One of the greatest achievements of the Royal Commission into financial services will be to shine a light into the dark recesses of superannuation.
While the horror stories from banks were even more shocking than a jaded public might have expected, superannuation is arguably a much larger problem because it is so large at A$2.6 trillion and covers the vast majority of Australians and yet it is so poorly understood.
Other than those many brave souls who manage their own superannuation funds through SMSF’s, much of the population is quite disengaged with their superannuation.
Young people most disengaged but have most to gain
For young people, the payoff seems so far into the future that it barely seems worrying about.
Yet, this group has by far the greatest chance to make a massive difference to their superannuation balance by ensuring that they continue to consolidate into one fund, ensure they are only paying for insurance that is absolutely necessary, have an appropriate level of risk and reward in their investment choice and have fund management fees that are as low as possible.
These small changes when made at a young age can literally make hundreds of thousands of dollars of difference to their future lifestyle in retirement.
Older workers also suffer through lack of engagement
Likewise many working people are also disengaged with their super and the need to make additional contributions to boost their retirement and also the need to potentially reduce the level risk in their super savings as they approach retirement and face up to the very real problem of sequencing risk – an issue that that can make a lasting impact when several years of poor super fund performance are bunched together.
Then there is the actual retirement itself, which is a minefield of choices between how involved the saver wants to be with managing their money, who can they trust with the job, how do they keep fees as low as possible and how to maintain a liveable income at a time when most asset classes are throwing off very low returns in the form of interest and dividends.
How trustworthy are superannuation trustees?
The real value of the royal commission will centre on what appears to be a breakdown in the level of trust people can have in superannuation funds, which in many cases seem to be arranged so that all of the vested interests in insurance, fund management, asset allocation, platform providers, sales commissions and various other hangers on can get their slice of returns, leaving the superannuation saver at the very end of the queue.
That is the polar opposite of how superannuation is meant to be managed but it appears to be a system that has developed as the size of the industry grew and member engagement remained so low that bad practices could spring up unchecked.
The impact of fees that swamp returns
That was starkly pointed out by the commission which was shown a statement on returns and fees from a super fund member in the MLC MasterKey Personal Super product, which to be fair could have probably been replicated exactly by a very large number of funds in the market.
The member involved had fully invested in the cash option which returned a skinny 1.2 per cent over the year.
That was bad enough but after all of the various fees were added on, which added up to of $929, that slashed the fund member’s return of $1032.95 down to just $103.95.
This example demonstrates two problems – it is highly unlikely that any person other than the most ultra-conservative on the very brink of retirement should be invested in a full cash option, which may well be an issue of education rather than only being a fault with the fund.
Secondly, the opportunity forgone by chewing the return down to such a puny figure will keep cascading into the future.
In simple terms, the fees that are no longer in the account won’t achieve the multiplier effect of investment over future years and the fund as a whole if it remains invested in cash will struggle to even keep pace with inflation, leaving the member struggling to even maintain the real spending power of their money, let alone have enough saved to have a decent retirement.
How did fees become so bloated?
The royal commission will need to come to grips with this problem of how fees became so bloated and how the interests of super fund managers ended up becoming so out of alignment with their members in many, but not all cases.
The fees issue is one of the most crucial for fund returns, as we found when looking at why industry funds dominated the top ten best performing funds.
The other big issue the royal commission will need to come to grips with in forming its recommendations for the Federal Government is how the regulation of super funds became so piecemeal.
Who is regulating the industry?
Counsel assisting the commission, Michael Hodge QC, said there was some confusion between the main regulators, the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority, in their attempts to co-operate as they supervised the industry.
Indeed, he said the lack of supervision was so profound that it became a matter of: “What happens when we leave these trustees alone in the dark with our money?”
“Consumers are unable to do anything more than peer dimly through the darkness of their superannuation trustee,” said Mr Hodge.
Mr Hodge is right to suggest that it is no longer good enough to allow poor behaviour by superannuation trustees to fall between the cracks due to jurisdictional anomalies.
While many super investors will not even know they have been consistent victims of bloated fees on their investments, it is an issue that will return to haunt them in the future and also concerns the broader taxpaying public, given that the superannuation tax concessions and public pensions are all ultimately borne by the taxpayer.