The Grand Plans of Industry Funds

GW The industry fund sector now is about $115 billion. It’s obviously grown from zero over the past 20 years.

MP And what’s your target, in market size?

GW Well, total superannuation assets in Australia are growing pretty rapidly, like $750 billion-something now, and we’d like to think that one day we could be 80 per cent, but I think that’s a fair way off.

MP Eighty per cent of the market?

GW There’s no reason why not. On the current competitive advantage, it should be able to get to that figure. Maintaining that competitive advantage, of course, is a challenge, and there is also the problem of a lot of misinformation, and getting the message out to people that we do, in fact, have the competitive advantage that we believe we have.

MP This must indicate that you think you’re already winning the super choice war?

GW We’re not 100 per cent clear on that. It does appear to us that we’re doing fairly well on early indications. Certainly recognition of our message is getting through. Whether that’s translating in terms of market share I think will take a little '¦ because these days, with a lot of companies putting in returns monthly or quarterly, it means that we don’t really get those company returns entirely until probably October to see what the move is. And, of course, for all the talk about choice, this system really revolves around employer choice.

MP So it’s too early to say there’s any particular pattern, particularly when company funds fold?

GW Company funds are certainly going to fold. Corporate funds are folding anyway. The real question is the market share battle between industry funds on the one hand and retail master trusts on the other, with the other wild card being self-managed or do-it-yourself super.

MP $115 billion, that’s, what, less than 20 per cent of the market?

GW It’s more like 13 per cent '¦ but it is growing. It’s only growing fairly slowly in funds under management terms. In terms of number of members, of course, the market share is much higher. Something like half the workforce would be members of industry super funds.

MP To get from that level to 80 per cent, you would be taking a lot of market share from private funds. You must be expecting a big fight?

GW We are expecting a fairly hot environment, and it’s been warm. The financial planning community and the accountants who receive commissions to sell master trusts don’t like [our] industry funds because we don’t pay commissions; and, obviously, the big brand master trusts, the banks and the big commercial master trusts that sit behind the commission agents, are being low key in a way, but they’re obviously relying on that commission-based selling to win the day.

MP What are your weapons to increase your market share so markedly?

GW We do have a large share of the workforce. We have a lot of members, and those members can get the message that they’re actually getting out-performance. What’s really crucial is that people understand that performance is what’s in your account at the end of the day, not what people say and not what people headline. So it’s about a combination of fees and investment returns. We talk about net benefit to members. We try to publicise that as much as we can and, if we need to, we will spend money to publicise that to the public.

MP You mentioned employer choice, particularly when a company fund closes. Are you coming across employers getting any pressure to offer a default fund, that is, a private rather than industry fund?

GW Yes, that’s the real name of the game, and a lot of advisers and a lot of companies do start out with a favoured position for some of the big-name master trust providers. The history of industry funds means that they are not always warmly embraced. After all, historically, industry funds were created by industrial bargaining, and there’s union involvement. Some people still have sort of a historic concern about that. These days, of course, most people recognise that industry funds are run by an amalgam of employer associations and union representatives and are extremely successful. There are not many super funds that actually can stand up after 20 years and say they have got a continuous record, let alone an out-performance record.

MP So what sort of percentage are you getting as default funds?

GW That’s really hard to know until the final employer returns come in '¦ as they’re coming in, it’s looking quite healthy. No one in any part of the market expects big swings in market share in any one year, or at least in the first year of choice. There’s a large inertia. Most people won’t readily change funds, and that’s a good thing. People shouldn’t be switching around every five minutes, but small changes in market share will be very important over time, so it’s looking quite reasonable. Until the September quarter returns are in from employers, we won’t know how many have either added industry funds as a default fund or crossed them off.

MP You haven’t got a feeling for it, though?

GW Our feeling is we’re going to do OK, but not that there’s going to be any major shift in market share in the single year.

MP To what extent are industry funds genuinely public offer? I mean, can I join CBUS or MTAA?

GW You can. Most of the major industry super funds are public offer.

MP Hasn’t there been a problem with some people trying to join and being knocked back?

GW I don’t believe so. I think they’re pretty keen to have new members. Some don’t market heavily outside their own industry sector, but I think all of the major industry funds are keen to have new members from whatever source.

MP Is there competition between the industry funds themselves? Is there a bit of rationalisation and a fight going on there that we don’t think about?

