(Pictured: Jack Gray)
by Greg Bright
The prevailing wisdom is that bigger is better for super funds, but combined research on the subject which tries to quantify benefits to members is inconclusive. A new research note analyses the conflicting elements of scale in a fund and illustrates how smaller funds can outperform, at least with their investments.
Jack Gray, an executive director of fund manager Brookvine and part-time academic with UTS’s Centre for Capital Market Dysfunctionality, last week published the research note: ‘Can Small Be Beautiful?’
The main reasoning behind scale benefits in super funds, prompting APRA to encourage more fund mergers, is the perception that administration, custody, insurance and passive fund management unit costs should be lower. It is well documented that investments are different – with size being a significant disadvantage – but even here some argue that the ability to be at the table for big infrastructure deals is an advantage for the large funds.
Gray questions these assumptions. “Even in administration scale benefits have limits. At some size ($100 billion?) decreasing returns to scale will push net marginal efficiency gains to zero and beyond. Potentially more damaging are legacy issues. Mergers leave funds exposed to rival and non-communicating people and software that undermine scale benefits,” he says.
The research note argues that the dominant way smaller organisations in general thrive is through specialisation. They often have single product lines and a sharp focus. Super funds are not like this.
“Yet aside from the colour of their brochures, super funds of all sizes are essentially indistinguishable in their offerings. In that uniform world – a world driven by peer risk, the fear of being different – specialisation appears to neither evident nor desirable, so focus is lost through a haze of complexity induced by offering everything to everyone.”
Some funds claim and demonstrate greater affinity with their members, such as Cbus and AvSuper. But Gray suggests that maybe it’s the “power of default Award funds” that explains most of the ‘affinity’.
On the investments side, which, after all, makes up all of the return for members on their own contributions, Gray presents some ideas for how a small fund – between $4-10 billion – might break from the uniform commoditisation and thrive through a degree of specialisation.
“The most evident sources of opportunities are capacity-constrained strategies, particularly, but not exclusively, in active listed equities niche strategies. Examples include US microcap, catastrophe bonds, local residential property, South American power generation and other investments deemed too small for consultants’ businesses and that large funds ignore because of the immaterial impact on total returns.”
A microcap manager with $400 million capacity represents about an allocation of only 0.5 per cent for AustralianSuper, even if it bought all the capacity, but about 10 per cent for SmallSuper, which would offer a material impact on returns.
As an aside, at last year’s Frontier Advisors client conference there was an interesting discussion about whether big funds would be able to invest in Australian small (not micro) cap managers into the future.
Gray suggests that to have a significant impact on performance initially 30-50 per cent of SmallSuper would be thoughtfully structured around similar opportunities across a variety of asset classes and strategies – allocations that would expand with experience and confidence. Investing in emerging managers is likely to generate a performance boost.
However, the attitudes and governance of SmallSuper will need to change to garner these rewards for members. The funds’ risk profile will change and the fund will be exposed to “business risk” of being different.
Gray says: “It can be re-positioned as the innovative higher-growth fund exposed to genuinely different risks; a super fund that’s resisting the imperative to become a marketing and distribution machine at the expense of investing.”
View full research note here