Crunch time for liquidity

Published in ASFA Super Funds Magazine November 2013. See http://www.superannuation.asn.au

Australian Superannuation Funds Liquidity

Australia’s superannuation system, best described as a hybrid structure that consists of a combination of compulsory superannuation contributions and individual investment choice, is regarded internationally as one of the best systems in the world. One of the central features of Australia’s superannuation system was that in establishing the legislative framework for the Superannuation Guarantee the Federal Government quite deliberately did not overly restrict the investments of superannuation funds. However whilst the Sole Purpose test allows superannuation funds to determine an investment strategy that is appropriate to members, choice of fund has in reality limited the capacity of superannuation funds to invest in illiquid investments that include unlisted infrastructure, property and venture capital.

As part of APRA’s Investment Governance Prudential Standard (SPS530) which became effective on 1 July 2013 superannuation funds are required to manage their liquidity. Liquidity itself is the technical term that refers to the ability of a superannuation funds to meet its obligations as they fall due. SPS530 codified what was becoming an industry norm, providing APRA with the power to manage what was up until the passage of legislation a guide to trustees.
One of the fundamental public policy issues that deserve further research is whether Australia’s choice of fund system, by limiting the capacity of funds to invest in illiquid assets, actually reduces long term retirement benefits.

One of the attractive features of illiquid investments is their ability to deliver an illiquidity premium. The extent of such premiums is subject to much debate and reflects the maturity of the underlying asset class. In a December 2012 paper APRA examined the issue of illiquid investments concluding that funds with moderate illiquid investments experience higher risk adjusted returns.
APRA found that not-for-profit funds have a higher illiquid asset allocation on average compared to among not-for-profit funds and that those with higher allocations to illiquid investments tended to be larger funds. According to APRA one of the main drivers of investment in illiquid assets was that funds with larger positive net cash flows and fewer members approaching the drawdown phase of their membership allocated a greater proportion of their portfolios to illiquid assets.

The challenge for Australia’s superannuation system is demographics. Australia’s compulsory superannuation system was established 20 years ago. In the early days of the system retirees had often only received compulsory superannuation contributions for a short period of time, with relatively small account balances. With twenty years of compulsory superannuation contributions behind them, retirees are now leaving work with decent superannuation account balances. Because superannuation trustees must be able to meet their obligation to pay out superannuation benefits on retirement the older the demographics of a fund, the more liquidity that is required.

As members age superannuation funds will need to consider their overall asset allocation. With 4.5 million baby boomers approaching retirement in the next decade this is likely to be a significant issue for the superannuation system, and not just individual superannuation funds. As APRA stated in a 2008 discussion paper “Not only will this demographic ‘bulge’ provide challenges for the Government in the coming years in terms of health care, social security and workforce participation rates, but it will also create a range of challenges for superannuation funds, not the least being the need for increased liquidity management so that benefit payment obligations can continue to be met going forward. While the proportion of benefit payments taken as lump sums will hopefully trend downwards, in dollar terms it is reasonable to expect that this drain may increase significantly in coming years as more and more ‘Baby Boomers’ move into retirement, and take their lump sum with them.”

As Australia’s superannuation system matures one of the questions that need to be considered is what is the role of illiquid assets? The demographic trend would suggest (all things being equal) that overall the portion that superannuation funds will be able to invest in illiquid assets will decline over time. Is this a good thing in terms of retirement outcomes?

One of the debated questions is whether, if unconstrained by regulation, superannuation funds would increase their allocation to illiquid investments? The ability to match long dated commitments with long term assets seems to make superannuation funds a perfect match for illiquid investments. However illiquid assets have other risks that need to be considered in determining an appropriate asset allocation. Risks include transaction risk (the risk that it can take an uncertain time to sell the asset, at an uncertain price) and valuation risk (the risk that the assets cannot be accurately valued). Illiquid assets such as infrastructure, property and venture capital may also require funds to have sufficient in-house experience to manage assets, adding to the cost and complexity of managing a portfolio.

An important public policy question is whether superannuation funds should be given flexibility that would enable an increase in illiquid investments? There have been a number of recent suggestions about the merits of establishing either a back stop facility through the Reserve Bank, or enabling superannuation funds to borrow through a line of credit offered by a bank.

