Australia’s superannuation sector is coming up against a raft of regulatory changes, giving rise to increased M&A activity, and influencing funds’ transition requirements.
The Australian pension fund market, or superannuation as it is referred to locally, is one of the largest in the world. Quarterly figures from the Australian Prudential Regulation Authority (APRA) indicate that superannuation assets totalled almost AUS$2.8 trillion at the end of March 2019 and the volume of assets under management is expected to continue to grow at a significant rate. According to an April 2019 report by KPMG, Super Insights 2019, the superannuation asset pool is projected to reach AUS$5.4 trillion by 2029.
Yet change is afoot as funds adjust to an evolving regulatory environment that looks set to refocus investment strategies and reshape the structure of the industry, which is in turn impacting transitions in the region and the support demanded of transition managers and consultants.
The overarching objective of recent legislative changes and reviews is to improve member outcomes while strengthening the superannuation and wider financial services sector, but they can pose a challenge for funds, such as increased reporting and cost pressures.
Regulatory developments include the Protecting Your Super Package (PYSP), effective from July 2019, which prohibits exit fees, places a 3% cap on administration and investment fees for accounts below AUS$6,000, and sees inactive funds under this limit transferred to the Australian Tax Office; APRA’s members outcomes assessment, due to come into force in January 2020, which seeks to sharpen the focus on quality outcomes for members through performance benchmarking and evaluation; the Productivity Commission’s final report, Superannuation: Assessing Efficiency and Competitiveness, released in January 2019, which details a number of recommendations to strengthen the superannuation system; and the February 2019 release of the Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, which sets out a total of 76 recommendations; the Banking Executive Accountability Regime (BEAR), which places greater accountability on senior leaders, is also due to be extended to APRA-regulated entities such as superannuation funds. These more recent measures add to existing regulation such as the Australian Securities and Investments Commission’s (ASIC) Regulatory Guide 97 (RG97), which came into effect in 2017.
John Venardos, managing director, head of implementation services – Asia Pacific at Russell Investments, says: “ASIC’s RG97 impacts which operating and transaction costs need to be reported and is in the process of being reviewed. The regulation is heightening awareness and generating focus on the frictional costs that are incurred when implementing investment ideas.”
Together, these measures are not only intensifying the need for greater operational and cost efficiencies, investment performance, and enhanced transparency and governance protocols, but also contributing to increasing merger and acquisition activity. “Funds need to demonstrate they are good value for money which involves delivering consistently good investment returns while minimising costs. Large funds have the advantage of economies of scale over smaller funds when it comes to finding operational and cost efficiencies. To date this has resulted in some smaller funds merging or being acquired by larger funds. This is likely to continue and will drive transition events as funds restructure their investment holdings,” explains Damian Hoult, chief executive officer at Basis Global Analytics (BGA).
Consolidation can enable funds to achieve efficiencies of scale and provide the opportunity to review investment strategies and investment manager selections. Transitions surrounding superannuation M&A activity often require transition managers to draw on all the services in their toolkit, deploy expertise across multiple asset classes, and work under tight time constraints. James Woodward, head of Portfolio Solutions for Asia-Pacific at State Street Global Markets, says: “We tend to find there is quite a significant project management component to these types of restructures. They are quite complex events - there are multiple stakeholders, and there is obviously a significant focus from the funds’ boards on these types of events.”
Shifting investment strategies
In addition to potential consolidation, regulatory changes are also one of the factors influencing strategic investment trends among superannuation funds, such as the shift toward passive investments - a shift which has also been evidenced more broadly in global markets. Mathew Cook, transition manager at Northern Trust, says: “One of the main trends in the last few years has been a result of the MySuper reforms that have been implemented. These have meant the Australian super industry has been tasked with offering a low cost and simple superannuation product for their clients. This has seen many of the funds moving from more active portfolios to more low-cost index passive funds.”
As the size – if not the number – of supers in Australia grows, funds are increasing their focus on global investments. According to APRA statistics, Australian listed equities accounted for 22.1% of superannuation funds’ asset allocation at the end of 1Q19, international listed equities accounted for 24.4%, and fixed income accounted for 21.2%.
“There has been more interest and appetite for non-domestic equity exposure and fixed income. Traditionally, the Australian pension market has been primarily focused on domestic equities but because of the massive growth in the super fund industry it is starting to face some liquidity constraints where it’s outstripping market cap growth,” says Stuart Anderson, client strategy – Australia, director, transition management at BlackRock. “There is a capacity issue that superfunds are having to deal with. On top of that there’s the search for yield in a low return environment, so investors are having to look further afield and restructuring their investments accordingly.”
