Australia has the world's riskiest super

Christopher Joye

In the AFR today I argue that Peter Costello is right that there is a role for the government to play in providing super savers with a public sector alternative to existing super funds---in fact, I argued exactly the same thing at length way back in 2009 with my "KangaSupa" proposal. I contend that Australian super funds are among the riskiest in the world as evidenced by their huge losses in 2008 and 2009 compared to all other OECD countries and the fact they carry among the highest weights to equities and lowest weights to bonds of any serious global economy. And despite assuming these huge risks, their returns have been ordinary, especially when compared to the lower risk Future Fund (click on that link to read for free or AFR subs can use the direct link here). Excerpt below:

"My idea, which I coined "KangaSupa", was for the Commonwealth Treasury, or an agency like the Future Fund, to furnish savers with a simple, low-cost and potentially capital-guaranteed option that would be managed by the public sector on their behalf. e Future Fund's chairman and former treasurer, Peter Costello, recently proposed the government step up to the plate in a similar fashion, which raised eyebrows given his libertarian heritage. But there is much merit to his vision. The government has already demonstrated that it has built an outstanding capability in this domain, with the $160 billion Future Fund assembling a team of over 144 professionals that have comfortably bested their aggressive return target of inflation plus 4.5 per cent over the decade since its prescient inception. Notwithstanding these resources and the talent inside Treasury and the Australian Prudential Regulation Authority—to say nothing of the massive global academic literature on the subject—the government currently supplies taxpayers with no independent research on optimal portfolio construction and asset-allocation approaches for a predetermined range of risk and return preferences. There is no public centre of excellence disseminating data on historical asset-class returns, risks, correlations, and/or tools that could help savers harness internationally recognised portfolio optimisation techniques to better understand the trade-offs between risk and return and the benefits of diversification across assets with imperfect correlations. If artificially-intelligent robots can purvey these services, surely the government can in the name of intellectual contestability. It is a perfect public good. Even more astonishingly, while the Australian Prudential Regulation Authority happily publishes rankings of super funds based on their one, five and 10 year returns, there is absolutely no accompanying time-series information on these funds' risks. That is to say, no data on the volatility of their returns, their worst months, or deepest peak-to-trough draw-downs. Private sector super fund rankings likewise assume savers live in a world in which only returns count with zero consideration of the accompanying downside, which is a disgrace. If as a super fund trustee your performance relative to peers is always judged exclusively in return terms, and you suffer no costs for the risk you assume to generate these pay offs, what do you think you will do? Max out your risk limits, of course. This is precisely why Australia has ended up with the world's riskiest pension system. The OECD's latest analysis finds that of the 34 developed countries it evaluates, our super funds have the second highest portfolio weight (51.1 per cent) to equities, which is more than five times larger than the median weight of 10.7 per cent. Australia also has the second lowest weight to bonds (10.2 per cent), which is less than a quarter of the median weight (42.8 per cent). Despite the enormous risks Australian super funds impose on members, they do not rank in the top quartile of OECD countries for the net "real" returns they have generated over the last decade. These hidden risks manifest more clearly when you assess our super funds' performance during difficult times. The OECD says Aussie super funds delivered a cumulative loss of 21.6 per cent over the years 2008 and 2009, which was the third worst in the developed world behind two nations afflicted by depression: Ireland (down 35.7 per cent) and Iceland (down 22.2 per cent). Imagine what would have happened to our super portfolios if Australia had actually experienced a recession! If APRA or Treasury ever pull their heads out of the sand, and require super funds to publish regular data on their returns and risks (measured as worst draw-downs and rolling volatility), and forced rankings to be made on the basis of risk-adjusted returns much like Morningstar rates managed funds, we would see major changes in asset-allocation. There would be far weaker incentives to load up on stocks simply to surpass rivals, and those trustees with higher allocations to capital-starved areas like domestic investment-grade bonds, high-yield debt, and direct loans would suddenly look like rock-stars given their much skinnier draw-downs vis-à-vis shares. This would also have the benefit of reducing Australia's reliance on four mega-banks, more evenly distributing the supply of credit between banks and the super system. Put differently, the real answer to improving competition in the world's most concentrated banking system is not increasing the number of deposit-takers, but rather motivating superior asset-allocation inside super. The industry funds don't realise this, but they are arguably much bigger threats to the big banks' core businesses than their advertising claims these (vertically-disintegrating!) behemoths are to savers. The great counter-factual in this debate is the Future Fund. Whereas Australian Super's "balanced" fund has an enormously concentrated and correlated 84 per cent allocation to Aussie shares, global shares, property equity, private equity, and infrastructure equity, the Future Fund's weight to these sectors is only 56 per cent even though it has a slightly higher return target. The exposure to cash and bonds is likewise revealing, with Australian Super limiting its members to just 18 per cent compared to the Future Fund's loftier 29 per cent allocation. The real rub is that whereas Australian Super's balanced option has returned 5.56 per cent annually over the last decade, the Future Fund has delivered 7.8 per cent, which is a 40 per cent better outcome." Read full article at AFR here.

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Christopher Joye

Christopher Joye is Co-Chief Investment Officer of Coolabah Capital Investments, which is a leading active credit manager that runs over $2.2 billion in short-term fixed-income strategies. He is also a Contributing Editor with The AFR.

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