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MySuper may be cheap, but can we afford it?

The MySuper concept, proposed by the Cooper review and adopted as policy by the Labor Government, has a certain superficial appeal. Its mantra of ‘simple, low cost product’ is saying to the consumer: “Super is good for you, even if you don’t want it, so here’s a way to get it as cheaply as possible”.

“A man who knows the price of everything and the value of nothing.” Oscar Wilde’s definition of a cynic


It treats super as a homogeneous product where the only differentiating factor is price. In doing so it fails to distinguish between price and value. While not suggesting that the Cooper panel’s approach was cynical (as the Oscar Wilde quote might suggest), we do believe it overlooked some important facts that show the difference between price and value in superannuation products.

There are many aspects of MySuper in its current form that we can fault. By far the most important are what it would mean for investment returns and member services, and those are the focus of this article.

Inferior returns will wipe out cost savings
Much has been made of the forecast cost savings of MySuper which, according to Treasury estimates contained in the Cooper Review report, will increase the average wage earner’s final benefit over a 37 year working life by $40,000, or 7%.

That is the total financial benefit that will supposedly accrue from the combination of lower management costs and the administration savings flowing from the SuperStream initiatives (ie savings of about $33,000 and $7,000, respectively).

We have to say we seriously doubt that such savings are achievable, since they rely on what we consider to be unrealistically low investment costs of 0.36% per annum, but let’s accept them for the sake of this article.

Our view, based on the performance data we collect and analyse, is that any such saving is likely to be eclipsed by the reduction in benefits resulting from reduced returns. If we adopt Treasury’s 37 year working life model, it would take a loss of 0.31% per annum in returns to wipe out the $33,000 gain it forecasts from management cost savings (ie administration and investment fees). We believe the MySuper model is likely to reduce returns by more than that over the long term, for the reasons discussed below.

Super is not a homogeneous product, and there are qualitative differences between funds. The better quality funds, in terms of investment performance, tend to have higher investment fees because of how they invest and what they invest in. But there is strong evidence that those higher investment fees pay off because they produce better net returns. In other words, the additional return is greater than the additional fee incurred to achieve it.

Those funds producing superior investment returns have overwhelmingly been industry funds. The table below shows industry funds have been the best performing group over a long period. In fact, over most of the past decade, industry funds have represented the entire upper quartile in our performance surveys.

Higher investment fees have paid off for industry funds
Alternative assets (%) Investment fees (% pa) 7 yr returns to 30 June 2010 (% pa) 7 yr standard deviation (% pa)
Industry funds   19 0.75 6.8  6.7
Retail funds   10 0.70  5.7   8.2
Vanguard    0 0.38  6.3   7.9

Notes:
1. Alternative assets consist mainly of private equity, infrastructure and hedge funds
2. Fees are for growth options (61 to 80% growth assets)
3. Returns are after investment fees and tax, but before administration and member fees

Note that industry funds’ investment fees are higher than those of retail funds. That’s mainly because industry funds invest significantly more in alternative assets which are more expensive to manage than traditional assets.

The table also compares industry funds and retail funds with the Vanguard Balanced option. This option is 100% passively managed and has no alternative assets.

Why do we include the Vanguard fund in the comparison? Because it gives an insight into the direction that retail funds are likely to follow under the MySuper regime. The commercial reality is that retail funds will be under pressure to get their costs down. They will need to do that to remain competitive and still make a profit. The two easiest ways to keep investment costs low are to avoid alternative assets and to use passive management as much as possible.

That is exactly what the Vanguard option does, so we can use it as a proxy for the ultimate low cost diversified product. How has it performed? About 0.5% per annum worse than the median industry fund over the past 7 years. That’s the sort of lost return we anticipate from the new breed of low cost retail products – all as a consequence of MySuper.

A loss of return of 0.5% per annum may not sound like a lot, but over 37 years in the workforce (again using Treasury’s modelling timeframe) it adds up to about $53,000 for the average member’s account (as shown in Chart 1). That’s why we say that the cost savings forecast for MySuper are very likely to be eclipsed by the investment returns forgone.



Looking again at the table, it shows that industry funds have not only outperformed retail funds and the Vanguard fund, they have also been significantly less volatile (a standard deviation of 6.7% against 8.2% for retail funds and 7.9% for Vanguard). This tells us that their investment strategy, and especially their higher allocation to unlisted alternative assets, has been successful in smoothing out the ups and downs of listed markets and reducing risk for their members.

Industry funds have been the success story of the past decade. They have outperformed retail funds by more than 1% per annum on average (as Chart 2 shows) and they have done so with lower risk.



Yet even those successful industry funds will be under pressure to lower their investment costs to compete under MySuper. That may result in them dismantling the very elements that have led them to deliver superior investment outcomes, measured by risk and return, for their members.

What will happen to member services?
The investment argument is one reason why we think MySuper is a mistake. The other main concern we have is that funds will be under pressure to reduce their expenditure on member communications and education.

MySuper is supposedly for the benefit of members who are disengaged with their super, and Cooper doesn't want them to bear the cost of what he calls 'bells and whistles'. But isn't it better to try to get them engaged and taking control of their retirement savings? We know this is a slow process, but surely it’s better than perpetuating apathy and financial illiteracy.

Members who are disengaged and poorly educated about their super are more likely to make bad decisions – or no decisions – not just about investment but also strategies such as co-contributions, salary sacrifice, insurance and transition to retirement. These are issues that members need to understand if they are to get the best out of their super. If funds pull back on education and communications, members will be the poorer for it.

There is a simple alternative to MySuper
The Government’s policy objectives can be met without the need for MySuper. Separating product fees from advice fees is already happening. That’s vital because it improves transparency and means that members will only pay for services they receive. The SuperStream initiatives will improve efficiency across the board, and will lead to meaningful reductions in costs without impinging on investment returns.

Significant cost reductions can also be made by eliminating the over-elaborate investment menus that, in some funds, can run to hundreds of investment options. Why not simply say that a default fund must offer no more than, say, 10 multi-manager investment options? That would provide sufficient choice to cater for different objectives and risk tolerances. It would also reduce confusion, promote active choice and eliminate a lot of unnecessary cost.

Australia has an excellent superannuation system that is the envy of the developed world. Of course it can be improved and made more efficient, and some of Cooper’s proposals will speed that process. SuperStream aside, simply opening up the Award system to include non-industry funds will level the default fund playing field, increase competition and bring down costs.

The MySuper proposal, however, no matter how well-intentioned, is unnecessary. It is not the way to increase Australian workers’ nest eggs, and is more likely to do the opposite. It may be cheap, but in life you tend to get what you pay for.


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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.

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