The government, the regulator and economic fallout from COVID-19 have combined to pressure Australia’s large and unwieldy pool of super funds towards consolidation.
Large cash outflows have exacerbated the underlying trend. These withdrawals follow a government decision to allow early release of retirement savings to cushion financial hardship caused by the COVID-19 crisis.
Australian funds have paid out A$30bn (€18bn) since April at a time when contributions are starting to shrink because of growing unemployment. Industry leaders say some funds already have negative cash flow.
Super funds have suffered a double blow. Last July 2019, new legislation was implemented to protect Australians’ super savings from erosion by fees and insurance costs.
Super funds must roll over inactive, low-balance accounts to the Australian Taxation Office (ATO). An ATO spokesperson says that during the financial year ending 30 June 2020, close to 663,000 accounts, with a value of over A$6.8bn, were consolidated.
At December 2019, Australia had a total of 185 regulated super funds, managing almost A$3trn collectively.
The over-arching regulator, APRA (the Australian Prudential Regulatory Authority), says those 185 funds offer more than 40,000 investment options, which suggests the industry is probably not operating at maximum efficiency. APRA continues to pressure trustees of poor-performing funds to merge or exit the industry unless they are able to materially improve.
To hasten consolidation, it has introduced a stronger prudential framework, intensifying its supervision activities. It has also published a heatmap exposing poorer performers.
The regulator says the decision to merge or wind-up a fund is primarily for trustee boards. However, APRA is ensuring trustees keep options for improving member outcomes open.
KPMG partner David Bardsley, a specialist in superannuation and a key adviser on several mergers, says that COVID-19 and the early release scheme put many funds under pressure and hardened APRA’s monitoring of some funds’ viability.
He says the impact of the coronavirus has raised the urgency for some funds to seek partners, and has played a role in some funds bringing forward merger plans by a couple of years.
The biggest consolidation to date brings First State Super and VicSuper together as Australia’s second-largest fund, with A$125bn in funds under management.
Australia’s largest fund is the A$180bn AustralianSuper, created by the merger in 2006 of the Australian Retirement Fund and the Superannuation Trust of Australia.
That will soon change. Two Queensland-based funds, QSuper and SunSuper, are in due diligence to create a A$195bn mega fund.
Other mooted mergers include industry funds MTAA and Tasmania’s Tasplan, and the construction industry fund Cbus and Media Super.
Bardsley is supporting Cbus and Media Super in the assessment of benefits and is a lead adviser to QSuper on its potential merger with SunSuper.
He says before starting a conversation around merger benefits, there needs to be a meeting of minds on key questions. These include growth strategies, sectors and geography in which each party operates.
To achieve a “successor fund transfer” both First State Super and VicSuper had to resolve such questions.
Deanne Stewart, First State Super’s chief executive officer, says: “The rationale behind the merger is clearly economies of scale.” She sees the benefits as threefold:
First, economies of scale help drive down administration and investment costs and ultimately lower member fees. They also increase access to investment opportunities.
Second, having scale enables the fund to have its own direct team. This lets them invest directly into significant assets to which it would not necessarily have access as a smaller fund.
And, finally, the combined entity will be able to drive its investment dollars further. “So instead of spending $2 on investments such as building out retirement services, digitalisation and administration, you spend $1,” Stewart says.
“The rationale behind the merger is clearly economies of scale” - Deanne Stewart
Bardsley can attest to this. Before joining KPMG, he was transformation director (2012-16) at AustralianSuper.
Scale gave AustralianSuper the ability to remove what he calls “frictional costs” associated with direct investment. It also allows the fund to undertake additional activities which release value.
Among other things, it also provided an opportunity to participate in book-building in large institutional raisings to benefit from discounts available to institutional investors.
Stewart would be the first to say that not all mergers are equal, and that not all mergers should happen. The fundamental challenge, she says, is alignment of culture and value between funds.
She highlights the similarities between First State Super and VicSuper. Both share similar demographics – mostly female members, average age 46, with similar-sized accounts. Both funds were born out of serving the public servants of their respective states – First State Super for New South Wales (NSW) and VicSuper for Victoria.
“We are also strategically aligned,” Stewart says. “Neither of us believes that the role of a super fund is just about accumulation.
“Our funds should have appropriate and tailored retirement products and services, and we want to be known for providing our members with the best offering in this stage of their lives.”
The enlarged fund is due to merge in November with Western Australia Super, which looks after A$4bn of the retirement saving of that state’s local government employees.
Stewart says some of the immediate benefits of the merger between First State Super and VicSuper will be a 20% fee reduction for VicSuper’s 240,000 members in the first year.
“A lot of the immediate savings come from a reduction of investment costs. The investment costs of First State Super are, on average, lower than VicSuper’s,” she says.
Over the next couple of years, Stewart expects further cost savings as the administration systems are brought together. It is estimated that, within a couple of years, First State Super members will see a drop in their costs of more than 10%.
Stewart says the two funds have already integrated their investment portfolios. “The two teams worked up to June 30 to make sure that valuations before June 30 were fair and reasonable on both sides.”
The other issue – that has stopped some other funds from merging – is the question of control. Who is to run the new fund and who will sit on the board? First State Super and VicSuper set up a leadership team that was seen as a “blend of the best” from the two funds.
“Four VicSuper board members joined the First State Super Board to ensure that the interests of VicSuper’s members are protected,” says Stewart.
“We want the integration of our products and investment done without bias to ensure that it is the best interests of all members.”
Some industry observers say Australia could go down the Canadian route with an industry dominated by just a few large funds. Others disagree, saying Australia’s super system is based on defined contribution, as opposed to Canada’s defined benefit system.
David Bardsley expects there to be 10 or so mega funds, managing over A$100bn, in five years. Probably another 10-15 funds will manage more than A$50bn.
The industry, however, expects there will always be a place for small funds serving niche markets and sectors.