ASFA asked Deloitte Access Economics (DAE) to consider the issue of a liquidity facility as part of the recent “Maximising Superannuation Capital” report. DAE illustrated a model that could operate. “Currently, banks can enter into a repurchase or repo agreement with the RBA, whereby banks can sell Commonwealth bonds and eligible securities to the RBA and buy them back at a later date. The repo agreement is essentially a secured loan, with the proceeds providing short-term liquidity. By charging ADIs for the liquidity insurance the central bank provides, the appropriate incentive is established for ADIs to manage their liquidity risk. At the same time, the design of the CLF will contain the impact of regulatory-induced demand for liquid assets in an environment where so few exist. Under the proposal, superannuation funds regulated by APRA could utilise this facility alongside banks. This arrangement would also create incentives for superannuation funds to hold more repo-eligible securities, in particular fixed income securities. Setting up a liquidity backstop for superannuation funds, with appropriate haircuts to guard against moral hazard, may provide a solution that would satisfy APRA and leave the superannuation funds free to make investment decisions that best meet their members’ needs. The CLF that the RBA manages for ADIs is a framework that could be considered. But the net benefit of such a facility for superannuation funds needs to be established first.”

There are a number of issues that need to be considered before concluding whether super funds should be given more flexibility to invest in unlisted assets. There is the potential that changes would introduce moral and economic hazards.

It is also important to consider what liquidity risks a back drop facility would seek to address. Superannuation funds could face a liquidity crunch due to either systemic or idiosyncratic events. A backstop facility is not appropriate to address a situation where a fund faced an outflow due to fraud or reputation risk.

It is likely that any systemic event would be global, and not just limited to Australia. One of the scenarios would be that a drop in the value of the Australian dollar would force funds with currency hedges to find cash to meet hedging commitments. In this scenario one of the questions is whether Australia’s banking system would be in position to provide liquidity to superannuation funds in the event of such a crisis. The experience from the Global Financial Crisis was that superannuation funds provided liquidity to banks, rather than the other way around. If there is a question as to whether the banking system could provide liquidity in the event of a global crisis then the best policy option would be a Reserve Bank facility.

One of the arguments in favour of having a facility in place is that it would prevent a knee jerk reaction by government. In the event of a continued period of disorderly markets a question would arise as to whether the Government should freeze withdrawals from superannuation with the exception of payments to retired members. In this circumstance the ‘too big to fail’ nature of superannuation would make any Government decision of national interest. In such circumstances the likelihood would be that government would also consider a freeze to compulsory superannuation contributions to provide a stimulus to the national economy. A Reserve Bank facility would provide a way for the superannuation system to manage any external shock without huge disruption.

Introducing a liquidity backstop is likely to be considered as part of a Financial Systems Inquiry which the Coalition has committed to establishing. It is important that change is not rushed into. There is currently no liquidity crisis and superannuation funds have not been constrained in making investments in illiquid assets.

The sources of liquidity crunch in Australia’s superannuation system include systemic events and long term demographic changes. The challenge that superannuation funds face managing international investments is the fact that the Australian Dollar is a football that is kicked around during global crises. The need to hedge investments will put ongoing liquidity pressure on Australian super funds. As the superannuation system matures superannuation funds will need to consider there asset allocation. The important point is that the trend is only going one way, and that is to make investing in illquid assets more difficult.

It is worth pointing out that the need for superannuation funds to invest in liquid assets has the potential to have broader impacts on the Australian economy. Australia has a concentrated equities market dominated by banks and financials. As the size of the superannuation pool grows the search for liquidity and diversification will drive superannuation funds to increase their exposure to international equity markets.

If Australian superannuation funds were not required to limit their illiquid investments then it is likely we would see at least some funds change their asset allocation. We do not know how many superannuation funds would change their investment strategies and by how much but we do know that there would be change. The fact that some funds would change their asset allocation can be seen as the explicit cost of having choice. This is not to suggest that we shouldn’t have choice of funds, but we need to recognize that it does potentially have a cost in terms of diversification and risk-adjusted returns.

