The problem with Grattan’s default fund tender

The Grattan Institute this week released a report into Australia’s superannuation system proposing that the Government should introduce a tender for default funds.

The aim of the default tender would be to reduce costs in the system – something that would have long term benefits for future retirees through increased account balances.

Grattan argue that a core criteria of the default fund tender would be fees. There are a number of ways that a superannuation fund reduce fees. One way, as identified by Grattan, is through scale. Another way is to invest passively, something that Grattan supports on the basis of the track record that active managers have beating their indexes.

Leaving aside the debate about passive and active management, there is a need to consider the impact that index investment has on capital markets and capital formation.

According to Jeffrey Wurgler, Nomura Professor of Finance at the NYU Stern School of Business, the dominance of indexed linked investing is having economic consequences.

According to Professor Wurgler “There is no doubt that indices and associated investment products are innovations that on the whole have benefited many individuals and institutions. On the other hand, their popularity has created underappreciated side effects.. (which) stem from the finite ability of stock markets to absorb index-shaped demands for stocks. Not unlike the life cycles of some other major financial innovations, the increasing popularity of index-linked investing may well be reducing its ability to deliver its advertised benefits while at the same time increasing its broader economic costs.

Wurgler documents a number of impacts of index investing including Index Inclusion Effects. On average, stocks that have been added to the S&P between 1990 and 2005 have increased almost nine percent around the event.

Once a stock becomes part of an index it starts to move with the index, something Wurgler describes as comovement. Over time index members slowly detach from the rest of the market. Evidence is also suggesting that increased index investing is associated with increased volatility in the market. Other impacts include on debt finance, with research demonstrating that new S&P 500 inclusions increase their rate of equity issuance and reduce their leverage.

As an investment strategy, indexing can make sense. However, the danger with the Grattan proposal is that we create policy settings that encourage indexing without any consideration whatsoever as to whether there is even the possibility that there could be an impact on the market and the Australian economy.

A default fund tender is not a bad idea. But before we proceed we need to consider all the impacts. The size of the superannuation pool means that superannuation is now interconnected with the Australian economy. And it also why it is time that the Grattan Institute established a permanent work stream on superannuation.

On the Economic Consequences of Index-Linked Investing
Jeffrey Wurgler
Nomura Professor of Finance, NYU Stern School of Business

WHO’s call for clinical trial transparency a wakeup call for investors

The lesson from WHO’s statement on clinical trials is how to build partnerships with community and not-for-profit organisations to enable active engagement on a broad range of issues.

The World Health Organisation this week issued a public statement calling for the disclosure of results from clinical trials for medical products, whatever the result.

The WHO’s statement has arisen out of growing concerns that pharmaceutical companies are systematically withholding reporting of clinical trials where the results may not be favourable to drugs that are being tested.

In their statement the WHO quote a study that analysed reporting from large clinical trials registered on and completed by 2009, 23% which had no results reported.

There has been a great deal of focus on the actions of Roche with respect to its Tamiflu drug which the Australian and UK Government stockpiled as a precautionary measure in the event of an outbreak of a global flu virus. According to Ben Goldacre, author of Bad Pharma, Roche withheld vital information on its clinical trials for half a decade. A global not-for-profit organisation of 14,000 academics, Cochrane Collaboration, finally obtained all the information, discovering in the process that Tamiflu has little or no impact on complications of flu infection, such as pneumonia.

There are big dollars at stake.

The UK government spent £0.5bn stockpiling tamiflu and since 2002, the Australian government has spent $380 million. This is taxpayer funds that could have gone elsewhere.

For investors there are broader concerns around the way large corporations are influencing government regulations by funding of academics.

In the last couple of months an investigation has revealed the extent of funding from Coca-Cola, PepsiCo, Nestlé and others to academics that sat on the UK’s Scientific Advisory Committee on Nutrition (SACN) and the Medical Research Council (MRC).

Beyond academic funding, there is also a concern at the extent of lobbying of particular industries including telecommunications, food, banking and pharmaceuticals.

As the fiscal position of governments in developed countries around the world deteriorates (as the retirement of baby boomers places strain on public health and pensions systems) it will be increasingly tempting for universities and other bodies to rely on corporate funding. The problem with this is that it will inevitably result in questions of conflict of interest that will undermine public confidence in research.

For investors who are seeking to grapple with the challenges around fossil fuels, the deteriorating community confidence in the corporate sector is an issue that is being put in the “let’s look at that later” pile.

For investors, the heart of the matter is whether it is possible to become active on a broad range of issues simultaneously. Whilst climate change is the issue of the century, other issues should also be addressed. Investors have for instance been caught flat footed when it comes to the debate around corporate taxation.

