Published in the Journal of Applied Finance and Investment, Vol. 1, No. 1, March/April 1996, pp. 13–17.
When he colourfully described some fund managers as ‘donkeys’, the then Prime Minister, Mr Keating, was popularising a critique of the invisible managers of funds, who have lost their elevated mandarin status as their performance has come under greater scrutiny.
A paradox has emerged in the development of the Australian funds management industry. Over the last decade, the amount of funds under management has grown astronomically. This growth is largely fuelled by the rise in investment through superannuation. Much of this has been sustained by government policy. Indeed, the support by the Federal government from the mid-1980s for industry superannuation has been the single significant factor in increasing the amount of money available to institutional investors. However, corresponding with the rise in the amounts of funds available to manage, has been the resentment on the part of many people in the community as to what might be happening with ‘their money’. Part of this debate relates to whether funds are being employed effectively or strategically. Some argue that the farm needs to be bought back. The performance of the superannuation funds in the context of that debate has been a vexed issue.
There is a vigorous debate in the wider community as to the relationship between performance of funds and the benefits that flow to funds members.
In 1995, the Prime Minister used a throwaway line in Question Time in the Federal Parliament describing some of the fund managers as ‘donkeys’. This was a surprising attack from someone who has also argued that one of the most significant public policy achievements of his government has been the growth in national savings through compulsory superannuation contributions. Such an attack is not inconsistent with support for more superannuation savings; what the Prime Minister was doing, albeit in extravagant and colourful terms, was to popularise a critique of the invisible managers of funds.
Fund managers have lost their elevated mandarin status with increasing scrutiny of their performance. The more competitive funds management industry has stripped bare the mandarin garb of some of the institutional players. Hence the paradox: Although there is strong support in the community about increasing savings through superannuation, private opinion polls and anecdotal experience indicate both confusion as to the regulatory environment and a mixture of suspicion and apathy about superannuation matters.
The best way that the national – and members’ – interest can be served is by fund managers maximising their returns within defined parameters determined by appropriate investment strategy guidelines.
However, it is increasingly common to hear arguments as to how ‘funds may be better directed’. Hence, the nonsense talk about ‘productive investment’ and so forth. It is not that the idea of effectively utilising funds is an unworthy goal: what other objective should there be? The problem with buzz words like ‘productive investment’ is that the term means all things to all people: what kind of investment is deliberately unproductive? Some of the users of the rhetoric like to dress up their favourite nostrums as geared to the national interest, as distinct from a more short-term, opportunistic approach. Putting the matter in this way may suggest that this debate is merely polemical and ideological. Actually, the issue raises some matters of genuine importance.
Amongst the most significant is whether the superannuation funds are fuelling a casino economy of speculative investments, and whether the evidence justifies such an assertion.
Rather than dealing with all the intricacies of the theoretical issues, or the fine details of the practical questions, this article will headline various matters that are relevant to this debate. Those issues are:
- a national savings policy;
- regulatory issues;
- what is rational behaviour;
- long-term investment and portfolio risk;
- targeted investments;
- infrastructure and national development;
- corporate governance; an example of alleged short-term focus: Pacific Dunlop.
In 1990, the then Federal Treasurer, Mr Paul Keating, commissioned Dr Vince Fitzgerald to undertake a report on national savings policy in Australia.
Dr Fitzgerald, a former head of the Department of Finance, made a frank assessment of the issues, and settled on the view that Australia had a significant savings problem. Much of the current account (deficit) problem was due to the fact that Australians were not saving as much as they did in the 1950s and 1960s. The demand for investment was increasingly financed offshore. There was a shortage of funds available for investment within Australia. Hence, foreigners were investing in this country, and some choice lots of the farm were being taken over. Based on those trends, Australia, without correcting its national debt problem, could go the way of a banana republic. Fitzgerald recommended that support for superannuation savings by the Federal government was an appropriate strategy. He laid particular emphasis on this idea, and Fitzgerald’s report, in part, coincided with the union agenda to extend national savings through compulsory superannuation contributions. (Not all of Dr Fitzgerald’s proposals were adopted, however, including the proposal to examine the Superannuation Savings Accounts vehicle to be offered by the banks and other financial institutions.)
