Measured Investment Inefficiency of the Australian Superannuation System

Abstract

The public’s positive impression of Australian superannuation comes from the rapid asset growth of the system and selective sampling inherent in focusing on performance of funds and options may over-estimate the performance of the whole system by two percent per annum due to survivorship bias. From 20 years of official data, it is shown that the poor performance of the system on average, at less than one percent over cash returns, has been masked by strong contribution flows and the exclusion of poorly performing funds in selective sampling. By using robust methods of statistical analysis, the poor performance of the system has been largely attributed to Retail funds which are typically inefficient, profit-seeking operations, with excessive choices, high indirect costs, and conflicted governance. Retail fund members pay significant additional costs compared to Industry fund members due to higher investment and operational costs which are measured here for a recent three-year period. Returns were lower (expressed as additional cost) by 1.1 percent per annum due to inferior choices of asset allocation, where the lower returns did not result in commensurate lower volatilities. Related-party service providers extracted revenue through additional indirect costs at 1.3 percent per annum. More complex operational structures of Retail funds cost another 0.3 percent per annum. The combined lowering of returns by 2.7 percent per annum of a Retail fund member compared to an Industry fund member, results in a nest-egg halved over a 45-year working life or a loss of about one million dollars. Better enforcement of the law on fiduciary duty of trustees is needed to improve the investment efficiency and to reduce cost of the system.