No market failure, so no need to cap fees

Thedebate over fees and charges preoccupying industry observers over the past 18 months peaked recently with the launch of the Labor Party’s policy platform, including recommendations to cap fees on compulsory super contributions.

But closer examination of industry research reveals two interesting points. First, there is no market failure to justify capping fees. And second, there is almost no difference in the price charged to members of large retail master trusts and members of large public offer industry funds.

Superannuation has transformed from a benefit for the fortunate few to a right enjoyed by most employees. Alongside this transformation is an ongoing shift in assets from subsidised company superannuation funds to public offer funds where members pay the full cost of providing investment management, administration, advice and education. In this competitive, privately managed system, both fees and fund returns are centre stage.

Several recent studies on superannuation fees conclude that on average industry funds are much cheaper than retail funds, which are said to charge anywhere between two and five per cent of contributions.

On that basis, commentators conclude that employees’ compulsory superannuation contributions are flowing in to high cost products and that fees should be capped. However, in analysing the argument, they should compare features on a like-for-like basis.

Currently, the entire retail product set, which comprises personal and corporate superannuation plans, roll-over funds and post-retirement income plans, is used to determine the average fee used by the so-called high-cost-of-retail camp.

In reality, the majority of superannuation guarantee (SG) money flowing into the retail sector is in employer-sponsored master trusts, so these provide the best comparison with their industry fund counterparts.

Earlier this year, the Investment and Financial Services Association (IFSA) released a report prepared by Phillips Fox Actuaries and Consultants that broke down the costs of retail superannuation funds between employer-sponsored and personal superannuation, and then compared these costs with other types of superannuation providers.

The report showed that in 2001 the average fee paid by an industry fund member was 1.18 per cent of assets. By comparison, the average fee paid by a member in a retail employer-sponsored super fund was 1.44 per cent of assets — higher than in an industry fund, but well short of the widely reported two to five per cent average fee for retail funds.

The table (left) shows that investment and administration costs in both types of funds were roughly comparable. Both charged a fee for education and advice, costing on average 10 basis points for an industry fund, and 26 basis points for a retail fund. In other words, for every $1,000 of super, the member pays somewhere between $1 and $2.60 for workplace education and advice.

Digging deeper into the fees for retail and industry funds shows some more interesting results. First, and not surprising, is that scale economies have a significant outcome for both retail and industry funds.

The large industry funds with more than $1 billion in assets (most of which are public offer industry funds like ARF and REST) charge an average total fee of 1.15 per cent, while smaller industry funds charge an average fee of 1.3 per cent.

For employer-sponsored retail funds, the average fee charged reduces from two per cent for small funds to 0.85 per cent for larger funds. Larger funds in both categories benefit from wholesale pricing arrangements.

Some 186,000 employers with fewer than five employees make superannuation contributions to the smaller retail funds. Often, these smaller employers are family businesses that generally have a high requirement for detailed financial advice. These smaller retail funds are also usually unable to negotiate wholesale investment management terms and plan discounts. The combined impact results in higher average fees for smaller retail funds.

If we were to exclude these smaller, more advice-rich funds from the equation, the scenario becomes very interesting indeed.

When smaller funds with fewer than $5 million are removed from the retail employer-sponsored master trusts category, the average fee falls to 1.16 per cent — which makes retail employer-sponsored master trusts with more than $5 million in assets generally cheaper than industry funds with fewer than $1 billion in assets, and roughly the same price as larger public offer industry funds.

And of the case for capping fees?

Both retail and industry funds charge similar amounts for investment and administration (with the exception of administration charges for smaller retail funds).

Both retail and industry funds charge for advice and workplace education. The total price difference between the two fund types is, on average, 16 basis points.

Governments generally only regulate, or ban, prices if there is a demonstrated market failure (such as monopoly rents or uneconomic provisions of goods or services).

It would seem difficult to accept an argument that a 0.16 per cent differential in fees, fuelled mostly by the higher costs associated with running smaller funds with less than $5 million in assets, constitutes a significant market failure.

Suzanne Doyle is AMP’snational manager ofsuperannuation andretirement income policy.