It is a lot easier for investors to become engaged around complex issues than it ever was before. Groups such as the Centre for Accountability in Science, All Trials and the Cochrane Collaboration are natural partners for responsible investors.

Investors should accept that they can’t do it all. The era of corporate accountability requires investors to develop new approaches to building partnerships.


Campaign for clinical trials to be released:

Roche’s Tamiflu saga

World Health Organisation’s statement on clinical trials:

Bad Pharma by Ben Goldacre

Flexible Petrol Levy the solution to addressing congestion

A flexible petrol levy that rises and falls with global petrol prices, is a better way to address congestion than the cost reflective road pricing model proposed by the Harper Competition Review.

According to the Competition Policy Review new technology provides an opportunity to introduce cost reflective road pricing. The Review states:

More effective institutional arrangements are needed to promote efficient investment in and usage of roads, and to put road transport on a similar footing with other infrastructure sectors. Lack of proper road pricing leads to inefficient road investment and distorts choices between transport modes, particularly between road and rail freight.

The advent of new technology presents opportunities to improve the efficiency of road transport in ways that were unattainable two decades ago. Road user charges linked to road construction, maintenance and safety should make road investment decisions more responsive to the needs and preferences of road users. As in other network sectors, where pricing is introduced, it should be overseen by an independent regulator.

Cost reflective road pricing would essentially involve different charges for different roads, with the potential to even charge different prices at different times.

The core rational behind cost reflective road pricing is that if a person is charged to drive on a particular road at a particular time they will assess whether the fee they are being charged is worth it. From an economic perspective those who have lower value uses, would shift their behaviour and travel at different times.

In economic terms the problem with cost reflective road pricing is the inelasticity of demand.

As a concrete example consider an employee who must arrive at their job at 8.00am. If they are late they will receive a warning and potentially dismissal. Theory would suggest that this employee would shift their behaviour, by perhaps taking public transport to their job. But the reality of where many jobs are located in Australia’s congested cities of Melbourne and Sydney, and increasingly Brisbane, is that public transport does not offer a realistic alternative at peak times. The problem is that with the exception of CBD based employment, jobs are distributed across the city. And it is the employer, not the employee, who has power over starting and finishing times.

Those employees that are employed with fixed working hours will simply absorb any road pricing increases on their particular transport route. Pricing will therefore not impact congestion.

Cost reflective pricing may result in some individuals shifting their behaviour ,but before we race to implement technology that will not be costless we need to understand where the burden of pricing would fall.

The problem with cost reflective road pricing is that it does not take account of the structure of cities, nor of the individual circumstances of road users. It does not take into account the way the control of employment exercised by employees.

There is an alternative that can provide the funding to address congestion.

My suggestion is to establish an infrastructure levy on petrol prices that would vary according to global petrol prices.

Now is the perfect time to introduce such a levy, which would be in addition to existing petrol taxes.

According to investment analysts, oil has been hoarded in around the world in empty tankers and we are now close to the point where all available storage facilities have been used. Once this point is reached there are predictions that the price of oil will fall again.

The problem with volatile oil prices is that they send exactly the wrong signals at the wrong times. If we believe that congestion can be addressed through pricing mechanisms, and we believe that the economic benefits of introducing cost reflective road pricing are worth it, then it would also make sense to regulate the current oil price volatility.

One of the challenges that governments have in building new infrastructure, whether rail or road, is how to fund them. One option is to introduce a new infrastructure levy on petrol prices.

If we want to send a price signal re congestion through pricing then it makes sense for the government to collect any windfall from reduced prices.

If, and when oil prices increase then the levy should be automatically reduced, which would result in a steady price at the petrol pump. Given the significant benefit to consumers from the recent falls in petrol prices, it is arguable that a levy price could be set at a rate that is modestly above the existing global oil price.

In terms of administration, establishing a flexible industry levy would not require a new regulator or the use of technology on every road and every car. It would simply require a piece of legislation mandating the collection of the levy at the wholesale point of production or import.
The flexible petrol levy would go straight into a national infrastructure fund that would provide the Federal Government with an additional bucket to fund projects aimed at reducing congestion.

Congestion in Australia is largely the product of the design of our cities, which were designed in an era of low petrol prices when the invention of the motor vehicle enabled urban sprawl. We have now reached the limits of sprawl, but we have not developed the efficient public transport systems that we commonly see in Europe.

Turning Sydney or Melbourne’s public transport system into something that compares to London or Paris may be decades away. The key will be finding the money for the necessary infrastructure investment, some of which may not be able to be financed by the private sector, would nevertheless have significant productivity benefits.

With global oil prices on the tip of another fall there has never been a better opportunity to capture funding in a way that doesn’t hurt consumers.