When it comes to both fees and performance, past experience is no guarantee of future outcomes.
The overly simplistic notion that industry fund = good; retail fund = bad; is just as unhelpful.
It has currency because the Industry fund lobby group spends a fortune (from its members' funds) on advertising. In 2019 it spent $45.9 million on advertising making it the 20th biggest spender Industry Super Fund – $45.9 million
There are good and bad funds on both sides of that divide. It's just an historic categorisation used by APRA for reporting and has little relevance to choosing a fund in 2021.
According to APRA data, there were as many Industry funds in the bottom 10 performing super funds (in the 70%-80% growth category) as there were in the top 10 performing funds.
So just ignore the category of the fund - it is not a useful predictor of performance.
Don’t start with fees
There is almost zero correlation between fees and net returns (after fees and taxes).
I have prepared a graph based on APRA data up to October 2020 for 416 My Super funds which demonstrates this. If anything there is a tiny positive correlation - higher returns are linked to higher fees. But this is statistically insignificant and can be disregarded.
The average total fee on a $50,000 balance was $525 (1.05%). The lowest reported cost was $210 (0.42%) while the highest was $800 (1.6%).
The overwhelming majority lie between 0.85% and 1.2%.
These differences are material, but of themselves provide no information as to the expected net performance after fees.
Don’t get me wrong; I’m not saying that fees don't matter. They do.
So let me be absolutely clear here. Fees matter. A lot.
But on their own, they are a very poor indicator of what you can expect.
So what should I start with?
1. Start with Asset Allocation
The biggest single driver of both risk and return is asset allocation. So get this right first, before you worry about anything else.
Asset allocation is the number one driver of net returns. Get this right and you are most of the way there.
Asset allocation is the type and mix of assets in your fund. It’s the mix between shares, bonds, cash and commodities.
It's also the mix within those broad categories. That is, how much of your allocation to shares is devoted to Australian or overseas shares, how much is allocated to large companies or small companies and how much is allocated to growth companies or value companies.
In other words, how much of your money you invest in shares matters more than how much of that is allocated to (say) Telstra.
Some asset types (like cash and bonds) tend to produce low but steady returns with a low risk of losing money. We call these Defensive Assets.
Others like Shares deliver higher returns but with more variability and a greater chance of losing value. We call these Growth Assets because they are capable of providing returns above inflation over time.
Generally, if you target a higher return, you need to accept a higher level of risk. But make sure that each unit of additional risk you take is rewarded by a corresponding increment in expected return
For long term investments like Super, mixing Defensive and Growth assets in the right proportion can deliver higher long term returns with less variability and risk.
Too little growth and inflation will erode the buying power of your savings, while too much in Growth assets can create volatility, potentially leading to panic reactions.
For most people controlling this emotional reaction is the key to achieving their goals.
But like most things in personal finance, if some is good more isn’t necessarily better.
In the chart, you will see that 100% allocated to growth assets doesn’t generally lead to higher returns than 80% or 90%. This is because of the benefits of diversification and the way the underlying assets behave in different market conditions.
Action step #1. Determine the right asset allocation for your needs. Assess your goals, circumstances, age, plans for retirement, risk tolerance and capacity to recover from a material loss as well as your money personality.
2. Check that you are getting the asset allocation you select
As important as it is to work out the right asset allocation for your needs, it is even more important to ensure that the fund you choose will actually give it to you in practice over the long term.
Many of the leading funds' flagship products have a wide discretion in their choice of asset allocation. None of them discloses how they choose where to be in the allowable range.
A little discretion is necessary, so that you don't create excessive trading costs by rebalancing too frequently. But most of these ranges are so wide that it potentially changes the nature of the fund completely.
That balanced fund you chose could end up being a conservative fund or a high growth fund and you'll only find out afterwards.