The funds management industry, by and large, has utilised the Fitzgerald Report as a marketing tool to promote the industry. The report is a handy argument for more funds going to fund managers in order to solve the so-called savings problem. The government has sought to extend the social wage as well as deal with savings policy. From its beginnings as a tax-advantaged form of remuneration for a minority in the community, including mostly the better-off, the government had sought in the 1980s to reform superannuation policy, with both compulsory and voluntary components, to ensure that superannuation savings are used equitably for retirement income purposes; are invested wisely and safely; are universalised as an employment benefit to all workers; and are affordable to the tax-payer. In 1992, the government introduced the Superannuation Guarantee arrangements, prescribing minimum levels of superannuation support for employees. In Dr Fitzgerald’s National Savings Report, it was estimated that the Superannuation Guarantee arrangements would eventually increase total private savings by about 1.25 per cent of GDP.
A key issue is how fund managers behave and in what way government might act in order to encourage ethical and well managed behaviour, and to generally protect beneficiaries and contributors from foul behaviour. The Federal government has, through the superannuation industry supervision (SIS) legislation, ensured that there is a strong regulatory focus by a central regulator, the Insurance and Superannuation Commission (ISC).
The SIS legislation sets down a number of important prudential controls governing investment behaviour by fund managers, as shown in Table 1, below.
What is Rational Behaviour?
Rational behaviour needs to be assessed with respect to the various players involved in the industry.
On the part of managers, performance is frequently measured on the basis of quarterly returns and short-term perspectives. There is also an issue as to the transparency of behaviour and performance. This relates to whether each of the funds are comparing performance in a like way. Hence, many of the advisers play a crucial role in developing and publishing indices of performance.
On the part of members, many wish to maximise returns on investment, subject to appropriate strategies. Actually, most people are not bothered with knowing the details of their investment strategy, as the take-up following the provision of choice in various funds has made clear.
However, in looking at the interest of members, there is a key issue as to how members of funds might better understand some of the investment issues. A small minority will always take a keen interest in having a say in how their funds might be invested. As the volume of funds under management grows and the sophistication of the community develops (the two factors are related), it is likely that the issue of choice will grow in prominence – something that is discussed below.
On the part of trustees, trustees need to determine appropriate investment objectives, and those objectives will be based on risk assessment and the various classes of members for which trustees are responsible. An important question will arise in Australia as to whether trustees by making ‘the wrong’ choices in terms of investment strategy might be legally liable. The SIS legislation provides some guidelines in this area, including the responsibility of trustees to act in an inquiring way as to information and advice provided by the appointed fund managers. A key issue is that there be an informed marketplace, and the role the trustees may have to encourage that. At a minimum Trustees need to consider:
- their time horizons;
- their size of membership;
- their assets under management;
- their potential and contingent liabilities;
- the employment conditions of their membership;
- entrance criteria;
- benefits and eligibility criteria.
There is nothing inherent, however, in those factors that dictates a particular model be followed; what is particularly important is that the interests of contributors and beneficiaries be comprehensively and fairly considered.
On the part of the regulators, there is the interest that formal rules be followed and that the industry’s performance is not hampered by the heavy hand of the regulator.
On the part of the advisers to the industry, many of these play an important scrutiny role in evaluating performance and adding to a more informed market.
Long-term Investment and Portfolio Risk
It is in the interest of funds that there be diversity in the spread of investments. Long-term investments will be part of a risk minimisation strategy of most large funds. The investment strategy of the fund will be crucial to the assessment of long-term risk and the positioning of the portfolio with respect to investment products. The various categories of members need to be assessed.
Whilst the investment strategies that could be adopted for each class of member might, having regard to those differences, vary, the common interest among all members is that the benefit payable on retirement or earlier and with respect to death, total and permanent disablement is:
- in the case of a defined benefit arrangement, able to be funded and paid from the scheme; and,
- in the case of an accumulation arrangement, an adequate amount having regard to contributions made, length of membership and investment performance.
Similarly, the difference in age profile between classes of members emphasises their different interests. Those members with a long horizon to retirement can afford to take the risks that are inherent in the short-term performance of, for example, a balanced strategy. The same members, however, can also afford exposure to a balanced strategy, having regard to their expected long-term exposure to the strategy. Alternatively, members close to retirement can probably not afford this exposure, and a capital stable or guaranteed product would be the preferred strategy for that member.
