Illiquid assets and solid superannuation funds

When the chief executive of the Association of Superannuation Funds of Australia (ASFA), Pauline Vamos, last week issued a release clearly aimed at countering adverse reporting around superannuation fund liquidity, her assurances undoubtedly covered the vast majority of Australia’s mainstream superannuation funds.

The adverse reporting was generated by new data released by the Australian Prudential Regulation Authority (APRA) which last week released the results of research into investment in illiquid assets by large APRA-regulated superannuation funds.

In a very real sense, the APRA research touched on issues raised during the global financial crisis when it was no secret that a number of superannuation funds found themselves confronted by liquidity issues and were forced to seek regulatory relief from APRA.

Thus, the suggestion by the regulator that “in recent years, many funds have increased their allocations in illiquid assets in the expectation that these assets would yield sufficiently large returns to compensate for their illiquidity” certainly raises questions for what then happened in the darker days of 2008/09.

Because, as the APRA paper noted, “Illiquid assets may provide diversification benefits and an opportunity to leverage existing investment expertise, but are less suitable in meeting the liquidity demands placed on superannuation funds, including those relating to members’ right to transfer their balances to other funds”.

APRA then outlined the key findings of its research as being that:

• Not-for-profit funds (corporate, industry and public sector funds) have a higher illiquid asset allocation on average, although there is a wide range in allocations among both retail and not-for-profit funds;
• Not-for-profit funds that allocate a greater proportion of their portfolios to illiquid assets are generally larger, have higher net cash inflows and have younger members — all factors which tend to reduce liquidity needs; and
• From September 2004 to June 2010, not-for-profit funds with more illiquid investments experienced higher risk-adjusted returns, which suggests they captured a return premium for investing in these assets.

The APRA research might have added that, for a considerable period of 2009/10, funds with higher exposures to illiquid assets were significantly out-performed by retail master trusts which had higher exposures to more liquid assets such as foreign and domestic equities.

It might have also pointed to the fate of MTAA Super – a fund with a higher than average exposure to illiquid assets at the time.

Vamos is right to reassure superannuation fund members that, given the endless flow of the superannuation guarantee into fund coffers, there is nothing inherently wrong with significant and well-designed exposures to illiquid investments, but she is wrong to suggest that all funds have always got it right.

The simple truth is that 2008/09 proved to be a period of significant liquidity stress for a number of superannuation funds which were then forced to interact with APRA. Only time will tell whether appropriate lessons were learned and appropriate fixes put in place.