This table shows the target asset allocation (shown as Growth %/Defensive %) for the most popular choices, derived from the product disclosure statements and APRA publications.
||Target Asset Allocation
||Actual @ June 30, 2020
|Australian Super (Balanced)
|Aware Super (My Super Lifecycle under 60)
|Uni Super (Accumulation 1)||70%/30%||68%/32%||50%/50%||90%/10%|
|REST (Core Strategy)
|HESTA (Balanced Growth)
|Hostplus (indexed Balanced)
Action step #2: Look carefully at both the target asset allocation and at the allowable ranges. This is your first filter to narrow down your short list of funds.
Australia’s super funds have long had a culture of secrecy about their investments and how they choose them, leaving fund members in the dark over how their retirement savings are being invested.
As a result, it is impossible in many cases, for members (or their professional advisers) to assess how the returns were achieved and whether they are appropriate for the risk taken.
It means that Australians have been given choice over where their retirement savings are invested, but the information to make that decision meaningful is being withheld.
Morningstar reports that Australia ranks at the bottom of 26 global markets for investment portfolio disclosure. This result is so bad that Australia is in the "bottom" category all on its own.
REST recently spent an undisclosed amount of their members’ money defending their refusal to disclose to a member (23-year-old Mark McVeigh) information about the fund’s exposure to climate risks and how those risks are being managed.
Of the major funds, Australian Super is the standout performer when it comes to disclosure. However, its disclosure is still well short of being meaningful.
Australian Super lists the 336 Australian and 1,960 overseas listed companies it invests in by dollar value and percentage of the fund. These make up 55% of the Balanced fund’s assets.
But when it comes to the other 45% of the assets, it is much more opaque. Australian Super lists only the names of the infrastructure and property assets with a very broad value range.
For example it lists its investment in Brisbane Airport and notes its value as being "between $300 million and $1.5 billion".
There is no disclosure of how this valuation has been derived, the nature of the holding or any restrictions that apply to its ability to sell.
No details beyond the name of private equity investments are provided.
For fixed interest only the amount and name of the issuer is disclosed – no disclosure of credit rating or duration (the two key factors that influence bond returns).
Action Step# 3: Look for a fund that clearly discloses what it invests in , how it chooses those investments and how it values them. You will need to look well beyond the product disclosure statements to find this information.
Tips to help you do this:
- Look for index funds where the index is named and is implemented by full replication. This way the constituents and their weighting is on the public record.
- When it comes to fixed interest, this may not be practical so if you cant find a full replication fund, a sampled or optimized fund is a close substitute.
- But beware of index funds where the name includes the word “enhanced”. This indicates some sort of proprietary approach which is usually opaque.
- Avoid funds that invest in unlisted assets (more on this below)
4. Beware of Unlisted Assets
Most of the big funds have significant investments in unlisted assets (property, private equity and infrastructure) which lack the clarity and certainty of ongoing market-based valuation.
In the absence of market transactions (which are infrequent), these investments are valued using financial models in a process managed by the custodian or fund manager.
The methodology for these valuations is rarely disclosed.
Unlisted assets also may be illiquid, especially in times of financial market stress.
The rules that govern how super funds classify their investments between Growth and Defensive mean that the reported growth/defensive split may not fully reflect the underlying assets. This makes it harder to assess performance.
- For example, Uni Super's investment in Sydney Airport (they own 17.5% of it) is classified as 100% growth because it is listed.
- However, Hostplus’s investment in Brisbane Airport (held through its $2.5Bn invested in IFM which represents 5.6% of total assets), gets counted as 25% defensive.
Yet, an investment in Brisbane Airport is riskier. Not only is it a secondary airport dependent on traffic growth for much of the investment return, it is also an illiquid unlisted asset with opaque valuation.
This makes it difficult to compare Uni Super’s reported 68% growth allocation with Hostplus’s 79%.
There is no evidence to demonstrate that investors are adequately compensated for these additional risks by way of higher returns.
The greater transparency and liquidity of listed investments are therefore to be preferred in the absence of evidence to the contrary.
Action Step# 4. Look for investments in unlisted assets and avoid where possible.
Two thirds of the money you will spend in retirement from your Super comes from the earnings on your savings. That’s why it is so important to get your investment decision right.
