Australian Superannuation Funds Research Articles

The impact of superannuation fund choice legislation and the global financial crisis on Australian retail fund flows


 
 
 We examine the extent to which cash flows into the Australian superannuation funds are affected by the past performance of the fund, the riskiness of the fund, the choice of superannuation fund legislation, and the global financial crisis. Both retail and wholesale investors base their investment decisions on the past performance of the funds. There is little evidence that the riskiness of the fund returns has any significance effect on the flow of funds. Legislation has resulted in more inflows into managed funds. There is more inflow into managed funds and equity funds since the period of the global financial crisis.
 
 

Planning for potential increases in disbursements and risk of managed funds conditional on desired short-term performance levels

ABSTRACT As increasing disbursements (such as costs and fees) and risk (such as portfolio risk and leverage risk) may affect managed fund performance, analysts go beyond risk-adjusted return measures for performance appraisal. A methodology that assesses performance in a multidimensional framework is data envelopment analysis (DEA). A variant of DEA is inverse DEA. In this paper, inverse DEA is applied to determine output (investment income and benefit payments) targets for a given fund to perform at a desired efficiency level when increase in disbursements and risk at known levels is envisaged. An output-oriented inverse DEA model assuming variable returns to scale is formulated with theoretical underpinning. The proposed modelling framework ensures that, when an input augmented fund with estimated output targets is included in the observed fund set, the frontier of best performance established with the observed fund set does not change. The inverse DEA model is applied to a sample of Australian superannuation funds to demonstrate how a given fund may obtain pathways to improve its performance under different input-augmentation scenarios. As different pathways suggest feasible output targets, fund managers may find them valuable in forward planning.

Director expertise and co‐option in industry superannuation funds?

AbstractThis study examines whether independent directors who possess financial expertise and are independent from the CEO (i.e., non‐co‐opted) are associated with improved outcomes for industry superannuation funds. Our results highlight that independence alone is insufficient to improve fund outcomes. Instead, we find that only non‐co‐opted independent directors benefit fund members in terms of higher performance and lower fees. Moreover, we find that independent directors' financial expertise is not associated with fund performance and fees. Our study has implications for regulators and superannuation funds who are currently debating the need for one‐third independent directors on the board of Australian superannuation funds.

Liquidity shocks and pension fund performance: Evidence from early access

We study how expectations of fund flows causally affect fund performance by exploiting a quasi-natural experiment in the Australian pension system where an unexpected policy change temporarily allowed fund withdrawals from a prespecified date in the future. Using fractions of young members, middle-aged members, and government co-contributions for low-income earners as instrumental variables, we find an insignificant effect of expected fund outflows on performance. A potential explanation is that Australian superannuation funds preemptively engage in liquidity management in response to changes in expectations of future fund flows and this helps to limit direct and indirect costs in the rebalancing process. JEL Classification: G11, G12, G14, G23, G51

Disclosure of liquidity and cash flow statements by Australian superannuation funds before Covid‐19

AbstractThe Commonwealth's stimulus package required the unexpected distribution of cash by superannuation funds to members during the Covid‐19 pandemic. We focus on disclosure and maintenance of an operational risk financial reserve and reporting of the statement of cash flows in annual reports by Australian superannuation funds. These disclosures represent mandated sources of information providing evidence of liquidity levels for meeting cash payouts and disclosure adherence. Many funds did not meet their statutory reporting requirements. More members and higher union board membership as measures of stakeholder power explain higher disclosure in support of managerial stakeholder theory.

Asset allocation of Australian superannuation funds: a markov regime switching approach

We extend an observable Markov Regime Switching framework to assess the switching behaviour of asset classes of Australian superannuation funds across different fund sizes. We identify the most prominent asset class which contributes to the performance of the investment options and what factors trigger funds’ decisions on rebalancing their portfolio. We find that smaller funds tend to be more active in switching to aggressive options and the larger funds are more conservative. However, in periods of volatility, the large funds are the risk seekers and tend to switch their asset classes and hence their investment strategies. The asset classes whose values add to the performance of the investment options are equity markets and bond markets with the domestic equity market having better performance than international equity market. The switch for the larger funds is driven by volatility of the equity market.

