The flaws and false claims of the proposed MySuper reforms

Many of the MySuper proposals are flawed, according to Robert Keavney, including the reduction of disclosure to members and the introduction of the concept of 'optimal' investment returns. 

MySuper is the corny new name proposed for default funds, which will be required to have certain characteristics.

During the global financial crisis (GFC) fund members saw their balances shrivel but, under MySuper, the future will see nothing but ‘optimal’ investment outcomes for superannuants — or so it is claimed.

The objective of trustees must be to: “Optimise net investment returns and provide members with an appropriately designed investment strategy at an overall cost aimed at optimising … net investment return over the longer term”.

This suggests a well intentioned but naïve worldview. Reducing costs will increase returns, everything else being equal.

However, there is no such thing as an ‘optimal’ investment strategy.

Would it involve active or passive management?

Would it use or shun alternative assets? Is it risk averse or does it seek high growth at the expense of increased volatility?

Does it run concentrated portfolios to maximise return or diversify more widely to reduce risk? Is it long only, or does it include shorting?

These are only a handful of dozens of hotly debated questions in investment theory.

It is misleading to suggest that any approach can be known in advance to optimise net long-term net returns.

If MySuper funds suggest this to their members, it will create false expectations. The harsh reality is that investment is uncertain.

Naturally, MySuper only speaks of aiming or seeking to optimise returns — rather than requiring them. Yet the truth is that all investment managers who are not subject to conflicts of interest already seek to produce optimal results — yet they produce very mixed results.

No regulation can change the uncertainty of investment markets or affect the ability to produce acceptable returns. Referring to optimising returns is meaningless and risks creating false expectations.

Regrettable recommendations

The recommendations make favourable reference to several questionable practices.

They call for publishing a targeted return, perhaps in the form of X per cent above inflation over rolling five-year periods.

The predecessor of the Australian Securities and Investments Commission (ASIC) banned projected returns from prospectuses in the 1980s, on the logical grounds that future returns couldn’t be known so they shouldn’t be displayed.

The reporting of targeted returns reintroduces a temptation to err on the high side as a marketing advantage. Those trustees who exhibit conservatism in their forecasts will be put at a competitive disadvantage.

If forecast returns are based on past history, they will be at their highest at market peaks (eg, in 2000 and 2007), just when suggesting a high return is most misleading.

For example, in 2007 the past returns of real estate investment trusts would have justified a high forecast for funds with large exposure to them — which would have proved tragically misleading.

Suggesting a prospective return of consumer price index (CPI) plus X per cent over rolling five-year periods is also meaningless.

No matter which value is substituted for X, it will be a rare occasion when returns are close to the target.

At times they’ll be well above, at other times well below — and everywhere in between.

What benefit is there in implying to members that a fund will achieve close to CPI plus X per cent, if most of the time it won’t?

Age-based default options are also mentioned (ie, portfolios becoming more conservative as members approach retirement age).

This misses the point that portfolios endure beyond retirement. Retirees with, say, a 15-year life expectancy would normally have exposure to growth assets.

It makes little sense to force them mainly into cash for the years prior to 65 if they would have more growth assets both before and after that period.

Further, it is not clear how moving members into different asset mixes at different ages would fit with the MySuper requirement of one default option with one asset allocation.

Trust your trustee totally

MySuper contains a strong focus on ensuring that “the trustee is truly accountable to members” and is “unfettered in its pursuit of [their] best interest”.

The laudable objective is that that those who purport to provide a benefit to investors must actually serve their interests.

Too many in the financial services industry have espoused hollow words about putting clients’ interests first — while trying maximise their clip of the ticket, as unnoticeably as possible.

As an aside, it is not clear how this requirement will be applied by profit making funds. How much profit is considered to be in members’ interests?

Given the increased accountability of trustees, MySuper would abandon “notions of informed choice and disclosure”.

Disclosure obligations in Product Disclosure Statements (PDSs) would be reduced, though comprehensive information would be available online.

