Need to know
- A series of proposed reforms known as Your Future, Your Super will see super funds subject to a performance test
- The Productivity Commission previously highlighted Australia's relatively high super fees
- Experts say that some funds could improve their returns by changing investment strategies, but other won't survive
Two of the ongoing problems with Australia's super system are closely connected: the existence of underperforming funds and the difficulties in working out if you're in one.
The proposed reforms will shine a light on struggling funds and make it easier than ever for Australians to see how their fund is doing with their retirement savings. This package of reforms is known as Your Future, Your Super.
The new performance test
How much super you end up with will depend on:
- how much you earn or add to your super
- how much your fund deducts for insurance premiums
- how your fund's investments perform
- the fees charged by your fund (including administration fees, investment fees and any other costs).
The last point is our focus here. When the Productivity Commission recommended introducing a performance test, it suggested that underperforming funds be given a year to improve their performance. It said they could do this by cutting fees.
The Productivity Commission also found that super fees in Australia are higher than in other OECD countries. One reason for this may be higher investment management costs.
A seemingly insignificant 0.5 percentage point annual increase in fees would reduce the nest egg of a typical worker by $100,000
The performance test will factor in both fees and returns to determine how well a fund is managing your retirement savings.
The Productivity Commission found that super fees have a "significant impact" on your retirement balance. A seemingly insignificant 0.5 percentage point annual increase in fees would reduce the nest egg of a typical worker by $100,000.
Further, it concluded that high fees are "clearly associated with lower net returns over the long term".
But not all low-fee funds are good performers.
"Our analysis suggests that there are some relatively low-fee funds that will fail the test as it stands because their performance is so poor," says Super Consumers Australia senior researcher and data analyst Matthias Oldham.
How could an underperforming fund cut costs?
There are numerous ways a super fund could lower the fees it charges its members.
In the long-term, it could merge with another fund and take advantage of economies of scale. This allows a fund to share its costs over a greater number of members, driving down the cost for each individual member.
Super Consumers Australia research showed that mergers which occurred between January 2018 and October 2020 led to fee reductions. On average, the reduced fees would see each member retire with almost $15,000 more in their savings.
In the shorter-term, however, a fund could choose to invest more of the money it manages in passive investments. These options tend to have lower costs as there is less need to employ expensive fund managers. Once you account for the extra costs, most fund managers can't beat passive indexes anyway, so in most cases, you're actually getting a higher return.
Robin Bowerman, head of corporate affairs at investment advisor Vanguard quotes the company's founder, Jack Bogle: "Unlike other parts of our life, the more you pay in investment costs, the less you get to keep."
"Costs are a clear drag on what retirees get to spend in retirement," he continues. "So keeping costs low is a clear objective. (Costs) are a known influence. The unknown is what the performance of markets will be."
Turning an underperformer around
Under the new performance test, funds which deliver returns below the benchmark will have to let their members know they're underperforming and refer them to the YourSuper fund comparison tool.
If a fund is under the benchmark two years in a row, it'll be banned from taking on new members until it improves.
So why are some funds falling under the benchmark, and how can they do better with your nest egg?
"An underperforming fund is probably using expensive – and ineffective – active investment strategies and charging high fees for it," says Chris Brycki, CEO and founder of investment adviser Stockspot.
The easiest way to turn performance around is to adopt lower-cost strategies and charge low feesChris Brycki, Stockspot
Brycki says another possibility is that underperforming funds are using passive investment strategies, but they're still charging high fees.
"The easiest way to turn performance around is to adopt lower-cost strategies and charge low fees," he says. "It's simple, and it works."
Alex Dunnin, director of research at Rainmaker, says it could take time for an underperforming fund to lift its performance. The new performance test will measure how a fund has been doing over the last eight years (or five for new funds).
"If a fund has poor long-run returns, it will take years of annual out-performance to push it back into the black," he says. "It will be easier to turn around a battleship. If, however, the time period is shorter, then the task is easier."
Dunnin says that fees are an important factor in how much you retire with, but that funds can do better than simply cutting fees.
"When a fund changes its investment strategy towards, say, using more indexing, it won't just improve its returns but cut fees too," he says.
A move towards indexing (passive investment)
Some commentators criticised the new performance test on the grounds that it would likely see more funds invest more of the money they manage in passive investments.
Dunnin says this criticism is wrong.
"Some super funds struggle to beat their asset class indexes ... Driving funds to indexing, which would lower fees, could boost net returns."
Dunnin says strong returns for super funds in the past year mean underperforming funds will need to make radical changes to catch up. This could include moving from active to indexed management, using fewer investment managers and changing their asset allocations.
"Cutting fees will help, but it's investment returns where this game will be played," he says. "Much more radical action will be needed."
Brycki says there are "no barriers" to struggling funds adopting more passive investment strategies.
"It's the responsibility of each fund to create the best investment strategies, and the best investment strategies also happen to be the ones that cost the least."
The test will likely lead to fewer super funds
When the Productivity Commission suggested the performance test, it said that some failing products "should disappear" and predicted that funds would either look to improve their performance or merge.
Benchmarking was framed as a means to give APRA "a clear lever" to get rid of underperforming funds.
Super Consumers Australia director Xavier O'Halloran says that funds that are just failing the performance test may be able to turn it around.
"We know that many funds underperform the passive indexes. In these cases, the funds can improve by moving towards more low-cost passive management and passing these savings onto their members through lower fees.
"Other funds may have simply underperformed for too long to turn around their performance. This is the test working as it was intended – it's in the best interests of Australians that only efficient super funds are able to look after their retirement savings."
This content was produced by Super Consumers Australia which is an independent, nonprofit consumer organisation partnering with CHOICE to advance and protect the interests of people in the Australian superannuation system.
Stock images: Getty, unless otherwise stated.