The good news is that we are not at the limit of the system’s ability to absorb new illiquid investments. The continued cash flow of superannuation contributions into superannuation means superannuation funds remain in a strong position to invest in illiquid investments. The Financial System Inquiry will provide an opportunity to consider whether changes are needed to ensure that the superannuation system continues to deliver long term outcomes for superannuation fund members.

Turning their backs on tobacco

Published in ASFA SuperFunds magazine October 2013, http://www.superannuation.asn.au

by Gordon Noble

A growing number of superannuation funds have now divested from tobacco. ASFA recently held a forum with First State Super to provide an opportunity for funds to share their experiences. With Portfolio Holdings Disclosure now legislated with implementation slated for 1 July 2014 it is timely for funds to consider the role that tobacco may, or may not play in their superannuation portfolios.

Dr Bronwny King, an oncologist at Peter Mac, a Melbourne cancer treatment facility, presented arguments at ASFA’s Tobacco and Superannuation Forum on why funds should divest from tobacco. Bronwyn represents what can be described as a new generation of activists. Articulate and intelligent, Bronwyn discovered by accident that she was effectively invested in tobacco when at the end of a meeting on her superannuation with a representative from First State Super the conversation turned to investment choices. Unaware that she could make investment choices the First State Super representative explained that the fund offered sustainability based investment choices that excluded investments in tobacco. Bronwyn’s reaction was a realization that while she had been treating the victims of tobacco she had at the same time been investing in the companies that manufactured and promoted smoking. Rather than just excluding tobacco from her own investments she felt she needed to do something, aware that many health professionals like her did not always pay sufficient attention to the details of their superannuation.

Bronwyn established Tobacco Free Super, and began campaigning for the removal of tobacco from superannuation fund investments. First State Super became the initial focus of the campaign and as a result of front page coverage in daily newspapers began a board discussion to consider whether the fund should divest from tobacco. As First State Super CEO Michael Dwyer admits the issue of tobacco was on the fund’s radar but as the fund was dealing with a raft of issues in respect to its merger with Health Super, consideration of divestment had slipped down the order of priorities. As newspaper editorials focused on the irony that a fund that promoted that it ‘cared for the carers’ was investing in tobacco consideration of the issue became a priority.

First State Super is not the first fund to divest from tobacco. Funds such as Local Government Super divested many years ago. One of the divers of change of opinion around the role of tobacco is Portfolio Holdings Disclosure. We are currently waiting for regulations to implement the legislated requirement that super funds disclose to members their investments. Once implemented, Portfolio Disclosure will mean that superannuation funds have nowhere to hide in terms of their investments. It will be easy for activists to aggregate fund data to produce consolidated data on the amount that the superannuation industry invests in any particular company or group of companies. We should not fear this. But it will mean that both as individual funds, and as an industry, we need to be prepared to explain why we invest.

For funds that have divested from tobacco there does not appear to have been a financial costs. Funds have found that they have been able to replace tobacco investments with investments with similar attributes – Coca Cola and Pepsi for instance demonstrate inelastic demand and target emerging markets but without the deaths.

One of the features of Australia’s superannuation system was that in establishing the legislative framework for the Superannuation Guarantee the Federal Government quite deliberately did not overly restrict the investments of superannuation funds. It is worth recalling APRA’s February 2001 clarification of the SIS Act outlining a set of Principles. The Principles state that a trustee should exercise care when considering investments to ensure that the provision of retirement benefits for members is the overriding consideration behind the investment decision. “However, the situation may arise where a properly considered and soundly based investment provides “incidental” advantages to members or other persons which could suggest that the fund is maintained, in whole or part, for an improper purpose.” The Principles go on to describe that “such incidental advantages would not necessarily, in isolation, amount to a breach of the sole purpose test. For example, investment in a well-researched and commercially sound project might incidentally create employment opportunities for members; and It is open to trustees to develop features of their fund which add value to, or differentiate it from, other funds.”

There has been little focus on the concept of ‘incidental advantage’ in the broader debate about fiduciary duties. However in the context of a legislative environment that does not restrict investment, there is no legislative and regulatory restrictions so long as investments were made for the purpose of providing retirement benefits.