An inverse DEA model for intermediate and output target setting in serially linked general two-stage processes

Abstract In this paper, we formulate an inverse data envelopment analysis (DEA) model for a serially linked two-stage production process operating under constant returns to scale technology. The inverse DEA model determines a set of intermediate and output targets for an input augmented decision-making unit (DMU) to maintain its relative efficiency at a pre-specified level. We solve the inverse DEA model using the constraint method used in multi-objective optimization. The input augmented DMU with intermediate and output targets obtained in the inverse DEA model is a hypothetical DMU. Under our modelling framework, when such a hypothetical DMU established on an inefficient DMU is included in the observed DMU set, the frontier established with observed DMU set remains intact. This is important in practice as the intermediate and output targets of the hypothetical DMU would be feasible. When overall efficiency of the hypothetical DMU is decomposed, individual stages have the same efficiency level as that of the hypothetical DMU. This is important to DMU managers as sub-processes also maintain the desired overall efficiency level. We apply our inverse DEA model to a sample of Australian superannuation funds. We demonstrate that each unique Pareto optimal solution of the inverse DEA model obtained through the constraint method provides a specific set of intermediate and output targets and they may offer trade-off between intermediates and outputs. When fund managers anticipate expansion or growth in their funds, choice of targets allows comparison of different trade-off scenarios and makes informed decisions.

Sustainable Development Goal Disclosures within Australian Superannuation Funds: An Exploratory Study

The financial reporting landscape is continuing to expand with both regulated and voluntary disclosures making their way into various reporting frameworks. This increased attention to disclosures is being pursued by professional bodies, governments, companies and other organisations given the changing demands by stakeholders for sustainability disclosures. The Australian superannuation industry is a compulsory system developed to ensure a comfortable retirement income for members. It is now a trillion-dollar business and therefore, has significant influence on the investment decisions that it makes on behalf of its members. The United Nations Sustainable Development Goals (UN SDGs) are increasingly being used as a signal to the market that an organisation is meeting the demands of stakeholders. The objective of this study is exploratory in nature, investigating the types of SDG disclosures made by the largest superannuation funds in Australia. Data was collected through a content analysis of the annual and/or supplementary reports produced by Australian superannuation funds. The findings suggest that Australian superannuation funds currently disclose a minimal level information in accordance with the SDGs in different reporting formats and the SDGs tends to prevail where superannuation managers believe they can have the most impact. Our results have implications for SDG reporting, policy and management practice. Future research that helps explain how managers choose which SDGs to report would be a useful contribution in the context of superannuation.

Investment Risk for Long-Term Investors

Investment risk is addressed from the perspective of long-term investors, with key concepts being discussed and methods outlined for evaluating risk over long horizons. The main themes include: the need to focus on shortfall versus objectives and sources of sustained loss, rather than return volatility; the potential influence of path dependence; and the benefit of directly modelling the wealth accumulation process. A framework is presented that decomposes the drivers of wealth accumulation into initial expected returns, discount rate risk, cash flow risk and reinvestment risk. Approaches are highlighted for forming distributions of accumulated wealth, while demonstrating the importance of incorporating prevailing market conditions into any risk analysis. Alternatives to the Standard Risk Measure used for Australian superannuation funds are discussed.

Liquidity Shocks and Pension Fund Performance: Evidence From the Early Release Scheme

We study how expectations of fund flows causally affect fund performance by exploiting a quasi-natural experiment in the Australian pension system where an unexpected policy change temporarily allowed fund withdrawals from a pre-specified date in the future. Using fractions of young members, middle-aged members, and government co-contributions for low income earners as instrumental variables, we find an insignificant effect of expected fund outflows on fund performance. A potential explanation is that Australian superannuation funds preemptively engage in liquidity management in response to changes in expectations of future fund flows and that this helps to limit direct and indirect costs in the rebalancing process.

The ‘right’ level for the superannuation guarantee: identifying the key considerations

AbstractWe deploy a stochastic life‐cycle model to examine how the superannuation guarantee (SG) impacts on welfare for Australian superannuation fund members under a reference‐dependent utility function that evaluates consumption relative to target, allowing for existing superannuation, taxation and Age Pension eligibility rules. The analysis highlights how the optimal SG can vary substantially with pre‐retirement income, the post‐retirement consumption target and various other assumptions. We conclude that no single SG rate is appropriate for all members and suggest that the main reason for increasing the SG above 9.5 percent would be an aim of replacing the Age Pension where possible.

