In capitulating to a Royal Commission into the banks, the Turnbull government has managed to trim the architects of global tax avoidance from the terms of reference, the Big Four accounting firms that is, while slotting in the industry funds sector. The union-backed funds are the natural political enemies of the Coalition and the move has been met with resistance. We investigate the sector leader, the $100 billion behemoth which is Australian Super.

“As Australia’s largest Industry Super Fund, we negotiate low fees and we are run only to benefit members.” Australian Super.

This claim warrants scrutiny.

While it is true that the retail funds, those funds backed by the big banks, perennially underperform the industry funds – retail funds mostly charge higher fees and their returns are therefore lower – there is an upswing in costs which is not in the interests of the millions of members of industry funds.

When industry funds were putting the case for deregulation, they argued deregulating would bring economies of scale, efficiencies; that is, more money under management meant lower costs.

What deregulation appears to have delivered however is empire building. Here are the critical facts which pertain to the leader in the sector Australian Super, facts which are not evident amid the fund’s blanket advertising:

Australian Super continues increasing, rather than reducing, its administration fees. According
to its annual reports, administration and operating expenses rose from $103 million in 2006 when it had 1.3
million members, to $262 million in 2016 when it had 2.1 million members. That’s a jump from $79 per member to $124 per member in a decade.

Funds are fattening up on superannuation fees

Its explanation for spending millions of member dollars on advertising and sponsorships each year is that size will drive economies of scale and better outcomes for members. But the data does not support this argument and based on the $250 million cost blow-out for the Superpartners IT project cost blow-out, the evidence suggests that there are actually diseconomies of scale once industry funds get above a certain size.

The best survey of fund performance, both industry and retail, is the annual Stockspot Fat Cat Fund Report which found again this year that industry funds outperformed retail funds.

However, there were question marks over the accuracy of industry fund reporting of costs and fees. Disclosure is a problem. Their fees, says Chris Brycki, Stockspot founder and the author of the report which analysed over 2,000 funds, may be lower than retail funds, but they are still too high.

Further, advantages of scale tend to completely disappear before a fund reaches $5 billion in funds under management. Many smaller super funds performed as well or better then their larger rivals. BUSS Super Queensland at $4 billion in size performed about 0.5 per cent a year better than AustralianSuper at $100 billion, both over five and ten years.

APRA’s statistics also don’t support the bigger-is-better mantra; at least beyond a few billion of assets. (Incidentally, the latest batch of APRA data shows the annualised return of industry funds over the past five years at 9.8 per cent versus 7.5 per cent for retail funds).

Assuming economies of scale therefore don’t exist, how does Industry Super advertising and sponsorship meet the sole purpose test?

The performance differences between industry funds also highlights another matter for concern. Despite the benefit-members mantra, industry funds still allocate the majority of their funds to expensive active fund managers – to the retail sector that is.

Perversely, this persists in spite of the overwhelming evidence that active stock picking and market
timing deliver worse outcomes for investors (because fees are higher). Over the 10 years to June 30, 2017,
75 per cent of Australian large cap active share managers, 90 per cent of international active equity managers and 86 per cent of bond managers underperformed their respective benchmarks.

Search for the biggest fat cat of the Australian super fund industry

An interesting aspect to this is the paradox of performance. Thanks to the lure of excessive remuneration, a lot of bright people are drawn to funds management and this competition tends to neutralise returns.

Some industry funds that have done well over five years like Prime Super, Statewide Super and MTAA super have been amongst the worst performers over ten years. The reason? Active managers made some
disastrous active decisions around the financial crisis.

Some like Prime learned from their mistakes and moved their investments over to indexing, but others have not.

This is why industry fund returns are so sporadic; most are still rolling the dice on active management where costs are higher. Mind you, industry funds are charged wholesale rates to manage superannuation by their retail counterparts so the fees are lower than individual clients of retail funds.

On a related note, scale is all about driving down cost for the end investor and it’s bizarre that most industry funds (Australian Super included) don’t invest with the world’s largest investment manager that puts all profit back into lowering fees – Vanguard. Vanguard manages $US4.4 trillion and has a 40 year history of reducing fees for clients as a mutual organisation owned by its investors.

Corporate lobbying a billion dollar business

A report into Australia’s corporate found a number of extremely well-heeled peak bodies in the banking and funds management arena. Financial services is big business and it has big lobby groups, both on the banking and retail side and for industry super.

On the bank side, both the Financial Services Council and the Australian Bankers’ Association were reticent about disclosing their financial statements but so was Industry Super Australia, whose accounts we found only after the report had been published.

This main peak body for industry super funds is owned by Industry Super Holdings Pty Ltd. Last year it recorded revenues of $22 million and employee numbers were 21. Besides lobbying, Industry Super Australia owns online news service New Daily.

For its part Industry Super Holdings notched up operating income of $279 million last year. It owns Australian Super and Industry Funds Management. The bulk of this income derived from providing funds management and trustee services.

In the four years from 2013, operating income has risen from $136 million to $279 million while expenses have risen from $133 million to $253 million. This confirms the view that economies of scale have not been the outcome from getting a lot bigger and consolidating other funds and services in the industry funds market.

In the past two years alone, staff costs are up from $115 million to $177 million while general admin expenses rose from $49 million to $64 million (it was $39 million in 2013) and executive pay rose from $2.4 million to $5.3 million. Advertising costs were not broken out but these must be huge.

There is political advantage to gain from advertising’s, it should be said. It is not just about getting superannuants to switch funds, for the sake of sheer size. It signals to government and a large part of Australian Super’s portfolio is infrastructure.

Nonetheless, there are reasonable grounds for industry funds to be included in the terms of the Royal Commission. We are talking about 22 per cent of Australia’s $2.5 trillion superannuation market. These are the rivals to the big bank funds. Their performance is superior to retail but there is still a lot of fat on this gravy train; the sector is consolidating and there is little sign of the grand “efficiencies of scale” which were promised. Nor are fees and charges well disclosed.

It is in the public interest therefore that there be more scrutiny. And while the Royal Commission is at it, special attention should be given to the regulators who are often found captive to the financial services institutions which they regulate, particularly the banks.

Emails reveal special ASIC exemptions for fund managers