There’s so much more to super than cutting costs
MySuper, with its overwhelming focus on costs, is unlikely to help Australian workers to build enough super to enjoy an adequate income in retirement. On the contrary, it is likely to do them a disservice, not just by delivering lower returns but also by making them less engaged with their super and less likely to make the right decisions at crucial times.
What’s really important in super? Is it to pay the lowest fees, or to achieve the highest returns? Or is it something more than that? Chant West would argue that, when assessing the merits of different super funds, there are other considerations that are at least as important as fees and returns.
In future, the members who will ultimately fare the best will pay reasonable fees, enjoy reasonable returns and – most importantly – will be sufficiently ‘in touch’ with their super and their long-term objectives to make good decisions and take sensible actions throughout their working lifetimes.
These members will be well-informed, and willing and able to seek advice on important issues as they arise. They will know how much super they need to amass to achieve their retirement income needs, and will have a good idea of how they are progressing towards their goal. If they are in danger of falling short, they will take advice on how best to catch up.
They will weigh up the options, making use of personalised projections, educational guides and modelling tools, and know how to turn their decisions into actions. In short, they will engage with their super and get the maximum benefit from it. This will only be possible if their fund makes it easy and affordable for them to do so. This is what will characterise the better funds in the future.
When we rate superannuation funds, fees are a consideration but by no means the most important one. They account for just 15% of our overall score, as shown in Table 1. And while investment gets the highest weighting at 40%, past performance is only a small part of that (just 10% i.e. 4% of our overall rating).
In our view, and despite what its proponents would argue, MySuper will inevitably lead to a ‘dumbing down’ of super in Australia. Competition between funds will be mainly about fees, not features or benefits. That will take its toll in several ways, most notably in investment returns and member services.
We’ll look at both those aspects in turn, contrasting the MySuper products of the future with what the best funds in the market are doing today.
|Table 1: Chant West Fund Ratings – Main Criteria|
|Criteria||Weight (%)||Key Considerations|
|Ownership, capital reserves, quality of senior management, vision of business plan.|
Choice, governance, internal investment team, external consultants, investment beliefs, portfolio structure, performance.
Magnitude and transparency.
Benefits offered, magnitude and transparency of premiums, automatic cover, terms and conditions, administration.
Record keeping system and supporting applications, workflow management, service standards.
Call centre, member statement, newsletters, annual report, education on web (including calculators), financial advice services.
Dumbing down investments will hurt returns
The best funds set out to provide the best net investment returns to their members. Not the lowest investment fees, but the best returns after those fees are deducted. That, after all, is what matters to members.
For well over a decade, the best net returns have come from industry funds. Those funds tend to have relatively high investment fees, but those fees are high for a good reason. It’s because industry funds have invested mostly in actively managed portfolios and more in alternative (unlisted) assets which, by their nature, are more expensive to manage.
Without being rash, they elected to incur higher fees because they believed in the investments they were making – and they have been fully justified. Those investments have added considerably more in incremental returns than they have cost in incremental fees.
History tells us, therefore, that having the lowest investment fees doesn’t lead to the highest investment returns – quite the reverse, in fact. But MySuper is mostly about low fees, and the pressure to reduce fees will most likely lead to inferior investment decisions and lower net returns for members, and even worse disclosure and hence transparency.
How will MySuper providers get their investment fees down? For many, the obvious answer will be to use indexing as much as they can. There is nothing wrong with indexing per se. In the retail investment market, where management fees tend to exceed any alpha generated, indexing makes a lot of sense.
But, for large super funds, the cost of active management is much less, so individual members are effectively getting wholesale prices. That’s why the best-performed super funds use indexing sparingly.
The best proxy we have when we want to look at the results of indexation is a product offered by indexing specialists, Vanguard. This is a fully-indexed diversified growth PST that operated up to August 2010. It’s not a perfect comparison because not every asset sector has an index so there are asset allocation differences, but it provides a useful guide when we want an indexed alternative to compare with the best-performed fund category of the past decade, namely the industry fund default options.Table 2
shows that, over rolling 5 year periods from August 2003 through to August 2010, the median industry fund’s growth option (i.e. 61-80% growth assets) outperformed the corresponding Vanguard fund by a minimum of 0.3% pa, a maximum of 1.5% pa, and an average of 0.8% pa. For the upper quartile of industry funds, the average outperformance was 1.5% pa. Those returns are net of all investment fees and tax.
This is not to criticise Vanguard, which is very good at what it does, but simply to demonstrate that if funds invest on the basis of fees alone they won’t be doing their members any favours.
|Table 2: Industry Fund Outperformance Relative to Vanguard – Rolling 5 Years (% pa)|
1. The analysis is based on rolling 5 year returns from August 2003 through to August 2010 (85 data points)
2. Performance is shown for growth options (i.e. 61-80% growth assets) and is net of investment fees and tax. It does not include administration fees or adviser commissions.
