While the coronavirus crisis and subsequent policy measures around superannuation access have revealed fundamental flaws in the management of industry funds, they have also raised questions about the research process behind approved product lists that recommend them.
As the risks to industry funds play out clients will eventually ask why their adviser didn’t see the red flags, and eventually the entire advice ecosystem – licensees, investment committees and research teams included – will need to review how it approaches fund assessment.
“Every investment committee and external investment firm would reconsider their research process in light of what’s happening with industry funds,” says Nathan Jacobsen, chief of mid-sized licensee Paragem.
Industry funds have outperformed retail funds for years, largely due to their dependence on the ‘illiquidity premium’; that is, the reward for investing in lumpy unlisted assets like property, infrastructure and private equity.
What seemed like savvy long-term investing actually had a small, but critical element of risk. Early super access – which could cause a run of up to $100 billion – has ignited concern that these funds won’t have enough cash to facilitate these payments, or will need to sell assets at distressed prices to do so.
Industry funds have seemingly obfuscated the depth of the issue by only marking down a fraction of the value of these assets, which brought into play the risk that fund unit pricing is not equitable.
The coronavirus has dealt industry funds another stinger; cohort risk, which refers to unique subsets of members like hospitality or retail workers being especially impacted.
Whether these risks were foreseeable is debatable. This crisis an extraordinary event, but one that should have been in scope for all concerned.
Challenge for researchers
Miriam Herold, head of research at Centrepoint – one of the ten largest dealer group owners in the country – provides an interesting context after putting industry funds onto its APL just last year on the advice of Lonsec and its sister research company, SuperRatings.
Like many licensees, Herold says Centrepoint will be guided by their researcher in terms of future adjustments after changes that “no one predicted”. She points out that the risks haven’t manifested as yet, so it would be premature to make sweeping changes to APLs right now. “It’s difficult to have a view on how to treat these funds at the moment,” Herold notes.
Herold says the crisis will provide APRA with an opportunity to consider its own fund guidance, but the prudential regulator will be hampered in the same way researchers are. “There has been no standard for comparison and classification of assets,” she says.
Haphazard and misleading labelling of assets is a core issue and one that plagues the industry. Researchers are constantly hampered because funds – both retail and industry – use labels as a lever to manipulate performance. It’s a problem Veronika Klaus, head of investment consulting at Lonsec, knows well. “That’s the biggest issue,” she says. “Classification.”
“All we can do is make the clients aware of the differences,” Klaus says. “Or at least try to show them the real underlying asset allocation.”
Klaus says Lonsec – whose research is used by a large slice of the licensee community to formulate APLs – has not been blind to the illiquidity issue and provides information about each fund’s exposure. “It’s not anything that gets ignored,’ she states.
Libby Newman, who heads up the active manager research at Lonsec, says the researcher conducts an “annual cycle of visitation” to review their processes. This year’s review will include an autopsy of the risks to industry funds that are now presenting themselves. “It’s been an interesting litmus test,” she says.
“We’re always looking to evolve the process, especially after the experience we had in the GFC,” Newman adds.
According to Dan Miles, the founder of asset manager and researcher Innova, any changes that researchers, licensees and advisers make to improve the process around fund selection should be matched by a willingness of industry funds to pick up their own game by providing clarity and standardisation.
He takes particular umbrage with the way funds have warped unit pricing by skewing the values of their illiquid unlisted assets.
“I wouldn’t be surprised if there were funds going out to valuers and shopping around to get the best valuation they can,” he says, adding that the unlisted asset write downs look “a bit generous”.
Transparency is a key issue with funds, Miles says. When Innova is researching funds, he reveals, the level of detail they get is “very, very different” across the board.
“Some are very open and some are not,” he says. “You have to read the results and interpolate and decide what’s more accurate.”
The division of responsibility for superannuation fund recommendations is problematic. Broadly, researchers rate fund viability and licensees decide whether it meets the APL benchmark.
The adviser, naturally, sits at the pointy end, disseminating which specific fund meets the needs of the client.
While assessing something as granular as the liquidity level of a super fund may seem inefficient for an adviser, it’s been argued otherwise. Back in 2010 the Financial Ombudsman Service – which has since been folded into AFCA – determined in what came to be known as the “Basis Capital Case” that advisers must always use their own judgement in discerning products.
“Advisers cannot abdicate their responsibility for assessing products to research houses or their licensees,” FOS stated in their 49-page report on the case. “The adviser must get a real personal understanding of the products they recommend.”
The case, which was a forerunner to the 2014 FoFA reforms, is also a reminder that while the current industry fund crisis highlights issues in the formulation of APLs by the people behind advisers, those on the front line of the industry bare equal, if not heavier, responsibility.
In the industry fund crisis wash-up, advisers themselves might also be due for a governance review.