How much does tax erode fund excess returns?

AbstractWe model the tax drag from active fund management based on reported monthly holdings of active equity funds. Tax drag erodes 65 percent of the 0.74 percent excess return in Broad Market funds, but only 21 percent of the 1.80 percent excess return in Small‐Cap funds for Australian superannuation (pension) fund investors. Tax drag varies with investment style; market state, which is most detrimental during bull markets; and fund turnover. For high‐income individual investors, tax drag is exacerbated to the extent that active management only generates meaningful after‐tax excess return for Small‐Cap funds of certain styles.

Interim Report: Risk Management Maturity in Large Australian Superannuation Funds

Given the immense importance of the superannuation sector for all Australians, the objective of this study is to investigate risk management maturity in the superannuation sector and identify areas for further improvement. The study focusses on large superannuation funds (i.e. those with assets under management in excess of $10 billion) and coincides with the fifth anniversary of the implementation of the prudential standards for risk management in July 2013. 1. Building on previous research from the safety field, and with input from our panel of subject matter experts, we have developed a 5 level model of risk management maturity. 2. The majority of subject-matter experts interviewed believe that Level 1 would be appropriate and desirable for the sector given the importance of managing retirement savings. While rapidly evolving, most large Australian superannuation funds, have not yet met this risk maturity standard. This is true despite the laudable focus of the industry on member outcomes. A majority of experts believes that most large funds are currently at Level 3, some at Levels 2 and 4, with few if any at Level 1. In other words, many large funds are still working to realise effective risk management systems and frameworks. At this level the focus is on ensuring that risk management systems are well resourced and functioning efficiently (people, IT systems, processes, reporting lines, remuneration and performance measurement); risk management is built into the governance framework; the board takes responsibility for risk management and ensures that the risk appetite is consistent with strategy. This is not surprising given the relatively short time since prudential standards for risk were introduced. A minority of experts had a more positive perception of risk management maturity in the sector, perceiving a number of funds to be at Levels 1 and 2 already. 3. We also developed a list of attributes of organisations with risk management maturity. These attributes should be seen as requirements over and above the implementation of effective risk management systems (Level 3). At Level 1 an organisation should have all, while at Level 2 an organisation should have some of the following attributes: i. Commitment to continuous improvement of the risk management framework. ii. Everyone has accountability for risk management. iii. Risk management viewed as an enabler. iv. Risk communication is effective. v. Right amount of the right risks. 4. Interviews with subject-matter experts highlighted challenges for the industry in all of the maturity attributes, thus confirming that risk management maturity has room for improvement. 5. Staff surveys in five large Australian funds confirm the interview findings in relation to risk management maturity. i. None of the funds we have assessed so far has achieved consistently strong ratings for risk structures, suggesting that there is further work to be done bedding these down. ii. In some funds we observed risk culture scores that were noticeably more favourable than the large Australian banks assessed by the research team in 2014. This suggests that some funds have made significant progress toward the implementation of a culture that prioritises and values risk management. iii. Similar to banks we have assessed, the weakest dimension of risk culture in the super funds was consistently Avoidance (the perception that risk events are ignored, downplayed or excused). Weakness on this dimension is likely to reduce the effectiveness of risk communication and thus the ability of the organisation to resolve issues efficiently. Regression analysis has shown that Avoidance is significantly associated with undesirable risk behaviour such as failure to report risk events, failure to speak up, lack of accountability, overconfidence etc. iv. Survey assessments of risk culture suggest significant variation between and within large superannuation funds. The least favourable risk culture scores were observed in Technology teams. v. Staff accountability for risk management remains an issue with many still perceiving that risk management is the responsibility of specialists. This suggests that implementation of ‘three lines of defence’ and other systems to build staff accountability need further work. vi. The survey assessment of maturity also highlighted that risk management in some funds has too much emphasis on mere compliance (as opposed to thoughtful engagement). Risk managers are also struggling to overcome perceptions that risk management is a drag on performance rather than an enabler for success. vii. An opportunity for improvement exists in relation to reporting of risk events, with between 11% and 41% of survey respondents admitting to under-reporting.

