The trillion-dollar superannuation industry may need some strategic shifts if super funds are to stay liquid.
State Super NSW has particularly powerful motives to tightly manage its investment risks. The A$41 billion fund has been cash-flow negative for the past 10 years and half its members are in retirement while the other half are nearing retirement.
No doubt, the trustees and chief executives of Australia’s super funds would place the challenges of State Super NSW high on their list of circumstances to avoid as the country’s population ages.
The reality facing Australia’s A$1.8 trillion superannuation industry is that contributions are decreasing in proportion to rising retirement payouts. And this change in cash flows is gathering pace. Some leading analysts forecast that within 30 years the Australian superannuation industry as a whole will turn cash-flow negative.
In short, State Super’s predicament in 2014 – with more money going out than coming in – appears to provide an unerring insight into the distant future of Australian superannuation.
Yet despite his fund’s maturing members, chief executive of State Super NSW, John Livanas, does not attribute its negative cash flow to the ageing of the population but to the particular circumstances facing it. The fund’s four defined-benefit plans are closed to new membership, meaning that a flow of new members cannot replenish its coffers. And its membership demographics must continue to age.
“The bottom line is that any fund experiencing a negative cash flow has to operate in a very different environment and run its investment process very differently to one with a positive cash flow,” Livanas stresses.
Over the past 20 months or so, State Super has intensified its management of investment risks, running all of its assets and its fund managers through a sophisticated risk-modelling system. “If a positive cash-flow fund makes a mistake, a pile of new money is coming in tomorrow [through contributions],” says Livanas. “But if we make a mistake, the money is gone.
Our way of responding to this is to manage our risk with extreme care – we just cannot afford losing investments.”
But this does not mean the fund is moving away from infrastructure and direct property investments. Livanas emphasises the need to achieve the returns from such investments to make the most of the fund’s assets. State Super expects the dollar value of its assets to remain at its current level until 2030. “And that’s a long way off,” as Livanas says.
So what does the ageing of Australia’s population and rising retirement payouts mean for super fund cash flows, investments in infrastructure and other illiquid assets, as well as for sustainability of the super system?
Well, despite their ageing memberships, the super industry is not plunging into a death spiral. And independent specialists believe there will be no flight from long-term infrastructure projects as cash flows become less favourable.
Michael Rice is chief executive of Rice Warner Actuaries, which looks into the long-term future cash flows of super funds with its annual Superannuation Market Projections report. He believes Australia’s superannuation industry as a whole will not become negative until about 2040.
“Predicting that far out is hard,” he cautions. “Much depends on population growth and if people retire later.”
Rice expects that a small number of super funds with particular characteristics could experience cash-flow difficulties in the foreseeable future. These may include defined-benefit funds with closed memberships and some smallish funds with stagnating memberships. In turn, more small funds will merge with large funds as their cash flows tighten.
But it’s a different scene for larger super funds. Large industry funds, for example, hold 10 to 20 per cent of their portfolios in infrastructure and direct property, and Rice doesn’t expect this to change in the next couple of decades. As some large funds face progressively tighter cash flows, they may actually increase their investments in infrastructure in an effort to maximise returns.
“They will want the illiquidity premium,” he says. With some infrastructure investments producing double-digit returns, it’s not hard to see their appeal.
Rice Warner’s latest Superannuation Market Projections report estimates that by July 2014, employer and employee contributions to Australian super funds will exceed benefit payouts by almost A$70 billion. And by July 2027 (the end of the forecast period), Rice Warner expects the contributions to still exceed benefit payouts by almost A$52 billion in today’s dollars.
However, the very, very long-term trend appears set as funds slowly move towards becoming cash-flow negative. Fund cash flows take into account more than contributions and retirement payouts, also bringing in fees, taxes, premiums and earnings.
In the meantime, Rice Warner forecasts that the number of super pre-retirement accounts will grow only marginally over the next decade and a half, while the number of retired fund members will more than double.
As a sector, self-managed super funds (SMSFs) are expected to experience by far the largest outflow of retirement benefits over the next 15 years. This is hardly surprising given that SMSFs already hold half of the superannuation money invested in retirement products.
Nevertheless, Rice Warner calculates that the SMSF sector will lose only a small slice of its pre-retirement and retirement market share over the next few years and will increase its assets under management in today’s dollars. Even in 2027, Rice Warner expects SMSF retirement payouts to reach only 70 per cent of contributions in that year.
From the industry fund perspective, the ageing of the population can be painted as somewhat of a good news story for decades to come. Rice Warner estimates that Australian industry funds will hold 18 per cent of post-retirement super dollars by 2027 – up from 5.5 per cent today. This is largely attributable to many more of their members retiring, as well as better pension products.
Deloitte’s Dynamics of the Australian Superannuation System: The Next 20 Years report also projects that the super industry as a whole will remain cash-flow positive for many years to come. However, Deloitte’s superannuation advisory partner, Russell Mason, and principal, Ben Facer, agree that some funds are vulnerable to becoming cash-flow negative much sooner.
Funds with a large proportion of “deferred members” are among those that are more susceptible. Deferred members are those who have left an employer but keep their super in the employer’s fund until retirement.
“The liquidity of such a fund’s investments is much more important,” says Facer.
"Australia has to move away from that lump-sum mentality." – Michael Davison, CPA Australia
Another potential liquidity issue as cash flows tighten is the reality that most members have the freedom to transfer their super to another fund. Mason says funds with very high levels of illiquid assets could be forced to sell those investments if members suddenly depart following an adverse event or bad publicity.
Particularly following the global financial crisis, the Australian Prudential Regulation Authority (APRA) has been emphasising to funds the importance of having sufficient liquidity to pay member benefits on switching to another fund, retirement or death.