As a result, funds investing outside of the local equity market will be looking to engage transition managers with the skills and scale necessary to manage global trading requirements across both equities and fixed income when undertaking portfolio or manager changes.
Transitions involving domestic managers, particularly mid- and small-cap Australian stocks, can present their own challenges. Sandeep Gurkhi, director, transition and portfolio solutions at Citi Global Markets, says: “Because the size of the Australian equity market is relatively small compared to the size of the super fund industry, whenever you are dealing with a domestic transition, the liquidity profile is a lot more challenging compared to global equities transitions.”
With larger funds also come larger and more complex transitions. This has also been accompanied by greater volatility and illiquidity, notes Gurkhi. “The way we would approach a transition five years ago is very different to the way we approach it now,” he says. “Most of our transitions have become high touch, so we’re spending a lot more time thinking about the strategy and the way you execute instead of just putting trades into an algorithm.”
While the processes involved in a transition in Australia do not differ from those conducted elsewhere, there are some particularities to take into consideration.
“The structures of a superannuation fund are similar to those of DC plans in the US, which present their own unique operational challenges,” explains Russell Investments’ Venardos. “Expertise in working with clients, asset managers and funds, custodians, and consultants is a necessity in navigating these challenges. Understanding the true operating cost of a planned implementation is critical – incorporating operational/ custody/redemption costs and frictional trading/transaction costs.”
The time difference with other financial market hubs is also a factor. BlackRock’s Anderson says: “It’s essential if you are trading non-domestic assets that the time difference to Europe and the US is well managed. Transition orders are often packaged together to manage an overall exposure and if there is a misalignment of those matching trades due to lack of market presence or miscommunication between the trading desks then that can have a significant impact on the performance of the transition.”
He adds: “There’s also justifiably a strong client demand in Australia for an onshore presence and face-to-face contact in order to have local accountability and regional expertise, so transition managers have to have local coverage combined with global exposure management.”
While limiting explicit and implicit costs is a key consideration in all transitions, and fees can belie the much more wide-ranging value transition managers can provide to clients, regulatory developments such as RG97 mean there is a more acute focus on fees and cost among Australian funds.
“The Financial Services Royal Commission shone a light on many deficiencies across the finance industry, especially those directly impacting the public. Fund fees and costs are in the spotlight, so it follows that costs associated with transitioning assets need to be measured, reported and justified. Funds and transition managers are engaging third-party analytics firms like BGA to provide objective, conflict-free transaction cost reporting for transition events on a more regular basis. Given the current regulatory climate and focus on cost transparency, this trend is likely to gain momentum,” explains Basis Global Analytics’ Hoult.
Australian superannuation funds, in general, are considered to have a particularly high level of understanding of the nuances involved in transition management. As clients’ knowledge of the area becomes more sophisticated, transition managers such as Citi’s Gurkhi have seen the conversation shift towards client experience. He says: “They realise that what’s important is the use of a service provider that they can trust, that the provider has effectively communicated trading strategy to the client, and that the provider has a plan for different market conditions.”
Meanwhile, some of the larger funds are bringing their trading desks in house, and a few are said to have internalised the transition management function. Northern Trust’s Cook says: “The shift to in-house trading desks has seen some supers internalise their transition management trades but this remains limited to a small number of funds. This has typically been for the less risky transitions such as one manager to one manager Aussie equity mandates, with the need to utilise transition managers for the more complex and risk-centric transitions, such as emerging market equity and fixed income where any errors can be costly. By hiring a transition manager the supers can take measures to mitigate the internal risk of errors.”
State Street’s Woodward notes that if an asset owner is considering performing a transition in house, it is important to take into account both the explicit and implicit costs of doing so. These can range from investment in technology, systems and staff, commissions on trades, through to the additional resource burden placed on support and oversight functions such as legal, compliance, risk, and operations. “It comes down to risk, finding liquidity, how operationally complex the transition is, and whether they have the skillset internally,” he adds. “Asset owners have to weigh up all the risks and costs and resources required, and then make an informed decision.”
This article features in the Transition Management Guide 2019. Download the full guide here.
Read more about what's shaping Australia's superannuation landscape in this column by Eva Scheerlinck, chief executive officer at the Australian Institute of Superannuation Trustees (AIST).