Table 1: Prudential controls governing investment behaviour of fund managers as set down by the Superannuation Industry Supervision legislation.
|Upon becoming a regulated superannuation fund||Once a relevant scheme becomes a regulated superannuation fund then: the structure of the relevant scheme must comply with SIS; the trustee must comply with all the operating standards in SIS; where there is a failure to comply with those standards, the trustee, or the person responsible for the breach of the standard, may be subject to a number of penalties imposing personal liability and criminal offences; and the ISC will have wide investigatory powers in relation to the relevant scheme.|
|Board of trustees composition||The board of trustees must be made up of equal numbers of employer representatives and member representatives.|
|Enquiries and complaints settlement||The trustee must settle on a system for dealing with all enquiries and complaints in 90 days. When the matter cannot be resolved under the internal disputes resolution system it must be referred to the Statutory Complaints Tribunal. The Tribunal can, where it considers the decision was not fair or reasonable: remit a decision to the trustee for reconsideration;vary the trustee’s decision; orset aside the trustee’s decision and substitute a decision.|
|ISC power to obtain information and conduct investigations||The ISC can: suspend or remove a trustee;appoint an interim trustee;freeze the sale of assets of a scheme; andformulate a proposal for the winding up of a scheme.|
Investment strategy for different superannuation schemes may be different, but the duties that are owed to the members are identical. It is quite possible for the same board to adopt appropriate strategies for different classes of members, but still discharge its duties to members without creating a conflict of interest.
Freedom of Choice
Within Australia there has been a lot of speculation over recent years as to whether there should be greater freedom of choice with respect to superannuation. There are two distinct arguments utilising the rhetoric of ‘freedom of choice’.
On the one hand, there is the argument that there should be choice on the part of an employee, that they be able to select the superannuation fund of their choice. This has been a particularly vexed issue in those areas of industry where industrial awards have provided that one or two (and typically it is rarely larger than that) funds be selected on a compulsory basis for employees.
On the other hand, there is the issue of choice within a fund. This debate is likely to develop. There are many important issues to consider in this area, including the costs to contributors to provide choice, the technologies associated with ensuring those costs are less onerous, and the need to ensure that there is a proper consideration of the returns required for people based on their life cycle. In other words, somebody at a younger age with a long period ahead in the workforce usually ought to take greater risk, such as participating more heavily in the asset allocation in the share market. A person nearing retirement usually ought to minimise risk by investing more in cash products. With the increasing tendency for employees to be offered investment choice in many accumulation funds, this issue of choice is likely to grow more significant.
To some extent, the very term ‘targeted investment’ suggests that somebody is pushing a barrow. Some people run a ‘what they like’ argument. Sometimes the argument collapses into rhetoric about productive investment and other such non-scientific assertions.
Historically, the collective nature of the economic system was geared to minimise risk, not only for employees, lenders and borrowers, but also for shareholders. To this end, many of the structures were mutualised or set up as cooperatives. This was a vital component in the redevelopment of a capital starved economy in the early post war era. By guaranteeing returns on investment, by tying-in business partners and by exchanging cross holdings, risk was diminished and less equity was required. More debt could be used and the nation’s capital could be used very efficiently.
The overriding national goal has been, and perhaps remains, to accumulate capital. Companies have, therefore, financed themselves disproportionately with debt. The risk is diminished by the securing of real estate collateral. A small amount of equity is exchanged with banks and business partners. The equity can be collateralised. Outside shareholders are few and their rights minimised. They comprise the original entrepreneur or original land owner. The goal has never been profit, which should be viewed truly as an accounting residual. Dividends were originally paid as a percentage of par at a level competitive with the prevailing interest rate and have never been the reward for risk taking.
The basis of the system evolved. It was not invented, it has been mutual and its goal is capital accumulation.
Infrastructure and National Development
This, in particular, has been an important issue in the funds management debate.
Infrastructure investments are investments typically made in engineering, construction or service facilities such as roads, bridges, power generation, gas pipelines and water treatment facilities. A broader definition includes hospitals, schools and other local community based investments.
Infrastructure investments are typically long term, large size and illiquid.
Investment in infrastructure is a specialised and expensive task.
Investments can be made in established assets (often via privatisation of a Federal or State government-owned facility) that can generate immediate cash flows or in the construction of new projects where cash inflows take a number of years to commence.
In the past investments have been predominantly carried out by the Federal and State governments due to the size of the projects, the legislative requirements and, in some cases, the non-revenue generating nature of the investments.
There is an increasing level of interest in infrastructure investments financed by the private sector. The Federal government is encouraging the development of infrastructure by the private sector via the availability of taxation concessions on debt instruments used to fund certain types of infrastructure projects. These debt instruments are known as Infrastructure Bonds.