GW There’s certainly competition, but while they try to compete in a sensible way with each other, there is great competitive spirit between them, and they all like to outdo each other, both in investment returns or in growth, and all of those measures. That’s probably a pretty good thing on balance. As to rationalisation, I think the first thing to remember is that virtually all of the industry funds have already scale advantages over most of their competitors. Having said that, there are still further scale advantages for the bigger industry funds, and I think there is some pressure towards some further rationalisation. Two of the leading funds, Australian Retirement Fund and Superannuation Trust of Australia, have announced an intended merger next year.

MP Then you get into the problem of how big is too big; the whole question of a smaller, more nimble fund, versus a big one. Industry funds by their nature will become larger rather than stay nimble.

GW We know that the economies of scale are huge. I mean, for example, the industry funds own, and IFS actually is the trustee for, Super Partners, which is the largest administrator in Australia, and administers most of the larger industry funds. We know from our own economics, as a business, that the large funds have a huge cost advantage, and the more members we can really add, the greater that unit cost advantage becomes. So it is possible that you can have some dis-economies of scale but, at the moment, we’re very much on the upward curve in terms of economies of scale.

MP Economies of scale, the lack of fees, it still comes down to the right investment decisions to get performance. What’s the secret there?

GW First of all, the industry funds have been very focused on getting returns. They’ve been very competitive from their outset. They were born out of an environment that set them up to fail, that people said you will fail, that people said you won’t do the right thing on investments, you won’t be able to outperform the so-called professionals in the marketplace. But they have outperformed. It’s measurable over one, three and five years, or a bit longer, but we know, we’re pretty sure anecdotally, that it’s also true over the whole 20 years of their existence. And, so, one is determination, and, second, it is not having some other external shareholders to feed; not being distracted by other factors like short-term pressures from external shareholders. And, partly because they have been under a lot of scrutiny, they’ve always had a big emphasis on professional advisers and on making properly calculated scientific decisions as far as they can. They’ve been early into new markets. We, as a company, have led in infrastructure and private equity investment. We’ve been very early for institutional investors. That’s produced substantial rewards. And, you know, I think, generally, just their attention to asset allocation has been a major winner for them.

MP And that success obviously will have the private funds, the master trust funds, chasing it?

GW Yes, well some of the funds. Some of the private funds are too small to access the unlisted markets and, to the extent that they chase listed vehicles to try to get investments into infrastructure, for example, then, of course, they’re piling in a lot of extra fees. But it’s true some of the larger retail competitors will, and are aggressively trying to, improve their performance. We haven’t really seen, at this stage, any indication that they’re reducing fees in any significant way, and we think that’s because they can’t in terms of their margin. They just don’t have sufficient margin to be able to do that, and so I think we’re in a pretty good position to keep leading the game.

MP Don’t they have to reduce fees though? There’s not an option is there?

GW So far, you’d have to say that, in financial services generally, the less efficient performers have chosen to confuse the marketplace rather than reduce fees. That is, they have chosen to try to broadcast a message or find new distribution channels that confuse the basic economics. You only have to think about banks and honeymoon credit card rates, honeymoon home loan rates '” and all the fine print and double asterisks that go with all of that '” to know that there are inefficient players trying to convince the world that they are not inefficient players. And they spend money to do that, rather than reduce fees, because they think that’s a better way home for them, and I think, to some degree, that’s certainly true in investment markets and in superannuation.

MP Your own structure is changing. Members Equity, the bank of the industry funds, is taking over IFS. What’s that about?

GW We have had a view, and I personally have had a view, for quite a number of years that we need to create scale in all things we do, and for that reason IFS itself has bulked up our funds management arm. IFM has bulked up. It’s now got to over $8 billion under management and, at the same time, Members Equity is, I think, probably the fastest growing bank in Australia, but from a very small base. And putting that all together will actually create some substance in the organisation, and that will be important not just in ordinary economy-of-scale terms but also in terms of simplicity of branding as a partner of the super funds. So there’d be one brand to partner with the industry super funds. It will concentrate the management resources. It will concentrate capital-raising capacity. So, I think on balance, it’s a very good thing, and, you know, it’s pretty strongly supported.

MP Don’t you run into the cultural problem that the others have got as well? That bankers just don’t make good funds managers?

GW Yes, I think there will be some real challenges. I think there are cultural issues partly caused by their regulatory environment and partly caused by professional traditions in the various sectors. And they will need to be managed, and it does remain to be seen whether we can manage that a little better than some have in the past. But one of the reasons for supporting the merger, or really the absorption of the IFS network into Members Equity, is that I have personally great confidence in the management of Members Equity and I do like the way they have been able to do things differently. And, in a way, that has a lot of similarity to what industry funds themselves have been on about over the years. So I think it’s a great start, but, of course, the future is what people make of it.

