Industry superannuation funds are one of the unsung Australian financial innovations and finally, the secrets of their incredible success have been laid bare.
The whole idea of a not-for-profit retirement fund manager is quite foreign to overseas investors and in many ways industry super developed due to a specific combination of Australia’s compulsory superannuation system, which was introduced in 1992, and also its industry specific and union roots.
Extensive research by the Ruthven Institute has now exposed the reasons behind the performance edge that industry funds have consistently shown compared to retail funds and also reasons why that outperformance might continue, despite the very large scale of the leading industry super funds, which in some ways makes outperformance more difficult to achieve.
Performance has been strong
For a start, that performance edge is worth exploring a little more closely.
The research found that all of the 25 top-performing funds over 10 years were not-for-profit industry funds.
It was a similar picture for the top 10 funds over five years with only one retail for-profit fund, Australian Ethical, making an appearance in the top 10 over the one-year period.
That is an incredibly dominant performance and it is also reflected when you look at the differences between the “average” balanced fund (the most common in Australia), which returned an average of 6.4% a year over the 10 years to 2020.
The best return, by giant $200 billion industry fund AustralianSuper, delivered members 7.6% a year over the same time frame.
That is a significant outperformance that would make a very large and meaningful difference in the retirement standard of living between two workers who deposited the same amount into superannuation over a working life.
How did they do it?
Many reasons have been given for the outperformance of industry super funds – some have pointed to their scale as an advantage in lowering administration and investment costs and others have pointed to the non-profit structure as also reducing costs because money that would have been siphoned off in profits instead remains invested in members’ accounts.
Both of those reasons are valid with administration fees falling from the 90 to 100 basis point range down to 30 basis points and lower as old high-fee retail products were withdrawn and the really big industry funds gained benefits of scale.
However, the real key to industry super fund outperformance is actually asset allocation – choosing investment areas that simply performed better and which even wealthy individuals with self-managed super funds would have difficulty accessing.
Infrastructure and private equity are two of the key investment categories here, but it is far from being the only one with international shares also being a surprising reason for outperformance.
Faster growing offshore shares a key point of difference
“What’s happened over the last several decades is that super funds have been allowed to have more freedom as to what to do with the funds they manage,” report author Phil Ruthven, who founded what is now IBISWorld way back in 1971, said.
“Funds have gone into more active rather than passive investment assets. Shares now account for about 60% of super fund investments and increasingly that is going into international shares.
“That is leading to higher returns because American shares have profitability levels almost twice as high as Australian shares,” Mr Ruthven said.
That sort of asset allocation is easily seen using AustralianSuper as an example, which at the time of the report had 32.5% of its assets in international shares, 22% in local shares, 12% in infrastructure, 11.5% in local fixed interest and just 4% in cash.
That compares to the “total” category, which includes many retail funds and had only 25.9% in international shares, 20.7% in local shares, 6.7% in infrastructure, 20.5% in fixed interest, both local and offshore, and a big 9.9% in cash.
It is easy to see from this comparison that AustralianSuper had a lot more of its investment money working in active assets – particularly offshore, where returns in areas such as technology are higher – and less in cash.
The average competitor had around a third of their money tied up in low performing cash and fixed interest.
After-inflation returns have been stronger for longer
The end result is outperformance which has been both consistent and impressive, particularly when you factor in inflation.
Using overall average returns, over the 20 years to 2020, inflation averaged 2.5% while super returns averaged 6.12%.
For 10 years, inflation averaged 1.9% while over five years it averaged 1.5%.
That means that over the past 20 years, superannuation grew a real 3.62% annually after accounting for inflation and a real return of 4.5% over 10 years.
Over five years – which includes the dramatic share crunch due to the pandemic – the real, after-inflation return was still 6%.
Rising inflation could be big test for all funds
What this also shows us is the importance of outperforming inflation – something that may become more difficult if, as some market pundits predict, inflation rises as the world economy recovers from the pandemic.
If returns fall below inflation, the purchasing power of super balances will fall, which is the opposite of what is intended.
Either way, the unusual industry super fund behemoths are in a strong position to react to changes in investment markets with significant benefits of scale, relatively low fees, diversified investment profiles across a range of asset classes and proven internal investment managers.
They may be a peculiarly Australian form of retirement saving fund manager but that has not stopped them from growing very quickly and, on the whole, outperforming the globally much more common retail fund model.