Aussie supers face equities overexposure
Australia’s superannuation funds produced high-teen returns in equities and close to double-digit returns in bonds last year, as the industry’s assets grew to 101% of gross domestic product or $1.6 trillion, finds a new study by consulting firm Towers Watson.
Released yesterday, the annual report into asset accumulation and allocation trends covers the world's largest pension markets, with Australia now ranked fourth, behind the US, Japan and the UK, in that order.
By many metrics, Australia stands on its own, including having the highest overall exposure to equities (at 54%) and the lowest allocation to bonds (15%), the study shows.
Martin Goss, senior investment consultant at Towers Watson in Australia, puts this down to the proportion of assets held in defined contribution (DC) funds relative to defined benefit (DB) schemes. Australia has the highest proportion of DC assets in the world at 81%, followed by the US at 58%.
“The dominance of DC enables trustees to place priority on long-term risk-adjusted returns," notes Goss, "whereas in countries with a greater bias to DB, matching liabilities is a priority, leading to higher bond allocations, despite the historically low bond yields currently on offer.”
Australia also stands out for its home-country bias in equities. Of the seven largest pension markets, Australia is second only to the US in its home bias, with more than 60% of equity funds dedicated to locally listed shares. In bonds, however, it has the lowest home bias of all.
Such a strong preference for home-grown stocks makes sense in a market the size of the US, which makes up 50% of global indices, says Goss. “But Australian equities only account for 3% of the global market, so this would suggest most super funds are running a fairly high level of concentration risk.”
The pro-equities philosophy is driven by tax considerations, he adds, particularly a system of franking credits that allows investors to pay less tax on their dividends based on the amount of tax the issuing company has already paid. Australian equities also pay relatively high dividends, with the ASX20 yielding 4.9% last year.
“While trustees are aware of the concentration risks, they also operate on the theory that there is no need to go offshore when Australian shares have performed better over the past 100 years – or even 10 to 20 years – than any other stock market,” says Goss. “Australia has avoided the global downturns that followed the tech wreck and the global financial crisis, and, rightly or wrongly, there is this feeling of immunity.”
It is a sense of security that could soon be tested. “There is some evidence that the next 10 years could be more challenging for returns on Australian shares,” says Goss, and that may prompt a review of existing allocations.
Another factor likely to prompt a rethink is the changing profile of super fund members as the first generation of compulsory savers moves towards retirement.
“The market is maturing, from an accumulation phase to a decumulation phase,” says Goss, adding that any shift in allocation won’t happen quickly. “It will be a slow-burn change, but in 10 years’ time I wouldn’t be surprised to see a 10% reduction in equity allocations and a 10% increase in bonds.”
A shift into bonds would be a break with tradition. Australian funds didn’t follow other institutional investors into the fixed income market after the collapse of Lehman Brothers in 2008. In fact, overall allocation to bonds has dropped from 20% in 2002 to 15% now.
“Cash rates have been high in Australia relative to other developed markets, which helped to diminish the attractiveness of bonds,” explains Goss. “There has been a feeling that bank deposits provide a decent return without the duration risk.”
Where Australia is in step with global trends is in its appetite for alternatives. Investments in infrastructure, real estate, hedge funds and private equity have increased from a combined 14% in 2002 to 23% in 2012. There was a similar jump in the US, Canada and the UK. Goss says Australian funds have a long history with unlisted property and infrastructure.
“Early on there was some over investment in greenfield infrastructure projects, and a few of these projects went belly up," he notes. "But now the focus is on long-term mature assets already generating a regular income stream and where there is no construction risk."
More and more, these assets are also being managed in-house. “There is an insourcing trend underway in Australia, and the alternatives arena is one place where pension funds think they can really save costs and add value by bringing together internal expertise with external management, but avoiding fund-of-fund structures,” says Goss.
The Towers Watson Global Pension Assets Study found that institutional fund assets in the 13 major markets* grew by 9% during 2012 to reach a new high of $30 trillion. This growth trend started in 2009 when assets grew 17%, following a sharp 21% fall during 2008, taking assets back to 2006 levels. Global pension fund assets have now grown at over 7% on average per year in dollar terms since 2002, when they were below half their current level.
The market with the fastest growth in the past decade is Hong Kong, where institutional pension assets have expanded at a compound annual growth rate of 14% (in local-currency terms), to now surpass $100 billion.
* The 13 largest pension markets included in the study are Australia, Canada, Brazil, France, Germany, Hong Kong, Ireland, Japan, the Netherlands, South Africa, Switzerland, the UK and the US. They account for more than 85% of global pension assets.