Decision-making in the management of property investment by Australian superannuation funds

Decision-making in property investment by superannuation funds is an important investment decision, but it is different to their decision-making on other asset classes included in their asset portfolios. The large value and heterogeneous nature of individual pieces of real estate make the market for real estate relatively illiquid and subject to larger transaction costs than other asset classes. Based on interview surveys of Australian superannuation funds, using the analytical hierarchical process (AHP), we identified strategic decision-making as being the most important factor used by the superannuation funds when making decisions on the management of their property investment portfolio. Comments during the interviews indicated that their decisions were influenced by restrictions in their fund’s investment mandate and the level of funds that they had to invest. The AHP technique has allowed this research to provide a more in-depth understanding of the management of decision-making factors than previous surveys.

How to Measure Risk Culture in Australian Superannuation Funds

In financial services these days, there is increasing interest in the concept of ‘risk culture.’ Risk culture has been identified as a dimension of organisational culture which is important for encouraging desirable risk management behaviour in the workplace and ultimately for producing both better organisational and customer/member outcomes in the financial services industry. Using a valid and reliable scale is very important when conducting surveys; an invalid measure may not measure what it purports to measure and therefore may mislead. The Macquarie University Risk Culture Scale is a set of 18 survey items initially developed for assessing risk culture in banks. The scale has now been validated for use in superannuation (pension) funds. This paper explains the validation process, giving confidence to those wishing to assess risk culture.

The Impact of Related-Party Outsourcing and Trustee Director Affiliation on Investment Performance of Superannuation Funds

The heavy reliance of Australian superannuation funds on service providers enables these entities to play an important role in fund operations and have a significant influence on the costs and investment performance of superannuation funds. The use of service providers creates a nexus of financial intermediation with multiple layers of principle-agent relationships and potential agency problems between trustees and service providers. Taking advantage of the industry’s new disclosure regime, this paper examines the impact of related-party outsourcing and trustee director affiliation on the investment performance of Australian superannuation funds. We find that for-profit funds significantly underperform when using related-party service providers. The underperformance is more severe when trustee boards are controlled by affiliated trustee-directors, and belongs to a vertically integrated conglomerate group.

Modelling superannuation fund management function as a two-stage process for overall and stage-level performance appraisal

ABSTRACTWe assess superannuation fund performance in a multi-dimensional framework by conceptualizing its management function as a serially linked two sub-process; operational management (OM) and portfolio management (PM). The procedure that we adopt is data envelopment analysis (DEA). We express overall efficiency as a weighted average of the two sub-process efficiencies and assess overall efficiency conditional on their relative importance. We demonstrate application of our model using a sample of Australian superannuation funds. By appraising performance in two sample periods; crisis (2008) and relatively non-crisis (2014), we show that some findings of previous studies may be explained further through the proposed multi-stage framework. The best overall performer in 2008 is public sector funds and in 2014 it is corporate funds. Decomposition of overall efficiency reveals that public sector funds, on average, outperform all other fund categories in OM. However, no specific fund category dominates PM performance in both assessment periods. The driving force behind the observed inverse association between superannuation fund size and performance appears to be PM performance. Number of investment options offered is not associated with overall, OM and PM performance. Here, we demonstrate that performance appraisal from different aspects of management provide insightful information to superannuation fund managers.

A review of superannuation fund performance studies

PurposeThe purpose of this paper is to showcase empirical findings in the literature relating to Australian superannuation fund performance in the pre-reform period, from 2000 to 2014.Design/methodology/approachThe authors synthesize Australian superannuation performance studies in an attempt to identify empirical approaches employed in the academic literature, showcase findings and uncover themes for future research.FindingsThe review highlights the following findings in the literature: actively managed “retail” superannuation funds appear to underperform passive index and/or portfolio approaches; high management fees and preference for liquid, less growth-orientated assets may be further undermining performance. It also reveals the need for future research to assess whether the recent government inquiries and the related reformative measures have achieved the desired effect of improving the Australian superannuation system. The authors therefore identify three areas of investigation that will cater for this research need: the fund performance of not-for-profit fund and self-managed super fund; the efficiency of super funds; and the appropriateness of wholesale fund benchmarks.Originality valueIt is expected that superannuation fund performance will be subject to heightened scrutiny to assess the effectiveness of recent legislative changes resulting from the Stronger Super reform and other public inquiries. This study provides a timely, substantive and informative review of empirical findings pertaining to Australian superannuation performance in the pre-reform period to assist researchers looking to conduct further empirical research on this topic.

