Reduced costs and consistent disclosure - now that’s an idea
So far, the Cooper Review’s public pronouncements have focused mainly on reducing the costs of superannuation. That’s a laudable intention, but to be really useful to consumers it’s important that lower costs are backed up by improved disclosure. Here we make 18 disclosure recommendations that, if implemented, will reinforce Cooper’s SuperStream recommendations.
For 14 years, Chant West has been in the business of comparing super funds. And for 14 years, we have been calling for improved disclosure standards in areas such as fees, insurance and investment performance. Because only when consumers – and their advisers – can compare funds on a like-with-like, ‘apples-with-apples’ basis, will they be able to make informed decisions based on reliable facts.
At present, the super disclosure regime is a mishmash of statutory requirements, some of which are open to selective interpretation, and unenforceable ‘guidelines’ which individual funds either follow or not depending on whether it suits them. It is abundantly clear that the industry is not going to move voluntarily towards uniform disclosure, so the industry regulator (ASIC in this case) has to do it for them.
Until that happens, consumers who rely on information ‘from the horse’s mouth’ (ie from the fund itself) risk comparing apples with oranges. And we, as researchers, will continue to have to make a mass of adjustments to publicly-disclosed information to convert those oranges back into apples.
To illustrate the point, we recently ran an exercise looking at the 30 largest industry funds and 30 largest retail funds. Taking the information from their Product Disclosure Statements (which is what unaided consumers would have to rely on), we had to make 146 adjustments
before we were satisfied that the information from all the funds was strictly comparable. There were:
- 39 adjustments to fees
- 77 adjustments to insurance premiums, and
- 30 adjustments to investment returns
Taking fees as an example, some funds report them net of tax while others report gross. Some include performance fees paid to their investment managers, others don’t. And some include the cost of protecting small accounts while, again, others don’t.
These may seem like small technicalities, but in fact they can make a material difference. For example, a typical large industry funds’ total fees for a $50,000 account would be $403, or 0.81% a year – Table 1
. After making adjustments to allow for a like-with-like comparison, we calculate the total fees to be $492, or 0.98% a year. That is over 20% higher
. This is not to single out industry funds in general. We find material differences across funds of all types and sizes.
|Table 1: Materiality of Adjustments to Fees |
| ||Annual fees for a typical large industry fund based on a $50,000 account |
|Fee ||As disclosed in PDS ||After Chant West adjustment |
|$ ||% ||$ ||% |
|Administration Fees ||78 ||0.16 ||92 ||0.18 |
|Investment Fees ||325 ||0.65 ||375 ||0.75 |
|Other Fees ||0 ||0.00 ||25 ||0.05 |
|Total Fees ||403 ||0.81 ||492 ||0.98 |
Fee disclosure issues
At present, funds do not disclose their fees on a consistent basis. For example, administration fees are a tax-deductible expense to the fund, and the fund passes on the benefit of that deduction to the member. However, the way in which different funds do so varies.
For example, some funds deduct a net fee of $85 from the member’s account, and that $85 is what they disclose in their Product Disclosure Statement. Most funds, however, deduct a gross fee of $100 and pass on the $15 tax benefit to the member (typically by way of lower contributions tax paid). In those cases, the fee disclosed is $100. The end result for the member is the same, but the mechanics are different. To enable fair comparisons, we gross up the fees where the fund shows them net of tax.
The treatment of member protection costs is another area of difference. This is where the fund is required by law to limit its administration fees on accounts of $1,000 or less to no more than the member’s investment earnings in that year. In years of low or negative returns, this can be a substantial cost for funds with a large proportion of small accounts, and that cost is borne by all members. The fee disclosure regulations are not precise, so some funds include these costs in their published management costs while others don’t. In our view, all costs should be included and, where a fund fails to do so, we adjust the costs accordingly.
A similar issue arises with performance fees paid to investment managers. We believe the intent of the regulations is that these should be fully disclosed in relation to past experience, and reasonable estimates given in relation to future expectations. Most funds, however, have chosen to interpret the regulations differently and give no indication of the likely impact of these fees on future performance.Again, we make adjustments to at least include the latest historical performance fees.
But the greatest distortion in the area of fee disclosure comes from the non-disclosure of fees paid to the underlying investment managers in fund-of-funds products (hedge funds and private equity).
By way of illustration, Table 2 shows the typical fee structure for a hedge fund-of-funds. The example is based on a targeted return for the investor of at least cash + 3% (after fees). To achieve this return, the hedge fund needs to generate a gross return of about 12%. Out of this gross return, the total fees paid are about 6.2%, leaving 5.8% for the investor.
The fees that are typically disclosed, however, are just the 2.2% accounted for by the fund-of-funds manager. The additional 4% paid to the underlying managers is typically not disclosed.
In the case of private equity, the fee structure is similar except that the underlying managers’ performance fees usually require them to meet a target rate of return. However, the end result is that the total fees for private equity and hedge fund-of-funds are similar in magnitude – and so is the degree of non-disclosure.
