Towards higher standards in performance reporting
The superannuation industry has had another year of outstanding performance. For two years in a row, growth-oriented portfolios have produced median returns above 13% – well above asset consultants’ long-term expectations. And again in 2005, industry fund growth portfolios outperformed their master trust counterparts, in this case, by about 1% on average.
Not surprisingly, industry funds as a group are making the most of their recent superiority over their master trust rivals. Leading the race is not an excuse for exaggeration, however, and there are aspects of the recent 'Industry Super Funds’ advertisements that need to be questioned.
Naturally, in a competitive environment and with choice of fund now an everyday reality, all funds want to be seen in the best possible light. At the same time, the industry owes a duty to the investing public to make sure that performance reporting is fair, consistent and realistic.
So what does fair, consistent and realistic reporting entail? In an ideal world, it would require:
- Consistent categorisation and labelling of investment options that accurately reflects their risk/return profiles.
- Consistent categorisation of growth and defensive assets, including ‘difficult’ assets, such as direct property, infrastructure and hedge funds.
- Consistent treatment of fees deducted from performance.
- Careful selection of criteria for case studies, illustrations, etc, so that any comparisons fairly represent the various market sectors.
One positive step would be for the industry to agree on the parameters that result in investment options being categorised as Growth, High Growth and so on. Consistency is important because we expect different patterns of returns for different categories of investment options. For example, we expect high growth options to outperform growth options over time, but for the journey along the way to be a little bumpier.
Trustees and fund members can only have realistic expectations if they know they are comparing like with like. Technically, that means we need to be sure that we’re comparing investment options that have similar objectives and risk/return profiles.
At present, we have a situation where different organisations use different criteria and different terminology. This is as illustrated in Table 1 below, which compares the category labels and criteria used by Intech (which we follow) and ASIC.
These are just two organisations, and the differences between their two models is enough to confuse even industry professionals. Throw in all the other players whose research is reported and it is little wonder that the average fund member is quickly confused.
|Table 1: Product Labels - Comparing Like with Like|
|Intech Product Category|
(% of growth assets)
(% of growth assets)
|High Growth (Growth)||75 - 100||70 - 80|
|Growth (Balanced)||60 - 75||60 - 70|
|Balanced (no equivalent)||40 - 60||n.a.|
|Conservative (Capital Stable)||20 - 40||30 - 40|
What belongs where?
Related to the investment option categorisation issue, there is also considerable debate about what should be included in the ‘growth assets’ and ‘defensive assets’ baskets. The debate is important because, depending on how assets are categorised, the investment options themselves may be included in a different universe for reporting purposes.
One contentious issue is how to categorise property-related assets that have a high, relatively secure yield component and a low capital growth component. Infrastructure is another asset class that is hard to label, since each vehicle has its own unique risk and return profile.
Categorising hedge funds is also difficult, as the umbrella term covers such a diverse range of products – both growth and defensively oriented. While the underlying assets may have one set of characteristics, the way in which the manager approaches them may result in a very different set of characteristics for the end product.
For practical reasons we, in common with most researchers, treat all property, infrastructure and hedge funds as growth assets. This has implications for how certain funds are categorised. If we take MTAA as an example, the strategic asset allocation of its Balanced option includes a ‘target-return’ portfolio of 45%. This portfolio comprises unlisted securities, mainly direct property, infrastructure and private equity. We treat this as a growth asset which, when added to the 50% allocation to listed shares, results in total growth assets of 95%. This places the Balanced option firmly in our high growth category.
Similarly, ARF’s Balanced option has growth assets of 84% (including hedge funds) and is included in our high growth category. We do not believe (as some commentators appear to) that it is appropriate to compare these ‘balanced’ options with investment options that have growth assets of 60% to 75%.
Performance after all fees or just some?
IFSA’s Standard No 6, which most superannuation master trusts comply with, requires performance to be reported after all fees – particularly administration and investment fees. And where there is a scaling of fees, it requires the maximum fee to be deducted.
Most superannuation master trusts (corporate and personal) report performance after deducting administration fees of 1% to 1.5%. Industry funds on the other hand typically do not deduct administration fees (mostly referred to as a member fee) from reported performance.
The effect of Standard No 6 is that the different treatment of fees can result in material differences in reported performance. This is an important area for the industry to address. To provide consistency in our performance surveys we report performance before any administration fees are deducted.
‘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 2 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.
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 master trust. 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 3 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 3 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 3 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: Industry Stastics – March 2005|
|Fund Type||Assets|| |
|* Source: APRA – Quarterly Superannuation Performance – March 2005 & Chant West (break-up of retail funds)|
|Table 3: 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 4 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.
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.
|Table 4: 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|
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