As we start a new year, it feels like a good time to break out the crystal ball and have a think about what may happen over the next year in the financial markets and in particular the superannuation industry here in Australia.
The year of commissions...
For the Australian financial services industry, 2019 was a watershed year. The Royal Commission dropped bombshell after bombshell on the banks and forced them to operate with a moral overlay - to act in the best interests of their clients. This may in part have hastened the walk away from their wealth management businesses, but it ended up with the financial advice industry left reeling and shattered, trying to work out what its future looks like without sales commissions from the banks.
The ramifications from the Royal Commission will take many years to unfold. But clearly the industry super funds won the war against the retail and bank-owned super funds. The big industry funds are getting bigger and are starting to look like sovereign funds. I only hope they look to reduce their fees as they get bigger.
Finally, the Productivity Commission into super reminded us that not all industry funds are the same and that there are a lot of small underperforming funds that will now have the bright lights shone onto them in the form of "APRA performance tables". These funds should seriously consider their future if they are not acting in the best interest of members.
The Year ahead... possible headwinds
We live in strange times. The geopolitical environment feels as volatile and risky as I can remember and the world is still awash with cash 12 years after the GFC reboot in 2008.
It still seems hard to believe that the cash markets in Australia are below 2% p.a., fixed interest is around 4-5% p.a. (although last year it jumped to 7% p.a.) and shares and property provided returns above 20% p.a.
Maybe this tells us that the financial markets have built in geological political instability as the new norm. Maybe there has been so many political shocks from our global leaders, the financial markets see it as 'crying wolf', have come to expect it and have moved on. Or maybe it's just the weight of money that needs to find a return better than what is available from cash and fixed interest. Last year there was around $100 billion in inflows to MySuper products... it has to find a home somewhere.
Whatever the reason is, if you believe in the law of averages or reversion to the mean theory, then investors shouldn't expect the share markets or property to deliver another year of 20% plus returns - it should head back somewhere near the average of 8-10% that it has provided over the past 30 years*. With this in mind, super funds take heed: it will be important to get on to this early in the year and help manage the expectations of your members and investors.
Sustainable investments become mainstream
Sustainable Investments have been one of the fastest growing segments in the Australian investment markets. But they have been growing off a fairly low base compared to traditional managed funds. The weight of consumer demand for these types of products will shift monies to these industries even if governments are still trying to work out policies.
The horrific bushfires over this summer will hopefully result in our politicians and government making a much-needed change to reduce and better manage this terrifying risk. What is sure, however, is that we have seen the general public's desire to make change. The environment is front and centre: the people want change and they will force change. As super choice continues to grow with individuals becoming more engaged with their superannuation, funds will offer more sustainable super options. Super funds, and in particular, industry super funds, will increasingly shift their monies to sustainable investments. This in turn will take sustainable investments into the mainstream.
Super funds mergers...a few more
It was great to see a number of super funds look to merge last year, such as VicSuper with First State Super and SunSuper with QSuper. But the reality is there have been very few mergers.
Super fund mergers to me feel a bit like the old blue light discos back in the 80s when I was a teenager. Near the end of the night when there was only a few songs to go and all the good looking kids had already coupled up and were dancing, the rest of the kids were in the corner of the room with that slightly concerned look on their faces worrying that no one was going to ask them to dance. In the same way, there are a lot of small super funds just waiting and hoping that someone will find them attractive enough to merge with. The unfortunate truth is that the dance card of many of the larger super funds is already full and there will be some smaller super funds who will have very real difficulties finding another super fund or funds to merge with.
I believe that we will see some more super funds merge, but it will only be a few. The regulators will continue to push and highlight those funds that are underperforming, but change will be slow unless we can find a new model to help facilitate the merger process.
More super funds will become fund managers
If your super fund has not internalised their investment management... they will. It started with the larger super funds and has been followed by many of the smaller funds as well. As I have written about before, time will tell whether this experiment has been successful or not.
It is very difficult to outperform the market and if funds are able to do it for less than Vanguard's growth fund at 30 basis points, that's a great result for members. If they do look to internalise investments it will be important to focus on asset allocation, unlisted investments and infrastructure.
The investment teams of some of the larger super funds are now larger than many fund managers and we may see some of these larger super funds start to provide managed fund investments outside of super directly to members.
Super choice bigger than default super
Over the past 12 months, we have seen a significant amount of FUM flow from retail super funds to the large industry funds. This shift in FUM flow was driven by members making a choice. Members that were unhappy with their super fund voted with their feet. The old days of members being disengaged with their super is all but gone.
In the old days, it was all about default super for the industry super funds. The fight has now shifted to winning the battle for super choice. We will see the larger super funds spend more on advertising to build the awareness and relevance of their fund.
It will be interesting to look closely at new member fund flows over the next 12 months to compare how much is from default members versus those that make a choice about their super fund. If super choice is not bigger than default super this year, it will most likely be so in the next couple of years.
And in the end...
Although 2020 is unlikely to be as big a year as 2019 for the super funds, it will still be full of challenges for those funds that don't have scale, a strong brand or that want to merge but are struggling to find a partner. Maybe it's an opportunity for these smaller super funds to move into the wealth management business, re-invent financial advice and fill the void left by the banks.