This may represent a new chapter for responsible investment. Many Australian superannuation funds have become signatories to the United Nations Principles for Responsible Investment. Whilst most attention is placed on engagement activities and ESG integration the PRI consist of six principles. Principle 6 states that signatories will ‘report activities and progress towards implementing the Principles’. For many funds this Principle has been interpreted as reporting to the PRI secretariat about progress implementing the Principles. However if you go back to the original guidance that was developed to assist interpretation it is clear that the founders of the PRI intended that reporting would also be to stakeholders and beneficiaries. Specifically the guidance on Principle 6 suggests that signatories can ‘communicate with beneficiaries about ESG issues and the Principles’ and ‘make use of reporting to raise awareness among a broader group of stakeholders.’

Portfolio Holdings Disclosure is likely to provide the impetus for superannuation funds to turn their attention to reporting their ESG activities to an external audience. Over the next decade superannuation will become increasingly competitive. As funds fight to recruit and retain members an active approach to communicating responsible investment may become an asset.

The superannuation industry, and indeed pension funds globally, is unique in that it has been able to largely escape the demand for corporate social responsibility or sustainability reporting. Whilst a large proportion of listed corporations produce their own sustainability reports, or report in some form on non-financial issues, the reporting by superannuation funds on their own activities is sporadic. Ac super funds increase their engagement with members there will come a time when it is the norm for superannuation funds to produce a sustainability report that provides details of what the fund invests in, how it engages and how it contributes positively to society.

Maximising Superannuation Capital

Maximising Superannuation Capital

printed in ASFA Super Funds Magazine June 2013

As the superannuation system climbed over $1 trillion of assets it first began to attract attention from public policy makers. As the system approached $1.5 trillion public policy makers became more heavily engaged, launching inquiries commencing with the Cooper Review that have resulted in the range of Stronger Super reforms that have been targeted at improving efficiency and reducing costs. Most recently there has been intense focus on the level and distribution of superannuation taxation concessions.

If we think that the attention of public policy makers will wane once these reforms are over then think again. With Treasury predictions that superannuation will hit $6 trillion by 2037 the system will become the largest financial asset in the country. The way in which superannuation invests will influence not only economic activity but indeed the structure of the Australian economy, financial stability and of course the wellbeing of millions of Australians in retirement.

Understanding the importance of superannuation to the nation ASFA commissioned Deloitte Access Economics to produce a report that examined whether Australia’s superannuation system is meeting its primary objective of helping individuals to fund their retirement. The report, Maximising Superannuation Capital, explores the impact of the growth of superannuation in the context of providing retirement benefits (income and capital) for people in retirement, linking savers and investors within the wider financial system, and supporting financial stability in the Australian economy.

The key conclusion of the report is that the superannuation system is flexible enough to meet the needs of the nation in the future. The report confirms that the superannuation industry has the flexibility to respond to the transition from accumulation to draw-down by evolving business models and developing new products.
The growth of the superannuation system should not compromise the stability of the financial system, even as the pool of funds grows.

Further the report found that whilst the superannuation system already supports Australia’s long- term economic growth it has the flexibility to accommodate future demands for capital.

One of the questions commonly asked is whether superannuation can do more to invest in assets including infrastructure and venture capital. DAE found that Australian superannuation funds invest a large majority of assets within Australia, exhibiting significant home bias. The Australian superannuation already invests more in its home country than other pension system.

Recognising that public policy makers may want to consider whether superannuation can do more to support particular investments the report found that the best way to do this was through incentives, rather than mandating. The report states “while incentives may help to maximise the economic impact of superannuation capital, mandated allocation risks leading superannuation away from its primary purpose―funding income in retirement. Market forces determine that capital will flow where it is most valued. This obviates the need for any specific interventions mandating asset allocation of superannuation fund investment strategies, as this is an invitation to poor performance and lower returns.”

Risk Management

DAE considered whether the superannuation system has the capacity to adapt to the demographic and structural challenges arising from Australia’s ageing population. Recognizing that Australia’s superannuation system is approaching a transition as the Baby Boomer generation approaches retirement shifting, a significant portion of assets from accumulation stage to ‘de-accumulation’ phase. Australia’s demographic shift means that retirees will make up a greater portion of the population in the future. Retirees will also live longer.

