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.
Fund furphys
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.”
Adviser duty
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.
Very well presented article.
For me it is just a light into the issue of performance comparison more broadly. It is almost impossible to compare superfunds performance unless you have an equal asset allocation and, even then, the main asset classes have a broad selection to populate from.
If, as this article suggests, there may be a liquidity issue if there is a run from COVID release applications, I would suggest the asset allocation is what is wrong, not the underlying asset selection.
From what I understand, around 750m are expected to be out of work due to CV-19, a doubling of the current unemployment rate. If not for JobKeeper, the number would be 15% so the number is around 1.5m (potentially) eligible here but unlikely to be the actual that take this opportunity up.
And remember, this is an opportunity of $10k twice over a period of 6-months. A lot of SGC rolls in during that time.
Why are Advisers now due for some governance review due to the Industry Fund crisis? This is just madness, Advisers have been very conscious and have been calling out Industry Super funds for over a decade for their blatant disregard for transparency, generous valuations of unlisted ill-liquid assets. Yes perhaps the “leaderboards” of returns for super funds looks fantastic and it helps the Executives and Directors of Industry Super funds justify their massive bonuses and salaries each year – BUT – these aren’t true valuations, these are made up returns and finally they are being caught out. Perhaps what is needed is a compulsory “independant valuation” of every asset held by these funds every 12 months, a true reflection of the value of the assets and also a true classification of the asset. If it cannot be sold easily like property and infrastructure and perhaps private equity, a much higher risk rating needs to be applied, much higher than equities, this then flows to the risk profile of the portfolios within the industry Super funds and disclosed to members.
I’m sorry, but Advisers are measured and held accountable for every single percentage over any asset class, judged on our assessment of every client, Industry super funds don’t even talk to their members. NO Advisers don’t need more governance review, Industry Super Funds need a full Royal Commission or at the very least – an Independent Government Review.
Puttng something on your APL because it has performed well and because a research house says its “ok” is just plain lazy and a lesson that should have been learnt in the GFC. Our job as licensee is to protect advisers and clients.