The looming $2.1 trillion growth in superannuation will change everything

One of the incredible changes in the Australian economy that the Banking Royal Commission tended to overshadow is the incredible growth in the superannuation sector.

Already super represents a massive $2.7 trillion – an incredible 1.5 times Australia’s gross domestic product – but over the next 15 years it is forecast to grow to $4.8 trillion.

If that comes to pass – and, if anything, these estimates by super experts Rice Warner have tended to undershoot what ends up happening – then super will absolutely dominate the Australian economy and totally outstrip the size of the conventional financial sector, including the big four banks.

Unlike the banks, the massive pot of money in super is even more powerful because there are no capital constraints on it and few restrictions in how it is invested so the people managing it will literally be scouring the globe for investment opportunities to put the money to work.

That is already happening but you can expect to see Australia’s massive lump of retirement investments to really start to appear on the radar of the world investment scene.

That is a really big change from Australia’s traditional history as a hungry capital importer with a current account deficit – something that has currently been turned around by the boom in iron ore and other mineral exports but will in the future increasingly be influenced by offshore superannuation investments.

The growing size of offshore financial investments has already transformed Australia and made it much less subject to balance of payments and debt crises and that situation will only strengthen as the pool of super grows.

Offshore investments by super funds now equate to about 25% of Australia’s GDP but you can expect to see that figure keep rising over time, particularly if super contributions move from the current 9.5% of salary to 12% by 2025 as planned.

The big question that does arise from the Banking Royal Commission is who will be directing these massive investment flows in the future?

Big changes happening in super sector

Since the Royal Commission there has been a big swing away from underperforming and overcharging retail super funds and a swing towards industry funds.

Self-managed funds with $746.2 billion remain a very big sector of the market but were recently overtaken by industry funds that now have $747.4 billion invested.

That trend may continue because SMSFs tend to have older members with big balances that are closer to or in retirement while industry funds with many younger members should continue to grow.

The big banks, which were heavily involved in running retail super funds, have almost all headed for the hills and have sold or are in the process of selling out of their retail super funds.

So, they are unlikely to be significant players in the superannuation industry in the future – something that they may one day regret.

Mega funds are already here and there will be more

The other big trend that leaves is the rise of the mega fund – which in Australia’s case will almost entirely feature industry funds, which have been able to grow quickly due to their not for profit status and generally lower fees and broadly better investment performances.

AustralianSuper is the big daddy of the sector with more than $150 billion of funds under management but with the pressure now on smaller and underperforming funds to merge, there are forecast to be many more mega-funds with more than $150 billion over the next few years.

One potential example is the combination of VicSuper and First State Super – two funds which are set to officially merge on 1 July in 2020, which will see the combined entity manage around $120 billion.

Big public sector funds are also expected to grow, as will the quite unusual Future Fund which is not strictly a superannuation fund, even though the $166 billion it manages will eventually fund servant superannuation.

So, if current trends continue, we can expect to see some really large financial institutions emerge that will become quite powerful in the international financial scene, let alone within Australia.

OK Boomer starts to bite

OK Boomer was meant as a shorthand way of easily disparaging the Baby Boomer generation but over the coming decade OK Boomer will also underscore a dramatic test of the superannuation system.

Increasingly boomers will say OK, show me the money and wind back their contributions to superannuation and begin instead to live off it.

Until now, the superannuation system in Australia has effectively been a growing pool of accumulated savings but from here on, even as that overall pool continues to grow, there will also be a significant flow of private pension money out of it to retired super fund members.

That is already happening with funds paying out $76 billion in retirement benefits in the 2019 financial year as the big population boomer bulge continues to move past 65 years old.

Eventually boomers and other retirees will represent about 18% of the population and many will be wholly or at least partly reliant on superannuation pensions for their income, with the age pension becoming less important as a source of retirement income.

Those outflows should not cause too many problems for super funds, given that they will usually be covered by fund returns but the combination of inflows and outflows is a new situation that could cause some problems, particularly for funds with a greater proportion of retiree members.

They may cause liquidity problems for smaller funds with members now much quicker to change out of underperforming or overcharging funds.

In general, the OK Boomer change should accelerate the current wave of fund consolidations that will lead to a much smaller number of bigger funds, which hopefully will pass the benefits of scale on to members in the form of lower investment fees and better returns.

No doubt there will be bumps along that road but the overall picture of a growing and consolidating number of very large superannuation funds with massive investment pools looking for a home is generally a great outcome for Australia and should improve our financial stability and reduce our reliance of foreign investment inflows.

If all goes to plan, it should also greatly reduce the reliance on the age pension at a time when a really big cohort of Australians are leaving the workforce.

That should leave the Federal Budget in a much better position than it might otherwise have been in had the superannuation sector not have grown since the Keating Labor Government effectively consolidated the current retirement income system back in 1992.