Australia’s superannuation system has been designed to deliver a lump sum. A challenge is for individuals to turn this into a retirement income stream. DAE argue that an individual’s ability to manage risk will hinge on the availability of suitable instruments to manage this risk. The shift in phases will be associated with several changes. Those in the de-accumulation phase face different risks, and have different priorities. Managing these effectively will be vital to the performance of the superannuation system in the future.

One solution is likely to be to make retirement income streams more attractive than lump sum payments. DAE proposed other options to address shortcomings in individuals’ ability to manage retirement income risks including continuing to improve financial literacy, offering incentives for the take-up of products well suited to managing retirement risk such as by encouraging products that provide an income stream in retirement and developing other products that yield a reliable income stream, such as Australian Pensioner Bonds.

DAE conclude that the superannuation industry is well positioned to manage a transition to de-accumulation. The transition will impact the business models of superannuation funds, as more accounts transition from the accumulation phase to the draw-down phase. Inevitably, as more of their members move into retirement, superannuation funds will adapt their business models and products to the retirement phase.

SMSFs present a challenge

The report identified that the size of SMSFs and their importance to the superannuation industry mean that there are a few key questions that need to be addressed to ensure the long term stability of this part of the superannuation industry.

According to DAE a potential longer-term problem arises from policies that encourage the growth of SMSFs. Typically SMSFs are managed at a family level. Generally, one person will be the primary manager of the account. If a person were to die, leave the relationship, or otherwise become unable to make investment decisions, it is unclear if the other individual would have the financial literacy to continue to manage the SMSF.

There are also risks associated with ageing of individual trustees, and consequent ability to manage the fund in the de-accumulation phase. It is also unclear whether the asset allocation of SMSFs, as they currently are, is the most appropriate asset allocation for investment as individuals move out of the accumulation phase and into the retirement phase.

Financial Stability

The report found that superannuation has the capacity to support stability of Australia’s financial system. By their nature, superannuation funds have a longer-term view of investment. Their key role is to seek the best risk/reward trade-off and, in doing so, they pursue an investment strategy that duration-matches their long-dated liabilities. As a result, they tend to invest in less volatile, longer-term assets and are consequently more concerned about corporate governance than other investors.

Superannuation and banking operate different but complementary business models, with different risks to manage. For its part, the Financial Stability Board (FSB) seems not to be especially concerned about the impact of defined contribution (DC) pension funds on systemic stability. Indeed, during the GFC superannuation funds repatriated FUM which helped augment the supply of capital for domestic banks and large corporates.

Superannuation and national savings

One area of debate is whether superannuation has had a positive or negative impact on Australia’s banking system. DAE concluded that the increase in superannuation assets has occurred at a time when authorised deposit-taking institutions’ (ADIs) share of system assets has also been rising. While assets of superannuation funds have grown, assets of ADIs have grown faster. Between 1999 and 2012, superannuation assets grew from 16% to 22% of system assets, while ADIs increased their share from 46% to 60%. Consequently, superannuation does not appear to be attracting funds away from banks, to the detriment of traditional borrowers from banks, but from life offices and managed funds. However DAE identified that this could change in the future.

Historically, Australia has not generated enough domestic savings to fund domestic investment needs, relying on offshore lenders to make up the difference. Available evidence supports the notion that compulsory superannuation has contributed to national saving. As a share of GDP, Australia’s national saving has tended to be higher than that in other advanced economies and has increased since the late 80s, whereas saving in other advanced economies has declined. This higher and increasing trend in national saving is in line with the introduction of award-based superannuation in 1985 and the compulsory superannuation guarantee system in 1992. Moreover, while funding investment through national saving lowers the risk profile of a country and thereby contributes to financial stability, this offshore investment provides a hedge to the country’s domestic investments, also lowering risk.

Liquidity

One of the challenges that superannuation funds have is the requirement to manage liquidity of investments. APRA’s new Investment Governance Prudential Standard (SPS530), which will become effective on 1 July 2013, requires superannuation funds to formulate and implement a liquidity management plan and undertake comprehensive stress testing of investment portfolios in a range of stress scenarios.

