The Great Superannuation Exodus

According to the Sydney Morning Herald there has been an exodus of funds from large superannuation funds into self managed funds.

The number of people with DIY super funds has grown by more than 30 per cent during the past five years to more than 1 million, collectively worth, in December last year, a whopping $568 billion.

More than a third of Australia’s pool of superannuation money is now held in self-managed funds. And the age at which people start their own fund is getting younger – 49 years of age now, compared with 54 five years ago.

Source SMH

It is posited in the article that the main reason for this is control, choice and an attempt to reduce the impost of fees upon the account. I believe this is true. The impact of fees upon a super account is often underrated simply because to us the difference between 1% and 1.5% doesn’t seem much in absolute terms but in relative terms it is a tremendous drag on the performance of the fund over the long term. It is an impost we are often blind to simply because of the way we anchor financial decisions.

To illustrate the impact of fees consider the chart below. To generate this chart I have made a few simple assumptions. I have assumed a starting balance of $25,000 with $200 being added every month and an investment term of 20 years. To illustrate how fees can hurt a final balance I have assumed that our 10% rate of return represents an idealised fund that charges no fees. I have then stepped down the return as a surrogate for increasing fees. It confirms the widely held notion that an increase in fees of 1% can have a 20% impact upon the final balance of a fund. The notion that higher fees diminish return is a given.

I do take the point that fees are an issue but I think the motivation to set up a self managed superannuation fund is perhaps more nuanced and is based around the sophistication of those who undertake such an endeavour. Investors who are somewhat more sophisticated will have noticed something at once intriguing and troubling when looking at the balance of their managed funds. They are paying for nothing. Those setting up self managed funds have realised that their fund managers bring no value at all to the investing equation and in most instances the actions of those managing their funds negatively impacts upon their returns.

This may seem like a harsh and dogmatic statement but it is one that is supported by the evidence. The Australian Prudential Regulation Authority (APRA) produces a wide range of statistics pertaining to the superannuation industry and one particularly telling piece of research relates to the returns achieved by the largest 200 superannuation funds in Australia. These 200 funds control the bulk of all superannuation assets held. If we look at the 10 year per annum rate of return of these funds we notice some very interesting things. Firstly, Progress Super Fund has managed a 10 year per annum rate of return of 0.1%. At the other end of the spectrum is Goldman Sachs and JB Were Superannuation Fund which generated a 10 year per annum return of 10.5%. The difference between these two is staggering and they do represent outliers. When we look at the frequency distribution of returns we see the inevitable clustering around the middle.

When you are a fund manager you have one job and that is to deliver value or what is known as alpha. A positive alpha means that you outperform that benchmark against which you compete, in essence you bring skill to the investment process. A return that is below the benchmark against which you compete means that not only do you not bring skill to the investment process but your decision making is actually a drag on performance. This means that all funds are assessed by comparison to a benchmark – in this instance the benchmark is the All Ordinaries Total Return Index. Over the same 10 year period as the APRA data covered the return from this index was 9.12%. Based upon this metric, only one fund manager managed to beat the index over this 10 year period, this means that during this period 99.5% of all fund managers failed to beat the index. And during this period each of these fund managers would have expected to be paid – what for I am not certain.

If we make simple assumption of a fund that makes the average return of 5.7% and compare that with the average return of the All Ordinaries Index we can see why those with the means to do so might be tempted to try their hand at doing better than fund managers. If you have $50,000 invested at 5.7% for 20 years your terminal value is $155,917. If we repeat the exercise but raise the rate of return to the index average of 9.12% ,the terminal value becomes $307,000. To me this is the most compelling argument you can mount for setting up a self managed superannuation fund – a simple long term ETF strategy would outperform the vast majority (read almost all) of fund managers in the country.

The issue of very poor superannuation returns intrigues me for a number of reasons. Some of these are structural and relate to my own experience in the industry – I wonder how long you can be incompetent for before someone notices and starts to asks questions. Since the burgeoning number of baby boomers relying upon superannuation to fund their retirement is increasing the question needs to be asked as the why the industry not held to account for its inability to generate better returns. This is an important question since it is of national importance. The system of government provided retirement benefits that our parents grew up with will not exist when we and our children retire because we simply cannot afford it. Yet, at present the system designed to take some of the strain off the government is clearly not working. Whilst, I understand the calls for a Royal Commission into the financial planning industry in terms of damage done the funds management industry seems to have them beat.