Why do industry super funds perform so well?

By John Beveridge - July 20, 2018

Hostplus’ Balanced fund returned the highest results for the 2017-18 financial year with an interim result of 12.5%.

Sometimes a statistic is released that actually proves a different point to the one many suspect it does.

Take the battle between industry super funds and for profit and bank super funds.

If you think the fact that industry superannuation funds exclusively dominate the top ten best performing balanced funds for the past year just because they are inherently better than the competition, you may be missing part of the picture.

While it is true that some of the largest industry funds have done particularly well over the past year, the reason behind those better returns is not simply because industry funds are structurally better or are run by investment geniuses compared to the hundreds of other funds.

While there are many variables in comparing super fund performance, there is one really large difference which stands out in a fairly low return, low interest rate environment.

Fees really do matter

The first – and I would argue the most important – is that fees really do matter.

If you are comparing two funds that are identical in all investment respects but one is charging 2 per cent in fees and the other is charging 0.2 per cent, there are no prizes for guessing which fund will come out with the best performance.

That is particularly the case if you then compound the returns over a longer period, which allows the lower fee fund to earn returns on money that would otherwise have disappeared in the form of fees.

It doesn’t matter where the fees are going – to financial planners or other sales avenues, to “guru’’ fund managers, to platform managers or simply to bank or investment company shareholders – low fee funds will almost certainly come out in front over time.

Buffett’s ten year bet showed superiority of low fees and consistency

Indeed, this was the major lesson that should have been learned from Warren Buffett’s very amusing “bet’’ that he could outperform a range of leading hedge funds over ten years simply by investing in a low fee index fund that mirrored the US S&P500 index.

The fact that Buffett won so easily – and there was no shortage of people who openly scoffed at his chances – is that he knew that a combination of very low fees and consistency would stand a very good chance against even very talented fund managers.

With high fees, even a gun stock picker is starting the race with a major handicap.

Industry funds not fundamentally better

This is not to simply swallow the claim by industry funds that they are intrinsically better than all other funds.

It is true that the history of industry funds has allowed them to minimise fee payments to intermediaries and to also accumulate significant scale advantages by being default funds but it is the ability to charge lower fees because of these differences that gives them a competitive advantage.

It doesn’t really matter how that circumstance has come about, the fact that many of the industry funds now have scale and a degree of internal fund management to reduce investment costs gives them an advantage that is particularly pronounced when returns are mainly below ten per cent.

Staying invested paid off this time

Another distinguishing feature of the SuperRatings top ten is that the best returns went to some of the big industry funds that stayed the course and retained significant exposure to local and offshore share markets.

By deciding to not listen to the many experts who believed share markets were dangerous over the past year and should be avoided, these very large industry funds – particularly Hostplus and AustralianSuper – were able to outperform the median return of 9.3 per cent across all of the low-fee MySuper default funds.

Hostplus chief executive David Elia admitted that it was hard to ignore the noise in the market and resist the temptation to move more money into cash to avoid potential losses should share markets dip.

More controversially, many of the large industry funds have quite large exposures to unlisted investments, although that is a story for another day.

Temptation to play it safe always there

Those temptations to “play it safe’’ will always be there for all fund managers and sometime that is the right thing to do.

Indeed, AustralianSuper’s chief investment officer, Mark Delaney, has already signalled that he will be dialling down the balanced fund’s allocation to international and local share markets from 62 per cent to around 55 per cent this financial year.

Both Host Plus, which was number one and AustralianSuper, which was number three are quite active funds and they will continue to adjust their asset allocations to economic conditions as they see fit.

That might be successful in keeping them near the top performers or it might not but whatever the outcome, in the very long term having lower fees offers a buffer of protection to the fund’s millions of members.