5. Fund Ownership
Many of Australia’s largest super funds (12 of the top 20 by assets) are operated on a “profit for members” basis.
This appears superficially seductive – no profit must mean higher returns, right?
We are used to this concept from cooperative businesses like farmers’ markets and book stores.
But super funds and investments are not bookstores, and the idea does not translate well.
When you shop at a not-for-profit book store, you can compare each purchase at the time you make it. Once you've bought your book, it doesn't matter what happens to the book store that sold it to you.
So, when an ill-judged investment and an inability to compete with Amazon led to the collapse of the Co-op Bookstore, it had no effect on the books its customers had already purchased. It only meant they had to buy future books elsewhere.
A super fund is different. You don’t know the price until the end of the year (the expenses disclosed in the PDS are just an estimate).
The Aware Super PDS (alone among the big funds) discloses this well by saying:
"Investment fees may vary from year to year and cannot be precisely calculated in advance. These amounts are an estimate of the fees and costs of each option for the 12 months to 30 June 2020. Past costs are not a reliable indicator of future costs."
And you don't know what performance you'll get until you actually get it.
That's why ASIC makes funds include in their publications warnings such as “Past performance is not a reliable indicator of future performance.”
Under-performance will only become evident after the fact, and there are significant tax and transaction costs involved in moving funds. It may also not be possible to replace insurance held through the fund if you move.
Profit is simply payment for risk. In a competitive market, there can be no excess return, so this will be the same as the economic cost of the risk.
If you are not paying someone to take this risk, you are taking it yourself.
As well as the usual risks of operating a business, there are risks specific to funds management operations.
These risks include overruns or delays in delivering IT systems, fines or penalties imposed by the regulator, marketing spend which does not generate the expected additional assets under management (AUM), unforeseen declines in AUM or member numbers, or unit pricing errors requiring compensation to affected members or former members.
The effect of these risks is usually realized as either higher expenses or lower investment returns or paid for from reserves (in effect, member’s money) and is quantifiable only in hindsight.
A “for-profit” fund will usually have a suitably capitalised manager able to absorb these business risks and an incentive to preserve the value of their business thus (in most cases) sheltering members from the risk.
But in a "profit for members" fund, the only place this risk can fall is on the members.
So any fine levied by ASIC on a fund will in effect fall on the very group of people the law was intended to protect.
For example ASIC have recently commenced action against REST for false or misleading representations made about the ability of its members to transfer their superannuation out of the the Fund.
ASIC commences civil penalty proceedings against REST for misleading and deceptive representations to members
If these allegations are proven and a fine pr penalty is imposed, this will fall on members.
These risks are (usually) relatively small and the fund’s investment in the subsidiaries responsible for managing the investments, although not explicitly disclosed, is likely to be less than 1% of the assets of the fund.
Overseas, some fund managers recognise this risk and have built a safety net mechanism.
Vanguard (the world’s second-biggest fund manager by assets and owned by its US investors) for example, caps the liability of investors at 0.4% of assets. No such cap is provided by any Australian super fund.
Moreover, the ownership of the underlying manager creates complications where poor performance would otherwise result in it being appropriate for the trustee to replace the failing manager.
As a general rule, you should only accept risks if you are being rewarded for taking them.
Accordingly, this risk should only be accepted by investors if there is a significant reduction in fees (all other things being equal) to compensate for taking this risk. In practice this is rarely the case.
Action Step #5: Examine the ownership of the fund. If it is member owned (or profit for members), then ensure you are getting something in return. In most cases this will be lower fees. In most cases this fee difference is inadequate or non-existent. Do the numbers based on your balance.
6. Does the fund structure support your investment choice?
Not all funds are built the same way. Much of these differences are obscure (even to many lawyers) but can make a huge difference to your outcome.
In some cases (Hostplus, I'm looking at you!) this means that you may not actually get the investment allocation you select.
Hostplus invests via the Hostplus pooled Superannuation trust, which in turn engages managers (some of which are owned by the trust) to actually invest.