DAE argue that APRA’s requirements for high levels of liquid assets are a disincentive for superannuation funds to invest in long-term and illiquid assets. It is not clear how strong this disincentive is but changes to regulation are intended to change behaviour. There is evidence to show that funds investing in illiquid assets are able to capture an illiquidity premium. A recent APRA paper entitled, ‘Risk and return of illiquid investments: A trade-off for superannuation funds offering transferable accounts’ (APRA, 2012) shows that ‘funds with moderate allocations to illiquid investments experience higher risk-adjusted returns, which suggests that they capture a risk premium for investing in these assets’.

One potential solution to alleviate the liquidity requirements for superannuation funds would be to establish a liquidity facility for superannuation funds. A liquidity backstop for superannuation funds, with appropriate ‘haircuts’ to guard against moral hazard, may provide a solution that would satisfy APRA and leave superannuation funds free to make investment decisions that best meet their members’ needs. The Committed Liquidity Facility (CLF) the Reserve Bank of Australia (RBA) manages for ADIs could be considered as a model. The facility would operate in a similar way to that provided by the RBA for banks. Currently, banks can enter into a repurchase or repo agreement with the RBA, whereby banks can sell Commonwealth bonds and eligible securities to the RBA and buy them back at a later date. The repo agreement is essentially a secured loan, with the proceeds providing short-term liquidity. Under the proposal, superannuation funds regulated by APRA could utilise this facility alongside banks. This arrangement would also create incentives for superannuation funds to hold more repo-eligible securities, in particular fixed income securities. DAE state that the merits of a liquidity backstop need to be demonstrated.

Contributing More to the Economy

Superannuation funds already contribute to the national economy. Australia’s superannuation system has a strong home country bias which means that the contribution of the Australian system is likely to be more than other nation’s pension system.

According to DAE it is not obvious that superannuation funds can plug gaps in financial markets. If capital flows to where it is most highly valued, this may explain why some sectors miss out. If capital will find its way to profitable investment, then all worthwhile opportunities will be pursued. The challenge is to find a way to prioritise these opportunities so the most worthwhile ones get funded first. If superannuation funds are asked to help meet economic objectives, it should not be in a manner detrimental to returns on fund members’ retirement savings.

The report examined a range of areas where superannuation funds could fill gaps. One area that was identified was investments in small and medium-size businesses, where superannuation funds would need more credit skills and access to more research on small companies.

Overall DAE argued that if the cost of leaving gaps unfilled is deemed significant and higher levels of investment by superannuation funds is regarded as essential, a more activist approach will be required. The best way to do this is not to mandate investments but to develop more instruments that are suited to superannuation funds (capabilities) and their members (risk preferences). Intermediaries will continue to play a part in facilitating superannuation funds’ involvement. For example, investment banks have traditionally brought new products to the market. Superannuation funds have taken up these new products where appropriate to the needs of their members.

The Future

DAE expect that the superannuation industry business model will evolve in response to current issues. Importantly they identify that superannuation cannot provide all the answers to managing retirement income risk―since superannuation is co-mingled with other sources of income and capital such as the age pension, houses and other assets―and that therefore other things must be done to complement superannuation.
Superannuation will continue to grow for many decades to come. Superannuation prudently overseen, should not compromise financial system stability. While incentives may help to maximise the economic impact of superannuation capital, mandated allocation will lead superannuation away from its primary purpose of providing retirement benefits for people in retirement.

ASFA invites comments on the report Maximising Superannuation Capital which can be found at:

http://www.superannuation.asn.au/policy/reports

Pension and Superannuation Fund Investment in Innovation

Superannuation Fund Investment in Innovation

Melbourne Financial Services Symposium

Thursday 7 March 2013

Today I wanted to talk about why it is important that the superannuation industry work collaboratively to address the challenges that we currently have investing in what may be called innovation assets.

In my presentation I will be specifically focusing on the role that the ASX plays in providing opportunities for superannuation funds to invest in innovation companies. Young, start-up companies in areas such as Biotech, Clean Technology and Technology already look to the ASX as a means to raise capital.

To start let’s have a look at where the superannuation system is currently at.
According to the APRA December Quarter statistics the system has $1.51 trillion.