MP It’s a future without you? You’re retiring?

GW Well, you know, these days, urged on by our federal Treasurer, of course, I wouldn’t want to have a sudden break from work. So you, know, I think I can see myself segueing gracefully into a period of greater leisure. I’m very keen to maintain a relationship and an ongoing role, but I think that can be done without the executive duties that I have these days. So, I’m keen to stay on in a governance capacity with both Members Equity and with the funds management business.

MP As an active investor, there have been a couple of headline cases, most obviously Pacific Hydro. Has that bedded down? It is a big single play for you?

GW It is, and it’s one we’re taking very seriously. It’s now, of course, delisted, and we’re coming to grips with the day-to-day exigencies of building value in that company. But, already you know, the management is saying to us how much they feel empowered by the fact that they’re not answering to analysts on a daily basis; that they can focus on the long term; that we can actually bring projects forward. We’ve actually brought forward a couple of projects in Chile. Hydropower projects in Chile are a big part of our focus. And those things actually add value to the company because, obviously, that is a company that is valued largely by its project stream '¦ so we think it’s got a really enthusiastic and focused management team; and, putting that together with our investment specialists, we think we can build a really world class company in renewable energy. It is getting competitive but, on the other hand, it’s a sector that can only go one way. It has to expand.

MP It must have worried you, though, as a funds manager that you’re making your biggest single bet on something that actually isn’t economic; that still relies upon a government handout to make a quid.

GW Well, we didn’t count on any improvement in the political environment in Australia, or encouragement of green energy in Australia, when we made the investment. We simply focused on what is the world environment for green energy, and we know that, under that environment, there’ll continue to be growth in wind energy, and in hydro, and in alternative renewable energy resources. As for Australia, the United States and Liechtenstein, I think, they haven’t yet ratified the Kyoto Treaty '¦ Well, I mean, you only have to look at George Bush visiting New Orleans and ask yourself when the journalists are going to do their job and ask him about global warming.

MP Another high profile case of shareholder investment, involvement, was the vote on allowing News Corporation to move to Delaware. Your cousins at Australian Council of Superannuation Investors went along with it. Were they dudded?

GW They were clearly dudded. First of all, I think it has to be said, they tried very, very hard to get an arrangement to force News into an arrangement that at least did give some recognition to shareholder rights. They did a good job in getting that arrangement. On the other hand, if you deal with people who simply don’t honour their word and that company ends up being a foreign company, there’s not a lot you can do. That’s the truth of it, and one is left simply to scratch one’s head and ponder about what Mr Murdoch thinks he can achieve. Immortality, presumably, is not available to him.

MP The industry funds still have considerable holdings in News Corporation. There are motions coming up at the AGM. How do you expect them to vote?

GW Well I’m not sure of the detail of how they’ll vote. It’s not my particular area. I think they will try to protest in some way in their vote. I think it is probably very difficult for them to have a real impact on a company given the way that company’s structured and owned. And, beyond that, they’ll just have to act rationally over a period of time in respect to their investment.

MP IFM, your funds management arm, is a News Corp shareholder?

GW It is, and it will vote according to our clients’ wishes, which are likely to be along the lines I have just described.

MP What’s the biggest challenge for industry funds? You had a great success story over the past decade or two. What’s the biggest challenge, what could go wrong?

GW The regulatory environment. There have been a number of regulatory or legislative changes that have appeared to be inimical to the interests of industry funds specifically. The first was the introduction of retirement savings accounts (RSAs) some years ago, which seemed to be '¦ trying to give the banks a bit of a free kick, and we were excluded from offering RSAs; and then, more recently, the choice legislation. The way it’s played out does seem to try to make it hard for industry funds, so the biggest challenge is winning the respect of the Federal Government. If they’re going to be around for a few years, we really have to. Not by going along with them '¦ We still need to disagree where we need to disagree, but we need to force their respect, and that means we need to strongly sell our message in the marketplace. We need to sell it to employers. We’ve got hundreds of thousands of employers signed into our network, and we need to improve on that, and really strongly sell our message that industry funds are the single greatest positive force for building this nation’s retirement savings.

MP You expect to run, and continue to run, a bigger percentage of private equity, direct investments? That percentage is going to grow?