Certainly there is a substantial financial and environmental cost in producing tonnes of PDSs that are disposed of unread.

However, reducing disclosure is a fundamental departure from modern legal practice. The theory is that, given the duty of trustees to serve members, trustees can be relied on to do the right thing.

I wish it was so, but long experience scrutinising the actions of financial institutions gives me zero confidence in this.

History suggests that it is easier to execute a scam than prosecute it. The best chance of discovery lies in disclosure.

It should not matter whether a disclosure is on paper or online — apart from the fact that online information disappears as soon as it becomes inconvenient.

Scrutiny of the websites of troubled funds through the GFC revealed that anything that had become inconvenient disappeared overnight. Online disclosure can quickly become ‘un-disclosure’.

If websites are to be the primary source of information, it is essential to impose an obligation to perpetually maintain an online archive of all material.

This would be unwieldy, but would be more than offset by the cost saved from printing PDSs.

However, enforcement would be problematic. How can you prove that something used to appear on a website?

Even if less disclosure was required under superannuation regulation, there is doubt whether lawyers would advise it — especially given an increased onus on trustees.

Further, the default options (ie, MySuper) can be offered in a PDS alongside other options (ie, Choice options).

It remains to be seen whether trustees will offer different levels of disclosure for funds offered within the one PDS.

Incomprehensively, the MySuper proposals describe the reduced level of disclosure as being more transparent.

Greater transparency of performance measurement is also proposed. If this is to be genuinely transparent, it is essential that funds be required to report results via Morningstar or other industry data providers (disclosure: I have no interest in Morningstar).

Only with a publically available history of unit prices is it possible to analyse the performance of funds over any historical period.

For example it would be possible in the future to see how a fund was affected by the GFC.

The publishing of annual results over one, two, five, 10 years (and so on) is not an adequate substitute. For years fund managers have reported returns in a manner designed to divert focus from periods of significant downturn. Without a publicly available record, detailed scrutiny of performance is impossible. This would involve minimal cost.

Retrospectively banning commissions

The banning of commissions was originally announced as coming into force in 2012. It is to apply retrospectively, at least in theory.

However, MySuper extends this ban to include insurance. There will be “no bundled advice costs” and “premiums would not be allowed to include … commission or like payment”.

There is no start date for this (ie, it applies retrospectively and prospectively).

This goes so far beyond previous announcements that it is surprising that there has been so little comment on it.

Paradoxically, despite the objection to bundled advice (ie, the cost of trail embedded in fund charges) or members paying for a service they don’t want, the proposals allow the possibility of the cost of intra fund advice being “shared across MySuper membership”.

Modern awards and cost

Modern awards direct default contributions to a limited number of providers and MySuper will ensure that most of that money ends in the default option.

Thus a small number of funds will attain great scale at the expense of competitors.

MySuper sees this scale as reducing costs. However, this is likely to be complicated by reduced competition.

Many employers are subject to a number of awards, and often find that only one or two funds are listed under each of the relevant awards.

Employers usually prefer to select a provider that covers all employees, and thus has little or no choice in fund selection. MySuper means they have no choice of default within this provider.

Thus most money in superannuation will be locked in! What motive will there be to reduce costs when assets under management are unlikely to move and inflow is virtually guaranteed?

Normally oligopolies allow fat margins.

This may defeat the laudable objective to force costs down.

Insurance and costs

When comparing superannuation options for an employer, the most meaningful cost comparison is the total cost, including insurance, for each pool of employees.

The cheapest fund on this basis is often quite different to the cheapest fund when ignoring insurance.

The business practice of certain funds is to promote their low fees for administration while charging what appear to be padded premiums on insurance — raising the question of why the risk insurer was chosen.

This can be verified by comparing the premium table in their PDS with the price of insurance made available by the same underlying insurer in other funds available to a broad demographic.

Some trustees even receive a commission on the insurance they deliver to their insurance provider.

MySuper has not taken the cost of insurance premiums into account in its report but it should require that trustees make no revenue from outsourced insurance.

