (the matchmaker), Michael Dundon, chief executive of VicSuper (the fiancé), and Naomi Edwards, the independent chair of Tasplan (Muriel), on mergers and their impact on investment returns at last week’s AIST Australian Super Investment conference in Hobart.

The consensus among the group was that while there were considerable costs involved in mergers and a lot of work, the benefits usually shone through within a couple of years. However, there were lots of caveats to this belief. For instance, the members of the smaller fund in a merger will usually benefit more than those from the larger fund. And some in the audience challenged the estimated investment transition costs suggested by the panel as being too low.

As previously announced, the $24 billion VicSuper is advanced in discussions with the $85 billion First State Super for a merger. Tasplan, after merging with the Retirement Benefits Fund of Tasmania, opted out of a three-way merger with WA Super and South Australia’s Statewide, and is now “engaged” to MTAA. For his part, David Coogan has advised on more fund mergers than, perhaps, anyone else in Australia.

Marshman looked to focus on the investments in a merger, although Dundon estimated that about 50 per cent of the benefits to members would flow from other aspects of the operation, mainly administration and technology. Asked what a $24 billion fund could not do that a $100 billion fund could, Dundon said it was true VicSuper could survive on a standalone basis, but there were certain asset classes where more scale would give it better access – big infrastructure and private equity deals.

“But what happens over time with more and more consolidation?” Dundon said. “We think we will see perhaps half a dozen funds with more than $100 billion or so, soon, and we think that the best place for our members will be at the top end of the scale… The VicSuper board has been focused on the opportunities that can come from greater scale and in the past two years we have become increasingly positive about the benefits for members… The benefits tend to flow to the smaller funds because they usually have a higher cost structure.”

Naomi Edwards said that while Tasplan’s mergers, mainly with RBF, have taken the fund from $2.5 billion to a bit under $10 billion in the past four years, most of the benefits had been on the administration side. “But we have been pleasantly surprised at the investment benefits, such as moving out of funds [trusts] and into mandates.”

Pressed to estimate typical savings, David Coogan said the they varied from fund to fund. For instance, in some of the larger mergers the funds could do in specie transfer of investments. Transition costs were “not too much”, he said. “In terms of ongoing savings, we work on 1-2bps a year.” Edwards said that Tasplan’s ongoing savings were “much higher than that”.

But Marshman said that in his experience when people who were managing money were managing more of it, the harder it became. What about the possible diseconomies of scale? Was there are stage when mergers got so big that the benefits go in the opposite direction?

Coogan said: “There has always been an upside benefit on both the investments and admin side. The use of a transition manager to transition the risk is important. Historically, we’ve always found benefits there.”

But there is usually a downside to everything. Edwards said that transaction costs were significant in the RBF/Tasplan merger. She estimated that for Australian equities and global equities there was a cost of transitioning the two portfolios of 20bps. For a 50:50 (equities:bonds) fund this indicated a cost of 10bps. “But we made our money back pretty quickly,” she said.

Asset servicing and funds management operations specialists later said that Edwards’ cost estimate was on the low side. Once you include emerging markets and illiquid alternatives, the transition costs were more likely to be close to 100bps.

Pressed further on costs, Edwards admitted that stamp duty and capital gains tax were also significant. Relief on stamp duty, in particular, is difficult to obtain. Even with the merger of two Tasmanian Government funds, with the Government encouraging the merger, it took Tasplan a full year to get an exemption – from the Tasmanian Government – for the stamp duty costs in merging the portfolios. Other costs to be managed include franking credits and, on the administration side, the probable cost of redundancies and getting out of certain technology contracts. APRA take note: it’s not as easy as you seem to think.

Marshman drilled down further on transition costs, testing the panel’s views and understandings for the benefits of his ‘members’ at that moment: the 350-odd attendees at the ASI Hobart conference. There are other issues. For instance, what happens to fund member ‘reserves’ and what happens in the case of a dud illiquid investment being held on the books of one of the merger partners? And what about if one fund has a ‘lifestyle’ offering and the other doesn’t?

“Do you sell certain assets a minute before you sign the merger document or do you wait for the combined entity to clean up the portfolio,” Marshman asked. The panelists’ answers were vague, it should be said. Marshman said: “Up to the stage of signing you can only look after your own members. Because, if it fails [the merger is aborted] you’ll be up for it.”

One brighter note was a question from the floor from Graeme Russell, the chief executive of the $5.5 billion Media Super. He pointed out that he had been on two merger committees, which, combined merged five funds into two in 2008. He was actually on the journalists’ JUST Super board (Media’s initial form) when it merged with JEST Super (the actors’ fund) in the late 1980s.

Russell noted that in a merger “it doesn’t all have to happen on July 1”. Naomi Edwards, experienced in mergers as she is, agreed. “You shouldn’t try to fix everything prior to the official merger date, otherwise you’ll go insane.”

NOTE: the ‘Muriel’ reference has to do with the classic Australian movie ‘Muriel’s Wedding’ whose lead character – “you’re terrible Muriel” – tended to play the field. Our ‘Muriel’ was now looking for a new partner after three previous relationships, Marshman said.

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