Even before MySuper arrives, we’re already seeing indexation as the inevitable answer to lowering costs. Some retail funds have launched pure index options so they can claim to be as cheap as industry funds, and some industry funds have responded by introducing fully-indexed options of their own (although they’re not exactly encouraging their members to use them).
Sadly, there seems to be a race to the bottom, and that bottom seems to be the 66 basis points (36 bps for investment + 30 bps for administration) quoted by Deloitte in its report for the Cooper Review and used by Treasury for its projection that the average member will be $40,000 better off under MySuper.
We firmly believe that the 36bps investment figure is unrealistic, especially when you consider that the biggest public offer fund, AustralianSuper, charges about 60bps for its default option and the average investment fee for the top 30 industry funds is about 75 bps. But even if you accept that 36 bps is possible, it implies a level of indexing that, based on the evidence quoted above, would reduce investment returns by far more than the touted $40,000 cost saving. In other words, MySuper’s focus on costs would be self-defeating. And that’s just the investment side of things.
Dumbing down member services will hurt retirement incomes
The other major concern we have about the MySuper model is that it will encourage funds to cut costs in areas such as member communications, education and advice, so as to reduce administration fees.
The 30 bps administration fee anticipated by Deloitte compares with an average figure of about 40 bps charged by the major industry funds today. This implies a 25% cut in administration fees to be competitive. Some of that may come from more efficient processing of data and contributions, but the most obvious candidates for a ‘haircut’ are member services. Indeed, the Cooper Review labelled most member services ‘bells and whistles’ and seriously questioned their value to members. We disagree. Cutting back member services would be a tragedy, given the progress that has been made over the years in improving the general level of understanding of super.
Financial illiteracy is a national problem, and super funds have been more successful than any other bodies in addressing that problem. Super continues to be the Government’s preferred way for us to save, and its importance will only increase if compulsory contributions rise from 9% to 12%, so it’s vital that funds help members to understand their super better and get the most out of it. That requires better communication, education and – above all – advice.
The priority has to be to give members a better understanding of:
- What income they will need for an adequate standard of living in retirement;
- What size nest egg they need to accumulate to generate that income;
- How they are travelling along the road to building that nest egg; and
- What steps they can take to improve their current position.
Currently, only about one person in five seeks financial advice. One of the big drives underway, led by the better funds in the industry, is to increase that ratio. That is going to be the main game in the industry over the next five to 10 years, getting affordable advice to a much wider spread of members.
That doesn’t necessarily require a huge increase in the number of advisers, because other changes are already under way both in the scope of the advice provided and how it is delivered. Most members neither want, nor can they afford, a wide-ranging plan that encompasses all their financial affairs (so-called ‘full’ advice). Instead, they want advice from someone they can trust on simple, one-off issues that are relevant to their situation at a given point in time. Funds are meeting that need by making available scaled advice, mainly delivered over the phone by well trained staff who know the fund intimately, either free or at a heavily subsidised cost.
Advice is an essential component of a coordinated suite of member services that, ideally, should include all of the elements shown in Table 3
. The table, which is adapted from our fund ratings scoring guidelines, indicates the key issues we consider.
One exciting development is the personalisation of member communications. Some funds are starting to deliver consistent personalised messages through annual statements, website, campaigns and call centre. These messages focus on the best action(s) each member could consider to improve their super, based on their individual circumstances. The move from generic messages (which often haven’t worked) to consistent personalised messages delivered through multiple channels, has the potential to really drive positive behaviour.
Of course there is a cost to deliver these services, but we would argue that this is a necessary expense if funds are to fulfil their true potential. The quality of Australia’s super funds is far higher now than it was in 2005 when choice of fund was introduced, especially in terms of the range and quality of services available to members. Those improvements may have resulted in a small increase in fees overall, but on balance that has been a good thing. It’s certainly a lot better than the MySuper world, where funds will compete mainly on costs and member services are likely to be scaled back as a result.
What is needed is a behavioural change in members. And that is best fostered and developed by funds themselves. It is far more important, surely, for a member to be able to get personalised advice on investment choice, insurance, co-contributions, salary sacrifice, transition to retirement etc, and to know how to make use of that advice, than it is for them to pay a few dollars a year less in fees.
|Table 3: Chant West Fund Ratings – Member Services|
|Criteria||Weight (%)||Key Considerations|
|Call centre staff have ready, online access to a range of product, superannuation and member-specific information so they can adequately answer member queries.|
Member statement, annual report and newsletter are engaging, personalised (or segmented) and have calls to action on key strategies to grow super.
Secure internet site
Members can view their account balance, how it is invested, how their investments have performed, a personalised consolidated asset allocation, how much insurance they have and full details of charges and commissions.
Educational material is presented in a variety of formats, both hard copy and online, and focuses on strategies to grow super. Use of case studies and online tools including a retirement calculator, a risk profiler and insurance needs calculator.
Financial advice services
Members have access to scaled (single issue) and comprehensive advice. The cost of advice can be deducted from members' accounts. Members' external adviser has online access to account information.
© 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.