Reducing insurance costs is as important of reducing administrative costs.

Loss of negotiating power

There is a commercial relationship between fund providers and fund members. Members are buyers and fund providers are sellers. Nothing can remove this commercial tension. MySuper stacks the deck in favour of fund providers.

Super funds have a published price but a process of negotiation can often reduce it. Yet the MySuper proposes banning negotiation (though it is considering allowing different pricing varying with the scale of employer participation).

Already there is limited choice under Modern Awards, and MySuper would force members to pay the asking price, without negotiation. Being unable to either shop around or negotiate can only benefit fund providers — to the detriment of members.

Allowing pricing to vary only with the scale of employer participation is inadequate as other factors influences the economics of a group of members (eg, average balances). This is especially important when considering the insurance offering.

Different pools of employers have different demographics, claims history, etc. These can justify lower costs.

Banning negotiation disempowers employers and advisers — the only parties who can act on the employees’ side against fund providers.

Corporate superannuation advisers

It is reasonable to acknowledge that the role of many (but not all) corporate super advisers (CSAs) has been to promote to employers a fund with which they have a relationship — often on the basis of the highest commission — and to receive an annuity income stream not in proportion to their ongoing service.

This has been a drain on the savings of Australians.

The banning of commission will destroy this practice. The CSA of the future will charge a fee for service (to employers or employees) and will survive only while they provide value for money.

A number of high quality CSAs exist today who will successfully manage the transition to fees. It is vital that any consideration of the future of superannuation recognises and supports the role of fee-based advisers.

Today the best quality CSAs not only negotiate on behalf of employers (on cost, insurance, etc) but provide a valuable ongoing role protecting members by representing the individual against the bureaucracy.

The back offices of big superannuation funds are rarely models of administrative perfection.

Some service-oriented CSAs chase up unallocated or misallocated contributions (this has reduced but not disappeared with clearing houses), ensure that members’ recorded insurance levels align with their correct employment category, and verify and correct member data in annual reviews/member statements by comparing employer data with fund data (eg members addresses, salaries, TFNs, dates of birth, name changes, terminations and new members).

These tedious functions ensure members’ entitlements are protected. They also provide valuable services at the time of an insurance claim, protecting the entitlements of those making a claim.

This is the classic role of the adviser: representing their clients against the institution. They are the only party who can redress the information asymmetry favouring fund providers.

It was the emergence of a strong, vocal body of fee-for-service planners which paved the way for the banning of commissions. Likewise, client-focused advisers will lift standards in the superannuation environment.

Therefore the desire to reduce cost should not be used to prevent CSAs engaged on a fee basis from receiving access to relevant member data.

MySuper should include a provision that requires access to this data, consistent with the desire for transparency.

Intra-fund advice

MySuper proposes that the provision of intra fund advice should be compulsory. Beyond this, it does not forge new territory in this area, deferring to ASIC’s RG 200.

One of the ironies of the banning of conflicted remuneration is that it will lead to an increase of the most conflicted advice of all: advice paid for by salary from providers.

Surveys of the employees of financial institutions have revealed wide spread sales pressure by employers. No doubt this will continue under intra-fund advice, disguised by the usual disclaiming statements.

For example: “You should weigh up the benefits of extra super against … paying off your credit card or other debts,” followed by a recommendation to increase contributions to the fund. Ironically, this example was taken from ASIC’s guide (RG 200) as an example of acceptable intra fund advice.

Conclusion

The MySuper proposals contain flaws and makes unjustified claims (eg, that it will be “easier for members and their advisers to make comparisons” between MySuper products, including fees, performance and service standards).

Yet it is not clear what, if anything, MySuper can do to improve measurement of any of these matters.

In its earlier phases The Super System Review addressed much needed improvements in back-office efficiency. The MySuper proposals are not of the same standard. It is to be hoped they are reworked.

Robert Keavney became a financial planner in 1982, and has played many roles since then, and still believes financial planning can be an honourable profession.