Can the rapid rise of super funds pose risks to Australia's financial stability?
The Reserve Bank of Australia (RBA) has signalled caution on the rapid growth of Australia's superannuation sector, warning that it could pose risks to the country's financial stability.
In its September Financial Stability Review, the RBA highlighted the sector's increasing importance to the financial system, noting that it now makes up one-quarter of the system and has doubled in size over the past decade to A$3.9 trillion ($2.6 trillion).
The sector's rapid growth and the rise in herding around common benchmarks mean that superannuation funds' investment decisions and liquidity risk management practices have "a greater potential than before to amplify shocks in the financial system," the RBA report stated.
This marks a significant shift from the sector's historically low-risk profile, which was characterised by limited use of leverage and steady inflows of defined contributions.
John Livanas, CEO of State Super, Australia’s oldest superannuation fund, said he could understand the RBA's concerns.
State Super
"When you have concentration of management, you have concentration of risk on the people who make decisions," Livanas told AsianInvestor.
He agreed with the RBA assessment although emphasised the complexity of addressing these issues.
"We must be really clear that the rules don't create unintended consequences that lead to similar behaviour to the extent that there's no resilience in the system," he cautioned.
ASSET CONCENTRATION
Thomas Dutka, director of manager research at Morningstar, provided insights into the potential risks emerging from the concentration of assets in a small number of "megafunds."
He noted that the impact varies by asset class, with international equities and bonds posing less concern due to their larger market size.
However, Dutka highlighted potential issues in smaller asset universes, particularly Australian equities.
"Having a handful of very large investors each holding a material proportion of the local share market can present challenges to both the super funds and the market," Dutka told AsianInvestor.
"For example, if one super fund holds 5% of the listed equity of a large stock, a decision to materially reduce or increase its holding can be difficult to implement quickly without impacting the share price due to the large volume of shares that will be traded."
MorningStar
The RBA review also pointed to a potential ripple effect on banks, a concern that Dutka agrees is cogent.
"This could be an issue for banks, as a big fall in their stock prices driven by megafunds selling down their holdings means a fall in their Tier 1 regulatory capital, which can increase financial stability risks," he said.
Adding another layer of complexity, the MorningStar researcher noted the impact of foreign currency hedging.
"If they all have to concurrently make margin payments on foreign currency derivatives when the Australian dollar falls in value, they'll have to rely on their liquidity sources.
"This may be cash and traditional fixed income to begin with but could also require selling down holdings in other asset classes.
"If the funds do it simultaneously, that could also drive down asset prices in those classes."
LIQUIDITY RISKS
Addressing the RBA’s concerns on liquidity risk management, Dutka emphasised that it's a multifaceted issue not necessarily linked to the challenges of deploying capital.
"Challenges in deploying capital arise due to funds receiving significant net inflows – and when a megafund gets billions each year — AustralianSuper received nearly A$20 billion in the 2022-23 financial year — they have to ensure they can invest this promptly while maintaining their preferred asset allocations," he said.
"It's like a pie-eating contest where the first prize is more pie."
While strong net inflows are generally positive, they come with the challenge of deploying quickly while maintaining preferred asset allocations.
"Liquidity risk needs to be managed to ensure the investment process isn't constrained during bouts of unexpected volatility, when asset allocation rebalancing can be challenging," said Dutka.
Despite these challenges, Dutka pointed out some mitigating factors.
"Megafunds are unlikely to be highly active in their positioning, and may instead take an approach that is less active and has a lower turnover," he said.
Additionally, he observed that large funds often take diverse approaches to investment strategies, which could "dampen the risk of most or all megafunds making near-identical decisions simultaneously".
While the RBA's concerns about the superannuation sector's growth are valid, Dutka believes that the risks are nuanced but insists that ongoing vigilance and robust risk management practices will be crucial to maintaining financial stability.