Could Australia’s superannuation funds become risky investors as an unintended consequence of rules to improve their performance?
It is an interesting example of the law of unintended consequences, but that doesn’t make it any less likely.
The current superannuation changes before parliament, which are due to come into force from 1 July, aim to improve investment performance by cutting off poorly performing funds from new members.
Game of musical chairs may make super funds worse investors
However, speaking at a parliamentary hearing, The McKell Institute spokesman James Pawluk said the laws might have the perverse effect of turning funds that are currently professional investors into behaving more like amateur retail investors – chasing investment trends and copying each other to avoid being the one left out in what will effectively become an ongoing game of musical chairs.
He said the bill was drafted for perfectly behaved markets but did not take into account “black swan’’ events which occasionally bring rapid and unexpected investment challenges.
One example that he used is very current – how should a superannuation fund react to asset bubbles?
Unintended consequences can be good or bad
“The proposed performance benchmarks will make it less viable for funds to adopt a strategy of steering clear of an asset bubble as it’s forming, unless they are convinced it will burst or dissipate before the current performance period ends,” Mr Pawluk told the parliamentary hearing.
“The only rational strategy would be to pile in on the bubble, aiming to pull out just before it bursts or hug the index for good or bad,” he said.
“These reforms will cause superannuation funds to behave more like retail investors, taking on their animal spirits, rather than acting as sophisticated long-term investors that provide a stabilising influence.”
He said if funds don’t chase the bubble and match their peers, they could be named and shamed for poor performance and be cut off from new members until they improved their performance.
It is an interesting example of an unintended consequence – a concept that the father of economics, Adam Smith, used to describe how each individual, seeking only his own gain, “is led by an invisible hand to promote an end which was not part of his intention,” that end being the public interest.
In that example, the unintended consequence is a happy one of individuals improving society simply by seeking to gain for themselves.
But, in the super example it would be a negative consequence, with tightly bunched super funds potentially all putting in a poor performance when a more reasoned and professional approach to investment might have led to better results.
How will the regulator approach performance?
The problem really only arises if the prudential regulator, which is judging funds annually, only looked at performance rather than how it was produced – something that at this stage is hard to guess at.
For example, if a large fund started to outperform after it made a controversial but very public investment in Bitcoin, would the other funds really be dragged into buying Bitcoin as well?
Probably not, given that most funds running a “balanced” investment approach have reasonably strict investment allocations that they are loathe to move away from.
Where the asset bubble pursuit might become a problem could be if, say, US technology shares were rising rapidly and unsustainably and one large Australian fund had a heavy exposure to the Nasdaq exchange.
That would provide a strong temptation for other funds to try to catch up on that fund’s outperformance by buying directly into the bubble rather than – for example – maintaining exposure to a more broadly based and “safer” US index such as the S&P500.
Best financial interests’ duty has been controversial
It is far from the only controversy in the legislation, with the reversal of the burden of proof for the best financial interests’ duty being the most bitterly contested.
Under that change, the onus is on the trustee of the superannuation fund to show why any payment is justified, such as sending a letter out, running an advertising campaign or holding member briefings and meetings.
Some industry super funds see this change as being aimed at stopping their lobbying efforts on behalf of members – the most recent high-profile example being the campaign to continue the legislated rises in superannuation from the current 9.5% to 12% from 1 July 2025.
Other changes are less controversial such as a stronger focus on each individual having one superannuation fund instead of the current system, which can leave people with multiple funds.
The parliamentary inquiry is due to report back to parliament by 22 April, with the draft bill to take effect from 1 July – assuming it gets through both houses of parliament.