What is of particular interest is the rate growth. Over the last twelve months the value of superannuation investments has increased by $192.2 billion. In the last quarter alone we have seen we have seen $21.9 billion contributed to APRA regulated funds. Total contributions in 2012 were $92.2 billion up from $83.8 billion in 2011.

We can expect that the system will continue to grow. Deloitte estimates that by 2028 the system will have $7 trillion in assets.

I want to look at what this may mean for future asset allocation by superannuation funds.
In particular I want to look at the ASX where super funds invest a significant portion of new monies. The market cap of the ASX is around $1.38 trillion.

There are 2,183 companies in the ASX but 95% of the value of the market is in the ASX 200.
Superannuation funds roughly allocate 95% of their investments in ASX to the ASX 200.
The 5% that super funds do invest outside the ASX 200 is still significant, making up over $21 billion.

But here is the problem. The superannuation industry is rapidly outgrowing the ASX 200.
The continued strong cash flows each month into superannuation mean that funds must invest.
If we assume around $80-90 billion of annual contributions on a typical asset allocation we could expect that funds will invest up to an additional $20 billion into the ASX each year.

This equates to 20 $1 billion companies. Given that 92% of the market is made up of companies with a market cap less than $1 billion this indicates the size of the challenge.

There are already a number of implications of our growing size. Super funds for instance are increasingly drawn to dark pools because the size of some of the larger funds in particular means that it can be hard to execute in the lit market without moving the market.

But the more significant question is where does the super industry turn to for future investment?
The challenge that we have is that outside of the ASX 200 the market is illiquid and concentrated.
While liquidity is largely a function of size there are very good reasons why outside the ASX 200 more than half the market is mining and resources related.

We may think this is due to the all the ore that we have in the ground but in reality it is due to the regulation of the market, in particular the Joint Ore Reserves Committee that has meant that Australia has become an attractive place to list for international mining and resources companies.
There are over 200 ASX companies that solely work in Africa. We also have 15 mining companies based in Mongolia. One of the reasons we have such presence is that ASX has actively sought listings by putting people on the ground in Mongolia to recruit companies.

One option of course is for superannuation funds to seek investments outside of the ASX – and this is happening already. However it makes sense for the superannuation industry to consider how the whole of the ASX could be made a better place for future investments.

There are a number of ways the superannuation industry can work together to create more opportunities in the ASX.

The first thing is to understand that markets are a regulatory construct. The codes that have been developed for the mining industry have supported the development of mining and resources companies. The question is can we use similar codes in other areas to support the development of other sectors. One example is the Code of Best Practice For Reporting by Life Science Companies which is currently being reviewed. We know that there are US biotech companies that are now attracted to list on the ASX because of this Code. Are there ways that this could be further supported?
The second area we can concentrate is for the superannuation industry to collaborate to explore how we can support the development of the ASX. This could take a number of forms including establishing a working group that explicitly focus on this end of the market.

The size – and continued growth – of the superannuation system means that it is in our best interests to address the challenges in the ASX.

To finish it is worth asking the question does this is all matter. Is it a problem if super funds simply increase their allocations to global markets and diversify away from ASX?

It is worth delving for a moment into the economic history of one of the great economic empires of the modern era – the Netherlands. Kevin Phillips in his polemic book Wealth and Democracy examined the decline of the Netherlands which had been a significant merchant power in the 1600’s but by the 1740’s consisted of a divided society with a wealthy Dutch upper class and growing unemployment in towns that had once been thriving places for industrial production. Phillips attributes the decline of the Dutch empire in part to the fact that the Dutch upper class preferred to invest in economies other than their own, a fact that was not seen to be a significant issue at the time. In fact there were elements of Dutch society that advocated that the increased size of the finance sector that grew to service the Dutch upper class would more than compensate for the loss of domestic industries. This did not prove to be the case and the Dutch empire gradually faded, its demise accelerated by numerous wars.

Whilst things may have moved on over the last three hundred years the reality is that the superannuation industry and the economy are interlinked. Our contributions come from millions of Australians who rely on a strong economy for their future work. For that reason alone we have a responsibility to do what we can to make the ASX are better place for future investment.