Efficiency of Australian superannuation funds: a comparative assessment

Purpose The purpose of this paper is to measure efficiency of superannuation funds using data envelopment analysis (DEA), using data related to financial performance of superannuation funds. The sample comprises 183 superannuation funds covering approximately 79 per cent of the 231 largest Australian Prudential Regulation Authority (APRA)-regulated funds in 2012. The research covers a period of seven years from 2005 to 2012. The results indicate that most Australian superannuation funds are inefficient relative to the benchmark efficiency frontier based on efficient funds. The findings emphasise the importance of improving the efficiency of Australian superannuation funds by reducing overall fund expenses to narrow the gap in performance between efficient and inefficient funds. Design/methodology/approach This study aims to contribute to policy, theory and practice in several dimensions. Member protection and the efficiency of the superannuation system are topical issues (Donald, 2009). Despite its importance from a regulatory point of view, efficiency has only been discussed in relation to operational issues such as managing agency relationships, fees and charges, investment return or economies of scale. The relative efficiency of the Australian superannuation system from an economic productivity perspective has rarely been examined, except for a study by Njie (2006), where the Malmquist productivity DEA technique was used to measure the efficiency of Australia’s retirement income system. Findings Most inefficient funds had very low efficiency scores and were fell into the lower quintiles such as Quintiles 4 (scored 0.200-0.399) and 5 (scored 0.001-0.199). Consequently, input reduction targets were significantly higher for these two quintiles. Similarly, input reduction targets were high under the period DEA estimates. In order to be comparatively efficient, Quintile 4 funds were required to reduce total expenses by 75 per cent (−0.754) and volatility of return by 80 per cent (−0.801). Similarly, Quintile 5 funds needed to reduce total expenses by, on average, 83 per cent (−0.824) and volatility of return by 89 per cent (−0.894). Research limitations/implications As in other empirical research, this study also depended heavily on the data collected from the secondary sources such as APRA database and other financial reports. The issues of measurement errors in data sources such as APRA database are well documented (see, e.g. Cummins, 2012). This issue needs the attention of future research on the efficiency of superannuation funds. Practical implications The findings on individual year DEA estimates indicate that most funds were inefficient due to high expenses. Therefore, mandatory disclosure of fees and charges in a comparable manner may be necessary to justify fee payments and to address transparency and accountability issues, which are critical issues identified by the Cooper Review and the academic literature (Australian Government, 2014; Cooper et al., 2010; Gallery and Gallery, 2006). Social implications The issue of Australian superannuation funds concentrating the majority of fund assets in highly volatile investment vehicles such as the share markets has been in the spotlight in the aftermath of the global financial crisis. There have been proposals to better diversify superannuation assets in other asset classes (Cooper et al., 2010). Originality/value This study contributes to the current literature on superannuation funds by investigating efficiency. As efficiency studies using DEA have not been conducted on the Australian superannuation industry, this study also contributes to the academic literature on DEA and its extensive applications to various economic sectors. Efficiency scores using DEA, ranking, trends and shifts in the efficiency frontiers could be obtained for Australian superannuation funds on an on-going or annual basis.

How Much Does Tax Erode Fund Alpha?

We model the tax drag from active funds management by simulating portfolios based on reported monthly holdings of 207 active Australian equity funds between July 2000 and December 2010, and then compare both pre-tax and after-tax fund returns versus those for passive indices modeled under the same assumptions. Tax drag erodes 65% of the 0.74% excess return in Broad Market funds, but only 21% of the 1.80% excess return in Small-Cap funds for Australian superannuation (pension) fund investors. We also find that tax drag varies with investment style; market state, and is most detrimental during bull markets; and fund turnover – although the relation between turnover and after-tax excess return is non-monotonic. For high-income individual investors, tax drag is exacerbated to the extent that active management only generates meaningful after-tax excess return for Small-Cap funds of certain styles. Our study highlights the importance of considering tax when choosing between active and passive funds management, as well as how tax impacts can vary according to the circumstances.