There is the issue of market failure.
There is also the issue of long-term investment as against short-term return on capital; and the tax driven benefits associated with investments in this field. Further, there is also the argument that infrastructure tax benefits should be available to private individuals. Why should the institutions be the only ones favoured by tax breaks?
Avoiding onerous prudential controls is a sub-motive for some fund trustees. However, a primary aim with respect to reserving is to smooth out returns to beneficiaries.
The popularity of setting up reserves is, in part, a reaction to an argument about ensuring a ‘fair’ return to beneficiaries at any point in time, as well as a response to the nature of the accumulation funds compared to the defined benefits schemes. Generally, there are good arguments against reserving, especially if the primary motive is to avoid prudential control and participate in more risky investment.
This is an especially significant issue, as the institutions play an increasingly large role in the share market, and crowd out other investors as the major players in the marketplace. The institutions and advisers have played a major role. Some directors and trustees, however, have been slow to react or have been unadventurous; for example, it has been where market failure occurs that institutions have been particularly active in the field of corporate governance.
The AMP Society has played a major role in this field, as might be expected, given their dominance in the funds management field.
The Coles Myer Board imbroglio illustrates the circumstances where the fund managers will get together in order to ensure a more representative board.
A danger of that experience is that there is a selection of a nice bunch of people who know nothing much about retail. Hence, an entirely ethical, clean skinned board is selected, but are they up to managing the business? The Coles Myer experience raised many legitimate issues of corporate governance and ethical behaviour, but sometimes resembled the behaviour of chooks in a yard; the sight of blood and they all go madly pecking away.
In the last 12 months, many people have expressed their concerns about how Pacific Dunlop was restructured during the early part of 1995.
Pacific Dunlop sold its food division in which it had invested considerable sums after purchase seven years ago.
However, there was sluggish performance by the company for several years and the share market heavily penalised Pacific Dunlop’s failure to meet its projected performance targets. The institutional fund managers, after being patient concerning Pacific Dunlop’s performance, grew frustrated with poor excuses; the institutions argued that a more radical approach be adopted. It is at this point that the argument becomes controversial. The institutions were accused of putting pressure on the management and the board to get out of the food business.
As this segment of Pacific Dunlop was alleged to have the greatest upside, the myopic nature of the institutions’ alleged pressure is criticised.
Hence, it is argued the short-term approach of the fund managers led to a decision to throw away a major industry in Australia to foreigners. It is also argued that foreigners will reap the benefit of Pacific Dunlop’s investment. Moreover, the sale prices gave every indication that the foreign buyers were fully conscious of the value and the potential of the assets.
This is regarded as a pre-eminent example of where the short-term focus of fund managers acts against the long-term interest of the beneficiaries of superannuation.
There is also running with this argument the view that Australia has a different kind of capitalism to that which exists in Japan. Too much can be made of this argument that Australian capitalism is uniquely short-sighted or that some of the recent characteristics of the Japanese economy can be universalised into a coherent model. That is a debate for another occasion.
What is interesting in the Pacific Dunlop case is that the ‘case’ of the institutions was inadequately presented in public; should it be? If performance is all that matters, then a continuation of sluggish returns by Pacific Dunlop may see a turnaround to this debate.
In many respects, the problem for Mr Keating’s ‘donkeys’ is to balance the imperative of short-term performance (by which funds are judged in terms of maintaining and attracting business) with longer-term investments that are secure and serve to minimise risk.
Given the newness of industry funds and the correct diligence that trustees attach to their new roles, an ‘over the shoulder’ level of scrutiny has been applied to the fund managers that has demystified the profession and attracted a high level of scrutiny. The insistence by the union leadership that the role of award superannuation was to provide retirement income and, thereby, that it was the return that mattered (as distinct from the investment), together with the intense competition on the part of funds managers, has led to the very kind of investment strategies that are now being criticised.
Indeed the debate within unions and industry funds about ‘correct’ investment strategies, in many ways is analogous to debates on industry policy. There is no agreed approach and indeed a ‘kaleidoscope’ effect is developed so that where one sits determines what one sees.
The actuary and academic John Evans, who had once done some technical work for Chifley Financial Services, asked that I write something for this new (and soon defunct) journal. I had left the board of NSW ‘State Super’ the year before. And I had helped to form AssetSuper (now amalgamated into Care Super) in my Labor Council days. I tried to distil insights from my experience in the writing of this piece.