Comment by Patrick Liddy*
In human affairs the great movements of a period tend to be driven by day-to-day expediency. What seem to be, in retrospect, the greatest and most important changes tend to go unnoticed at the time. Their conclusions come as a surprise to many and are often treated with indifference until long after they first occurred.
This was the case with creation of the House of Commons in England in 1236. It was simply a matter of chance and expediency. Landholders began to send representatives in large numbers to petition the king over taxes and rights. After a time the knights and burgesses chosen as representatives (who from the commons) began sitting in a separate chamber from that used by the lords and nobles.
The collapse of the Iron Curtain, on the other hand, came as a shock to many at the time. “Against all odds, the west won – economically, ideologically, militarily – with astonishing speed and finality”, writes Norman Stone in his book ‘The Atlantic and its Enemies’.
A case can be made that human history is the sum total of accident and unintended consequence. This is exactly what is happening to the Australian superannuation industry, the results of which are just being felt. It will effect all in the industry – custodians, fund managers, brokers, investment banks, platform providers, super funds and, most importantly, members. These changes are not benign.
The Australian industry is now being driven by well-meaning rules achieving unintended consequences. These rules are not just Australian in origin; they are worldwide and their results are being felt by the world economy.
The drivers of these changes can be traced back to the global financial crisis, the Australian Government wanting fewer super funds through more regulation and regulators wanting stronger institutions. Taken in isolation each of these rules is very sensible. Combining them in the real world is having some far-reaching unintended consequences.
The financial crisis led to one of the grandest reductions to both the money supply and the multiplier effect. It also led to a quite remarkable increase to the cost of capital.
One of the largest providers of liquidity before the crisis was the investment banks. They no longer do this. The ‘traditional’ banks and other lending institutions have also tightened their criteria on lending. As a consequence less capital is circulating the economy, there is less growth and this has had an adverse effect on the capital appreciation of assets. Shares and property are not the performing assets that they once were. Coupled with the changing demographics of the baby boomers these assets will not appreciate as they once did.
So, an area in which ‘professional’ management reigned is now finding far less demand. Fund management is not the game it once was. The effect down the value chain is being felt. Investors and members are questioning the advice they are receiving from their professionals and, for the most part, those of them with the highest account balances are going to self managed super funds (SMSFs). This means that the big super funds are losing their most ‘profitable’ members. They are fighting back through new platforms that allow them to compete with the SMSFs. Those who do not will be left behind. The Government does not have the stomach to stop SMSFs. An irony of policy is immediately brought to bear.
The Australian Government has made no secret of the fact that it would like to see fewer, but stronger, funds. The new Simpler Super legislation has made it harder for funds. The critical mass for a fund was, just a few years ago, $3-5 billion but this figure is now probably at least in the $10-15 billion range. Risk, compliance and their legal cousins are making it far more expensive to administer funds. Members also want increased functionality. If they do not get it they simply vote with their feet.
It should be no surprise that funds such as Australian Super, Host Plus, Care Super, Club Plus and Telstra Super are all introducing SMSF-style functionality. The loss of their members to SMSFs will be stemmed through this functionality. All others will follow over time. This has implications for all providers of services in the superannuation industry.
Custodians will be disintermediated by new platforms. Some fund managers will have fewer clients of higher mass and they will be required to trade volume for price. On the SMSFs side, they will be required to hand over their intellectual capital in the form of models. They are already starting to do this. Some managers find this confronting. Brokers will face the same pressure and they are fighting back in a variety of ways. Interestingly, UBS, Australia’s largest broker for flow, and Macquarie are pursuing this new market with vigor and insight. And both have staked up areas in the new fund SMSF space. Other brokers will rue the day they did not take close enough note.
Basel III (or the Third Basel Accord) is a global regulatory standard on bank capital adequacy, stress testing and market liquidity risk agreed upon by the members of the Basel Committee on Banking Supervision. The new capital adequacy rules mean that banks get more points for retail money than flighty wholesale funds. This difference means that individual retail investors can get more for their money than professional investors. The difference is up to 100 basis points on term deposits and cash holdings. In a low-growth environment this is critical. Professional investment managers are losing out to the ‘uninformed’.
A larger proportion of investors and members are managing their portfolios and for the most part are out-performing the professionals, at least recently. A mixture of both will be the equilibrium longer term.
The statistics, from the Australian Taxation office, are:
. SMSFs are $399 bill or 32 per cent of the market
. $16 bill outflows from large super funds to SMSFs in 2011
. 64.4 per cent of SMSFs assets are held in equities, cash and TDs.
So, the big super funds’ fightback, through SMSF-style platforms for their higher account-balance members, may determine whether they will survive as standalone entities. The platform options are proving popular, and there are a great many other funds looking to implement them.
The outcome of all this will mean more control to members and investors through in-fund SMSFs. Smaller funds will not be able to fight on functionality lines, or their offers will be sub standard. Funds’ critical mass will continue to get much higher – say $20 billion fairly soon. Brokers who get on board, such as UBS and Macquarie so far, will win more flow through a most cagey play. Custodians who do not adopt the new platforms will lose functionality and business. The new model is like master custody for individuals. The early adopters are already making hay.
*Patrick Liddy is the principal of consultancy MSI Group. He advises super funds and others on platforms. He is also involved with the IO&C Conference..