Around nine months ago I asked what I thought was a pretty fundamental policy question that sat at the heart of our superannuation system. It was an essential incongruity that I had not heard anyone remark on before:
Does it not strike you as odd that although Australian governments since 1992 have forced workers to invest up to 9% of all their pre-tax earnings into a savings system known as ‘superannuation’, there is no government-managed solution (union-initiated super had actually been in place since 1986 via the awards)?
Imagine, if after introducing the Medicare Levy in 1976 (a tax to compel us to fund universal healthcare), the government had not established Medicare, but just left it to private operators, such as the company you worked for, to supply whatever services they thought appropriate. This is exactly what happened with superannuation. Up until 2005, it was difficult for employees to choose who managed their super — employers made this decision on their behalf. And even today it is not possible for an Australian to allocate their super to a government-managed product (e.g. the Future Fund).
I then proposed the following solution, which, it would appear, both the Cooper Review in canvassing a “low-cost and easy to understand national default fund”), and Alan Kohler, have both backed:
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Over and above the need to improve the quality of asset-allocation decisions through better training and regulation, one potential policy idea is to create a capital-guaranteed, government-managed investment solution that any superannuant can select — call it “KangaSupa”.
The rationale here is that the Australian government would offer at least one low-cost investment product that they would stand behind and which would be conservatively managed by only investing in fixed-income securities. Many risk-averse employees would doubtless find this attractive. Importantly, the government could then invest these savings into cash-starved areas of the economy such as highly-rated bank debt, corporate debt, and mortgage-backed securities, which have been inadvertent casualties of the GFC.
Indeed, KangaSupa might offer a superior solution to taxpayer guarantees of bank debt, and/or taxpayer investments in senior ranking corporate debt, mortgage-backed securities, and commercial property debt. It could also provide one of the first retail avenues for mums and dads to invest in government debt, which is about to balloon.
Regular readers will know that I have for a long-time been critical of the default Australian super fund’s ridiculously high 50-60% portfolio weight to Australian and international equities, which exposes members to untenable risks and is not supported by any credible actuarial analysis that I am familiar with (see, for example, here and here). Without going into more detail, it suffices to say that the Future Fund evidently agrees with this critique: its total target weight to global equities and private equity is just 35%, which is around half the industry average.
Since the beginning of the year I have repeatedly pointed out that the key casualties of super funds’ love affair with the casino that is the sharemarket has been much safer (ie, lower volatility) fixed income securities, such as highly rated corporate debt, and AAA-rated RMBS and CMBS. KangaSupa could, therefore, offer one powerful policy solution to the illiquidity that has plagued these three markets during the GFC.
What is potentially most interesting is that a capital guaranteed national superannuation fund that only invested in fixed income securities would, heaven forbid, actually serve as an effective surrogate for a publicly owned bank (aka the “people’s bank”). That is to say, KangaSupa could help significantly enhance competition in the banking and finance markets by supporting what is known in the jargon as “non-intermediated” forms of funding. Indeed, KangaSupa would, for all intents and purposes, look like a bank.
Think about it: workers would be investing their savings with the fund, which would then redistribute those savings into corporate and household debt securities (ie, business loans packaged up as corporate bonds and home loans securitised in the form of RMBS). Critically, this is finance that does not ordinarily involve the big banks — that is, it would compete with the “intermediated” funding offered by the major banks.
So with a single policy initiative Kevin Rudd and Wayne Swan could address: (a) the absence of simple government-managed super solutions; (b) the flaws associated with many super asset-allocation strategies that leave members overexposed to equities; (c) the lack of liquidity in the corporate bond, and securitised residential and commercial mortgage markets; and (d) the parlous state of competition in Australia’s banking and finance sectors.
A few months after I published the original article, the idea was reiterated in the open letter I co-authored with five eminent economists calling for a full financial system inquiry in response to the learnings yielded by the GFC — a so-called “Son of Wallis”*:
“Should citizens who feel unsure and unqualified to shop wisely in our financial markets be able to access basic savings, payments, and wealth management products that have been vouchsafed by governments as being safe and professionally managed (eg, why can’t Australians invest with the Future Fund)?”
More recently I have spent a significant amount of time one-on-one pushing the KangaSupa proposal with senior politicians (including one especially enlightened government minister). I’ve argued that the implementation could be easily achieved through the Future Fund, which would simply establish a new dedicated fixed-income portfolio with a narrowly defined investment mandate (ie, limited to highly-rated debt securities with extremely low probabilities of default).
While still on the subject of super, I want to throw out another idea for the Cooper Review to consider. APRA has spent a lot of time recently trying to get the reporting of superannuation fund “performance” right.
But there appears to be one particularly profound problem underpinning the regulator’s approach to measuring investment performance. Take a step back and ask yourself the question, What do we actually mean by the word “performance”? Are we talking simply about raw returns , or the critical trade-off between risk and return? Surely it is the latter. Surely we are not going to encourage unsophisticated mums and dads to focus on just returns and completely overlook risk? Yet by ranking super funds by their raw performance, that is precisely the consequence of APRA’s approach.
In the research world, this is schoolboy error No. 1. You never evaluate fund performance on the basis of raw return outcomes. You always risk-adjust those returns by factor analysis or simpler measures such as Sharpe Ratios.
What is most concerning is that in APRA’s June Quarterly Statement on Superannuation Performance I can locate 32 separate references to the word “return”. There is, however, not a single reference to “risk” (or “volatility” for that matter). This seems like a very serious oversight.
Now one might respond that by making available the time-series returns APRA provides consumers with a “feel” for the probability of loss. But arriving at correct inferences regarding risk on this basis is way beyond most mums of dads. And by not even canvassing risk, the regulator is actively encouraging consumers to psychologically bury the issue in their minds.
A simple policy solution here would be for APRA to invest some time and effort developing a “risk-rating” analogous to the star ratings used by actuarial firms to rank mutual funds. The appeal of a simple risk-rating is that the regulator could embed a range of sophisticated metrics into it, which lay consumers would not need to worry about. (Of course, APRA would fully disclose their risk-rating methodology through a technical paper that the more informed could interrogate at their leisure.)
The key take-away here is that by providing a risk-rating of some kind APRA would be supplying a valuable public good to the community. They could leverage off their own sophisticated capabilities to distil a range of complex risk considerations into one easily-digested measure. And by putting risk back on the super fund agenda, they would force members to be more discriminating in making their choices as opposed to the current situation where raw returns are the only guide (and I have not bothered here to wade into the issue of the tenuous link between past performance and future outcomes that further undermines the current approach).
Interestingly, there is academic research that shows that “risk-adjusted star-ratings” such as the proxy I have proposed, which seek to incorporate more rigorous analysis of past performance, are much better guides to future outcomes than the raw benchmarks currently employed by APRA.
A final benefit of a risk-rating is that it would help compel super fund trustees to be more careful with their asset-allocation strategies. In a world where consumers can risk-adjust super fund returns, there would be far fewer rewards for those groups that load up on listed equities risk in order to chase high payoffs with much greater probabilities of loss.
One obvious complicating factor here is how one goes about measuring unlisted investment risk. But developing suitable risk proxies for unlisted assets is well within the capabilities of the regulator and should not in any way stymie the exercise.
*The momentum behind Son of Wallis grows every day with Stephen Bartholomeusz recently commenting, “It is a pity that the various reviews of the financial and tax systems are being conducted separately rather than as an holistic inquiry…The crisis has exposed some vulnerabilities, weaknesses, and, significantly, some opportunities that might have been easier to realise if a system-wide review had been undertaken.”
Christopher Joye blogs for Business Spectator.