As the average default fund invests about 10% in hedge funds and private equity, default option fees are potentially understated by about 0.4% per annum. This is material.
|Table 2: Typical Hedge Fund-of-Funds Fees (% pa) |
|Underlying Managers |
|Gross return |
Performance fee (1)
|Fund-of-Funds Managers |
Performance fee (2)
Investor net return
|Total Fees Paid |
Underlying manager fees
Fund-of-funds manager fees
1. 20% of gross return less base fee
2. 10% of net return less base fee
Chant West’s 6 recommended minimum disclosure standards – fees
- Separate product fees from advice fees
- Separate administration and investment fees
- Show all fees gross of tax
- Include the cost of member protection in management costs
- Include performance fees for the most recent financial year in investment fees, and show forward estimates (a range) based on normal expectations of managers
- Include the fees of underlying managers in fund-of-funds products.
Performance disclosure issues
Consumers need to be able to compare funds’ investment performance, and the purest measure is to look at returns net of investment fees and tax. Nothing else should be allowed to cloud the picture.
In practice, not-for-profit funds show returns net of investment fees and tax, while retail funds show returns net of all fees and tax. That is, retail funds deduct administration fees and adviser commissions. They do this to comply with IFSA’s reporting standards.
Not-for-profit funds do not deduct an administration fee (represented by the member fee) because it is typically a flat fee. In percentage terms, it will be different for each account balance. And of course, not-for-profit funds generally do not pay adviser commissions. In order to make like-with-like comparisons, we collect and publish returns that are net of investment fees and tax only.
Investment performance is not just absolute, it is also relative. Consumers need to be able to see how their fund is performing compared with other funds that are similar in nature. Our methodology is to show returns in different risk profiles, where risk is defined by the proportion of growth assets the fund holds. The risk profiles that we, and the majority of other research firms, use are shown in Table 3
. We recommend that these, and the suggested labels, be adopted as the industry standards.
|Table 3: Suggested Standard Risk Profiles |
|Label ||Bands of Growth Assets |
|High Growth |
81 - 100%
61 - 80%
41 - 60%
21 - 40%
A related issue is the categorisation of certain assets into growth and defensive. For example, some funds classify certain types of direct property and hedge funds as defensive, while others put them in the growth category. These differences cause confusion and make valid comparisons difficult.
Our view is that a regulator needs to set guidelines for the industry, monitor usage and enforce compliance.
Chant West’s 3 recommended minimum disclosure standards – investment performance
- Show all returns net of investment fees and tax
- Adopt standard definitions and labels for different risk profiles
- Adopt standard definitions of growth and defensive assets.
Insurance disclosure issues
Insurance is the worst disclosed area in superannuation. It is almost impossible for the layman – and difficult even for the expert – to compare one fund’s insurance offering with another’s. And some funds do not even publish their insurance premiums.
Insurance premiums, like administration fees, are deductible expenses to the fund. Some funds show their premiums gross, while others show them net of tax. Some funds show premiums based on an annual upfront payment, when in practice the vast majority of members pay monthly. In some cases there is a premium loading (of as much as 8%) for doing so. Some funds include the stamp duty which applies to income protection insurance, others don’t.
Retail funds often include a commission element in their insurance premiums. This is rarely disclosed, but it should be. In addition to the premiums, some funds charge a policy fee or insurance administration fee. While this may be disclosed separately, it makes premium comparisons difficult unless it is included in the premium calculation. Some funds offer discounts for higher levels of cover and loadings for small amounts of cover. This is not always clear in the Product Disclosure Statements.
There are also many differences in presentation. One would have thought that a member’s age was their current age, but about half the industry persists with the archaic practice of showing premiums at ‘age next birthday’. And almost half the industry expresses premiums as the cost per unit of cover, while the other half shows the cost per $1,000 of cover.
Chant West’s 9 recommended minimum disclosure standards – insurance premiums
- Show all premiums on the fund’s public web site
- Show all premiums gross of tax
- Show premiums based on current age
- Show premiums per $1,000 of cover
- Show premiums based on monthly payments
- Show income protection premiums excluding stamp duty
- Show any additional administration or policy fee alongside premium tables
- Separate insurance premiums from adviser commissions
- Show examples of insurance premiums similar to the statutory fee example. To be representative, the table should show the Death & TPD premiums for male and female, white and blue collar members aged 20, 35 and 50 for $300,000 cover (ie a table of 12 numbers).
© Chant West Pty Limited (ABN 75 077 595 316) 1997 - 2013. You may only use this document for your own personal, non-commercial use. This document may not be copied, reproduced, scanned or embodied in any other document or distributed to another party unless you have obtained the prior written consent of Chant West to do so.
The information above is based on data supplied by third parties. While such data is believed to be accurate, Chant West does not accept responsibility for any inaccuracy in such data. Past performance is not a reliable indicator of future performance. The products, reports and ratings do not contain all of the information that is required in order to evaluate the nominated service providers, and you are responsible for obtaining such further information.
This information does not constitute financial product advice. However, to the extent that this document may be considered to be general financial product advice then you acknowledge that you have been provided with a Financial Services Guide
and Chant West warns that: (a) Chant West has not considered any individual person’s objectives, financial situation or particular needs; (b) individuals need to consider whether the advice is appropriate in light of their goals, objectives and current situation; and (c) individuals should obtain a Product Disclosure Statement from the relevant fund provider before making any decision about whether to acquire a financial product from that fund provider.