‘Net benefit to members’ – an interesting concept to be used with care
Over the past year, Industry Funds Services (IFS) has promoted a new performance measurement – the ‘net benefit to members’. IFS combines past performance and fees into one measure. It calculates returns before fees and after tax and divides these by after tax fees to show the earnings provided for each dollar taken out in fees.
This is an interesting concept, which recognises that the end benefit a member enjoys is a function of investment returns and fees. While the concept itself has merit, we believe it needs to be used with care if it is to produce results that are helpful and lead to informed decision-making.
A higher net benefit can be the result of better investment returns or lower fees or both. So, if implications are to be drawn from historical data, one needs to analyse what contribution returns and fees made to the overall measure and then form a judgment as to whether those contributions are likely to be sustainable.
Looking first at investment returns, it is generally true that any investment option that has been underweight international shares and overweight Australian shares and property in recent years would have performed well relative to its peers. Broadly speaking, this has been the position of industry funds versus master trusts. We estimate that differences in asset allocation policy have accounted for most of the industry funds’ outperformance over the period.
The question is whether this outperformance can continue. It may, but, as we have noted previously, if asset sector returns revert to their long-term relativities, it will require industry funds to change their allocation policies.
The other element of IFS’s net benefit measure is fees. Here, our observation is that the case study used is very selective. Clearly, it is designed to show industry funds in the best possible light but, in doing so, it is unrepresentative of the real world. There are many individuals who are members of master trusts via their employer’s corporate plan who have fared much better than the advertisements suggest.
Table 1 below gives a break-up of the superannuation industry by fund type at March 2005 (excluding self-managed funds and annuities). It shows that retail funds (corporate and personal) accounted for about 44% of total assets. We estimate that corporate master trusts accounted for about $75 billion, i.e. 32% of total retail fund assets.
|Table 1: Industry Stastics – March 2005|
|Fund Type||Assets|| |
|* Source: APRA – Quarterly Superannuation Performance – March 2005 & Chant West (break-up of retail funds)|
The key assumptions in the advertisements are that an individual has a starting account balance of $10,000 and is a member of an employer plan with only $150,000 of total assets.
We believe that most employer plans in corporate master trusts would have assets much greater than $150,000. So this is a very small plan, and using it as an example produces almost the highest possible fees in a master trust.
While the $10,000 individual account balance is broadly representative of the average industry fund member, it is not representative of the typical member of a corporate mastertrust. Our research suggests that a figure of $50,000 would be far more realistic. Again, this has implications for fees and for the net benefit figure, as we show in Table 2 below.
A More Realistic Model
The IFS advertisements suggest that, over the five years to December 2004, the average industry fund provided a net benefit to members of $8.34 compared with $2.44 by the average retail fund (master trust).
While industry funds can justifiably claim an advantage, in the real world the magnitude of the advantage is much less, especially in the case of members of large and medium sized employer plans. To illustrate, Table 2 below shows the benefit for members in a typical large employer plan (assets of $100 million) and a typical medium-sized plan (assets of $10 million). The fees used in our calculations reflect our experience of the fees typically paid by such plans.
Table 2 shows the benefits for a starting account balance of $10,000 and for a starting account balance of $50,000. In the third column of the table, headed ‘Real World’, we show what is most likely the actual experience of members based on average account balances in the different fund types.
Our calculations assume that no adviser commission is paid in the large and medium sized employer plans, as this is our experience in these markets. In the personal market, where payment of adviser commission is common practice, we have assumed a 2% contribution fee and standard adviser trail commission (typically 0.4% to 0.6% per annum).
|Table 2: Net Benefit to Members|
|Fund Type||$10,000 Account||$50,000 Account||'Real World' Accounts|
|Retail Large Corporate||$6.49||$8.57||$8.57|
|Retail Medium Corporate||$5.26||$6.15||$6.15|
Our results are similar to IFS’s for industry funds and retail personal master trusts (assuming a starting balance of $10,000). However, we obtain very different results for large and medium-sized employer plans.
For members of medium-sized company plans, industry funds still produce a better result, but the gap is much smaller and is due more to investment performance than to fees. Our analysis shows however, that members of large employer plans may have been better off in a corporate master trust than the average industry fund, largely due to lower fees. This is unlikely to be the case with large industry funds, where fees are low and performance has been strong.
Finally, let us deal with the argument that including adviser commissions in the fees of personal master trusts is unfair because, presumably, members receive an additional benefit (advice) for the fees they pay.
There is considerable debate about whether adviser commission is really a distribution fee or a fee for advice. If it is an advice fee, it is clearly unfair to include it in the net benefit calculation. For illustrative purposes, Table 3 below shows the net benefit to members before adviser commission is taken into account. Once again, industry funds can claim an advantage, but the magnitude is clearly much less than they suggest.
|Table 3: Net Benefit to Members|
|Fund Type||$10,000 Account||$50,000 Account||'Real World' Accounts|
|Retail Personal (Nil Commission)||$4.31||$4.36||$4.36|
While past performance should never drive investment decisions, it is undeniably an important factor in the minds of fund members. They have a right to feel confident that, when they see performance reported, the numbers and the conclusions drawn from them are reliable, fair and relevant.
The issues we have raised here are not insoluble. With good will, the industry can lift its standards in the way performance is reported and that will be in the best interests of all stakeholders.
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