Mason believes that funds could remain in a strong cash-flow position for longer by getting to know their members better. By better understanding their members, Mason says funds will know when they are most likely to switch to another fund.
For instance, many people leave large funds at the time of retirement to receive a pension from an SMSF.
Another factor that adversely affects a fund’s cash flow is that many retirees take their super as a lump sum rather than a pension. Mason suggests the Australian Government should look at whether to regulate that most of a member’s super must be taken as a pension, perhaps with a deferred annuity component that pays an income from age 80 or 85.
The limiting of lump-sum payouts would make Australia’s retirement system more sustainable. Mason points out that 22 years after the introduction of compulsory super, 80 per cent of retirees still receive a full or part government pension. And Deloitte forecasts that this will only move down to 75 per cent of retirees over the next 20 years.
Michael Davison, senior policy adviser, superannuation, with CPA Australia, is concerned about the way super is used to repay debt on retirement rather than to provide a retirement income.
More than half of the currently retired super members took at least part of their pension as a lump sum, according to the Australian Bureau of Statistics. And almost a third used at least part of their lump sums to pay off home mortgages, buy new homes or do home improvements.
“Australia has to move away from that lump-sum mentality,” Davison says.
“We need to encourage people to take a pension, because at 60 their money may need to last another 30 years.”
The liquidity of some property-owning SMSFs may also be an issue, according to CPA Australia. Davison notes that some trustees in their mid-50s are setting up an SMSF with a geared direct property as its only asset. Once the members retire, these funds might not have the income to service the property loan and to pay member benefits.
Ben Facer of Deloitte says the retirement funds in many Asian countries face a much more fundamental liquidity issue than their Australian counterparts: Where is most of the money going to come from to finance the retirement of their ageing populations?
Unlike Australia, Asian countries typically have not built up a huge pool of retirement savings. They often have “very immature” formal pension systems, says Facer. And some have largely unfunded statutory corporate schemes, which are similar to defined-benefit plans. Asia has few centralised state pension plans, with the main exceptions being in Singapore, Malaysia and Hong Kong.
“Many multi-nationals operating in Asia don’t like having unfunded schemes so have voluntarily set aside assets for their defined-benefit plans,” Facer adds. It is also common for multi-nationals with branches in Thailand, for example, to set up additional defined-contribution plans.
Facer – who spent years in Singapore as retirement, risk and finance leader for South-East Asia with the Mercer group – expects that Asian governments will have to largely rely on adult children following their cultural traditions by caring for their ageing parents.
Some Asian countries have both immature pension schemes and unfunded defined-benefit schemes. These include the Philippines, Indonesia and India.
Japan and Singapore, which are expected to have the oldest populations in Asia, have different types of retirement funds. “Japan has a large corporate defined-benefit system,” says Facer, “and Singapore has a central defined-contribution plan.”
The state of Australia’s super and government pension systems are very different to Asia’s. However, the latest Melbourne Mercer Global Pension Index report suggests that Australia along with other countries take similar broad steps to ease the financial pressure on state pensions and retirement funds.
Common challenges include increasing the age that people qualify for a government pension, encouraging people to work until older age, promoting private saving and increasing the involvement of workers – including the self-employed – in private retirement plans. Another challenge is to reduce the spending of retirement savings on other things such as repaying debt.
In respect of particular Asian countries, the Mercer report suggests that Singapore needs to increase the participation of older people in the workforce, that Japan requires part of all retirement benefits to be taken as a pension, and that both Indonesia and India introduce a minimum age for access to retirement benefits.
Melbourne entrepreneur Aron Ping D’Souza, 28, is optimistic that his latest project – a superannuation fund that invests in a socially and environmentally responsible way – will engage many young people in their super for the first time.
D’Souza, who established Good Super with another Melbourne entrepreneur, Phillip Kingston, also 28, believes that socially and environmentally aware companies are exposed to fewer risks and make more sustainable investments.
D’Souza calls Good Super an “impact” fund rather than an ethical fund, because it assesses the overall impact of its investments. For example, the fund invests in resources stocks because of the need for materials to build much-needed infrastructure.
“Impact investing identifies businesses that are profitable and which deliver positive social returns,” he explains.
“By investing in these sorts of opportunities, impact investors look to do good in the world and do well for their personal nest egg.”
And he is adamant that people who choose to save through an impact fund should not be expected to sacrifice returns.
The “grand challenges” Good Super wants to address include extreme poverty, land use, food security, gender equality, Indigenous health, corruption, energy, clean drinking water and youth unemployment.
D’Souza is hopeful the fund will help set a trend so that fewer young people will face the sorts of issues that confronted their parents, including widespread disinterest in super, inadequate retirement savings, and seeing their money invested in ways that may be damaging to the environment and the interests of society.
Good Super invests in a range of funds managed by Perpetual, AMP Capital, Triodos Bank and Social Ventures Australia, among others. Its fees are in the range charged by standard retail superannuation funds.
D’Souza agrees it’s a challenge to get young people interested in super, given that many are 50 years off retirement. However, the fund has signed 4600 members since last October and aims to eventually hold A$20-$30 billion.
- Access the following CPA Library items online at cpaaustralia.com.au/liquidityguide
- “More Risk-Taking by Funds Seen in 2014”, by HH Cai, The Business Times, 2014
- “Can Hedge Funds Save Troubled Pension Funds?”, by J Sundt, Investment Advisor, 2013
- “APRA Sounds Warning For Super: ‘Funds Must Remain Liquid’”, by G Korporaal, The Australian, January 2013
Contact CPA Library on 1300 737 373 or email [email protected]
This article is from the May 2014 issue of INTHEBLACK magazine.