Industry fund outperformance - how long can it continue?
Industry funds, as a group, have performed relatively strongly in recent years. While their success is to be applauded, it also needs to be explained. Is it the result of conscious decision-making on the part of the trustees and, if so, can it be sustained? Or are there other factors at work?
Over the past three years, super funds’ investment performance has been modest at best. Investment markets have been unkind, but not all funds have suffered equally.
Industry funds generally have done well, especially compared with the commercial master trusts, who are their major competitors. Not only that, they have generally outperformed the implemented products of the leading asset consultants, as the table below shows. It compares performance on an after fees and tax basis.
| 3 Yr Performance to 31/12/03 (%pa) | | Industry Funds | 5.1 | | Master Trusts | 1.4 | | Consultants (Implemented Products) | 1.9 |
Asset allocation is key It is accepted wisdom in the investment world that asset allocation is the dominant contributor to performance. So to explain the superior recent performance of industry funds, the obvious place to look is their asset allocation. What we find is that there are significant differences between industry funds and all the other fund categories in their strategic allocations to certain asset sectors. These are all broadly speaking 70:30 funds, and the differences are confined largely to the 70% ‘growth assets’ component. Most notably, over 3 years: - industry funds have had a substantially lower allocation to international shares which, on an unhedged basis, has been the worst-performed sector over the period at –13.5% per annum
- they have had a higher allocation to property which, with a return of 11.9% per annum, has been the bestperformed sector over the period
- and they have had a significantly higher exposure to ‘other’ investments, which are mainly alternative assets such as private equity, infrastructure, hedge funds etc
| Strategic asset allocation (%) | | Aust Shares | Int’l Shares | Property | Other | | Industry Funds | 34 | 20 | 13 | 7 | | Master Trusts | 31 | 27 | 11 | 1 | | Consultants | 34 | 27 | 8 | 1 |
When you look at these allocations, together with the gross benchmark returns for the main asset sectors, the cause and effect become clear.
| Sector returns – 3 yrs to 31/12/03 (%pa) | Aust
Shares | Int’l
Shares
(uh) | Int’l
Shares
(h) | Listed
Property | Aust
Bonds | Int’l
Bonds
(h) | | 5.1 | -13.5 | -6.8 | 11.9 | 5.7 | 8.0 |
The differences in strategic asset allocations alone would give rise to a significant performance differential – in the order of 1.5% to 2% per annum (before tax). Some of the industry funds also consciously employed tactical ‘tilts’ that would have further improved their performance – perhaps adding another 0.5% to 1% per annum. These tilts were primarily to underweight international shares and overweight property. Several funds also increased their hedge ratio in 2003, which was most beneficial given the huge difference between hedged and unhedged returns (about 30% over the year).
Industry funds also benefited from superior manager selection, which added as much as 0.5% to 1% per annum. Finally, fee differentials, interestingly, added only a further 0.25% to 0.5% per annum.
Why the different allocation? Why, then, have the industry funds had different asset allocations? There are a number of possible explanations. One may simply be their choice of asset consultant. Others have to do with the origins and philosophy of industry funds. Each fund is different of course, so the comments that follow are general in nature.
Firstly, industry funds have long had an affinity with property, largely because of their stable and attractive returns. Perhaps it also reflects their membership, which knows and trusts ‘bricks and mortar’.
Secondly, industry funds have tended to favour investment in Australian assets. This is quite natural, given their broad membership base.
Thirdly, industry funds have taken a pioneering role in supporting alternative assets. The sheer size of their cash flows has enabled them to make significant investments in infrastructure, private equity and venture capital, for example.
Taken together, these factors have tended to limit the amount industry funds have available, within their 70% growth assets component, for investment in international shares. It may be that there has also been an element of conservatism at work, with international shares being seen as more ‘risky’, but that is probably less the case now than it was 5 or 10 years ago.
What about the future? Whatever the reasons, these asset allocation settings have served the industry funds well in the past three years and demonstrate their flexibility and innovation in setting asset allocation policies. But what does the future hold for them?
When we look at the consensus opinions of asset consultants as to future returns (which are broadly based on long-term historical relationships), we can see that industry funds would be at a disadvantage – unless, that is, they adjusted their asset allocations.
| Consultants’ long term projections (%pa) | Aust
Shares | Int’l
Shares
(uh) | Int’l
Shares
(h) | Listed
Property | Aust
Bonds | Int’l
Bonds
(h) | | 8.0 | 8.0 | 7.8 | 6.5 | 5.0 | 4.8 |
Of course the consultants’ projections might not come true. Property might continue to be the ‘star’ of the conventional asset sectors. Alternative assets might deliver the superior returns that some people expect them to. Or industry funds might adjust their asset allocations as the need arises. We will continue to monitor and observe with interest.
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