GW We’re constrained only at the moment by deal flow. In Australia, the issue is in infrastructure, which is constrained by political leadership and will, not by availability of funds or return constraints. Most major infrastructure projects '” and they need to be done for environmental and for productivity reasons '” require enormous organisational tasks on behalf of state, local and federal governments. And they need enormous sponsorship by strong politicians to make them happen. So that’s a struggle to get a sufficient deal flow in that area. That’s forced us offshore'¦perhaps the fastest growth in our infrastructure portfolio is now coming from offshore, and, as long as that deal flow is there, I think we can continue to hold our percentage allocation and perhaps grow it. Private equity is slightly different. It’s nurturing a local private equity market of really expert entrepreneurs. That’s really what it comes down to. Expert entrepreneurs and expert private equity managers at the micro level. You can’t force the pace of that, and so we’ve got again large global private equity offerings. We’d love to keep developing in Australia, and we think we can, but our funds are growing every year by well in excess of 20 per cent in net asset terms '” that’s after all their payouts and everything else to beneficiaries '¦ It’s very hard to keep growing the private equity sector in Australia at that pace for reasons of skill and experience constraint.

MP So you will be expecting a bigger percentage of investment offshore, in listed and unlisted investments?

GW I think that is inevitable over time, and we’d like that to not occur too rapidly. We would like to do as much as we can to grow the deal flow in Australia.

MP Part of the reason for industry funds’ success in recent years was that they’ve tended to be more overweight Australia than some of the others?

GW It’s true that a number of the industry funds, some of the bigger ones, did have a correct asset allocation balancing in the past couple of years but prior to that their out-performance came from completely different reasons, including at least one year of being slightly overweight in offshore listed assets. So you can’t always get asset allocation calls right, and certainly not to time them perfectly. But I think the task of asset allocation timing is a different task to the task of building up expertise in particular investment sectors, and we’ve got to do both of those things together.

MP Industry funds have played a major role in keeping the bastards honest?

GW I think that’s right. Well, it’s not quite right. We’ve played a major role in trying to keep the bastards honest, but to a large degree have failed. I mean, if you look at the most recent study by the Australian Securities Investment Commission, it basically found, and always finds, that there are real problems in matching commission-driven advice on superannuation to the best interests of the clients. In fact, as far as I can see, they seem to have given up. They’re really talking now about appropriate advice, and not saying that that means best advice in the interests of the client. So there is a legal point in that, and I honestly don’t think that, under the current structure, you can expect an accountant or a financial planner who has paid sales commissions to sell particular products from giving advice in the best interests of the client if the best products don’t pay sales commissions. It is a conundrum that can only be resolved by either, in the marketplace, one side winning or losing or by regulatory or legislative change.

MP You’ve got your own financial planning arm, which also tends to recommend only industry funds?

GW Absolutely, and we’ve started it simply because no one would recommend industry funds even though they had out-performance on every measure. So we’ve started that, and we’re part of that game, and we’ll have to keep playing that game. There’s really no alternative for us than to keep trying to build that, but it’s very tiny and it doesn’t have a lot of market penetration, so most of the members of industry funds have not gone anywhere near a financial planner. That’s the truth of it. But sure, we’re proud for our financial planners to continue to recommend industry funds, and if they have a significant issue or problem with any of them, then, of course, they can raise that and cross that off their list. But, at the moment, they’re in the happy position of being able to support the growth in industry funds and give best advice to the people that come to see them.

MP Don’t members, though, need financial planning; not the products, it doesn’t matter too much whose product they get into, but in terms of structuring their affairs, in terms of strategic advice? Don’t investors need some financial planning somewhere along the line?

GW The most difficult areas, first of all, for the great majority of people, are the tax and social security laws, and the way they interact when people get close to retirement. Mostly, that is generic advice that can be given. We do that through a series of free seminars. We offer free seminars to industry fund members to attend in either workplace or regional locations throughout Australia, and we try and get the basic messages about what you need to do to get the appropriate result from the social security system, if you’re affected by that, and certainly the tax system, which everyone is affected by, and some basics on investment advice. That can be given cheaply and generically. Beyond that, for those that have perhaps more money or more complex financial arrangements and need advice, I think it’s true that they do need often some professional advice. In that regard, I think we haven’t really complained too much about commission-selling as such. We don’t do commission selling, but what we really complain about is commission selling for the compulsory retirement income system: superannuation. So that’s our particular objective, and methods of charging people for other financial advice beyond that is really not a particular matter on our agenda.

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