When you make a choice, Hostplus does not acquire an interest in the investment option you choose on your behalf. Instead, you are notionally invested in the investment option. Hostplus predetermines the amount to be invested with any particular investment manager as part of their investment strategy.
The Hostplus Product Disclosure Statement (PDS) states:
“For example, Hostplus may have invested $10 million in Balanced Equity Management – Australian Shares. A member then exercises investment choice and directs us to invest $10,000 of their account balance in that investment option. We do not invest a further $10,000 (on top of the $10 million already invested), but notionally allocate the net investment returns received from that investment option to the member’s account.”
This introduces the risk of mismatch between the underlying assets and the investment options selected by Hostplus members.
There is no disclosure as to how the notional return would be allocated in such a scenario.
Action Step# 6 Look for different or unusual structural features and assess what they mean for your future outcome. You will need to read a few Product Disclosure Statements. Look for differences - these will provide clues for what might matter. The differences are likely to be hidden in vast slabs of common paragraphs - but it is worth persevering.
7. Check for Fees
Once you’ve worked through the previous six steps, its time to look at price. Now that you’ve got a shortlist of funds that deliver your required asset allocation with certainty and transparency, its time to look at fees.
You are now comparing apples with apples, and lower cost will generally win.
All funds charge fee; some fees are more evident than others.
Generally, they consist of a fixed weekly or annual membership fee, an administration fee worked out as a percentage of your balance and an investment management fee also based on your balance but dependent on which investment option you choose. There are also usually ad hoc fees for specific items like changing your investment allocation.
Look carefully at any ongoing fees and fees that are deducted from your contributions.
Don’t focus too much on the fees that you’re only going to incur occasionally.
But be especially careful about fixed administration fees. These seemingly innocuous fees can be a material part of the total cost of your fund, especially if your balance is low. That $1.50 a week fee is 0.5% on a $15,600 balance and is not taken into account when reporting returns in most cases.
Be wary of funds with unusually low fees. This may mean that the fee is not required to be disclosed. But just because it doesn’t have to be disclosed doesn't mean it isn’t eating away at your retirement savings. Identifying these fees can be hard.
Action Step #7: Now that you've got a short list of broadly comparable funds, look at fees based on your balance. Funds are required to disclose the fees for a balance of $50,000. If your balance is different (as it will be in most cases) look at the fee for your balance.
8. Finally a word about insurance
Never let the insurance tail wag the investment dog.
Most Super Funds provide some level of cover unless you choose to opt-out. But is it the right cover for you?
In most cases the default cover will be insufficient.
But you are not limited to the insurance provided by your Super Fund. You can now use your Super to pay for insurance from a number of insurance providers.
This can often be the most cost-effective way to buy insurance, and it means that you won't be locked into an under-performing or unsuitable fund in the future if your health or occupation changes.
There can also be tax benefits in having a separate fund to hold your insurance. A good advisor will help you do this analysis
For some people,however, the default insurance cover provided by their super fund might be the only cost-effective source of cover. This might be because of particular health issues or the type of work you do. If this is you, you may need to consider having two funds.
Action Step #8. Review your insurance needs. Check to see if you are better placed by choosing a policy outside your preferred fund. Only if you can't get cost effective cover elsewhere should you allow this factor to influence your choice of fund.
Never cancel insurance cover until you are sure you no longer need it or you have replacement cover in place.
It's Your choice - use it wisely
Remember, everyone is different. Before you make your decision, decide what really matters. This will tell you how much importance to place on each of the 8 items.This review may seem like a lot of hard work – and it is. But it matters.
Two-thirds of the money you will spend in retirement from your Super comes from the earnings on your savings. That’s why it is so important to get your investment decision right.
All this may seem like a lot of hard work – and it is.
But it matters.
Two-thirds of the money you will spend in retirement from your Super comes from the earnings on your savings. That’s why it is so important to get your investment decision right.
A good advisor will help to identify an appropriate fund for your needs and monitor it to make sure it continues to meet your needs.
Google and Facebook are no substitute for the right advice.
Just $499 could change your future. And you can usually pay for it from your Super Fund.
Life Sherpa can help.