Why cutting super fees is a multi-billion dollar microeconomic reform
by Jim Minifie
Published by The Australian Financial Review, Wednesday 23 July
Those who yearn for the glory days of red-blooded microeconomic reform, look no further. Here is a reform opportunity worth many billions of dollars to Australians: choose default superannuation funds using an auction.
The Murray review’s interim report has put the superannuation industry on notice for excessive fees. At about 1.2 per cent per year, fees on the $1.8 trillion of funds under management are over triple those in the best systems overseas. Fees are now around 1 per cent of GDP, even excluding the self-managed sector.
So how to get super fees down? The Murray review has put an auction system on the table. Murray notes the “dramatic reduction in costs” for Chile’s default superannuation funds since Chile started auctioning the right to be offered as a default fund in 2008. Default fees dropped by two-thirds in five years to just 0.2 per cent of balances. Achieving those fees here would, over time, add about 20 per cent to people’s retirement balances.
Chile is not alone. New Zealand runs a similar (though less fee focused) system and has reduced default fees to around 0.55 per cent per year. For Australia, the Grattan report Super Sting estimated that an auction system for default superannuation accounts could save about $3 billion a year at today’s volumes, and more as the system grows.
SUPER INDUSTRY REVENUES CUT
Savings from the auction will reduce industry revenues, so the industry can be expected to deploy arguments against it. How do they stack up?
First is the claim that the Stronger Super reforms already in place will achieve low fees. The evidence so far is not encouraging: despite the odd low-priced, low-volume product, Mysuper products are no cheaper than the previous defaults. That is not surprising because the reforms do not change the fundamentals of competition. MySuper may make default products easier to compare, but this has not cut fees much anywhere else. Most consumers are not financially skilled or interested enough to figure out their best choice. SuperStream back office efficiencies will probably be offset by costly efforts to retain and attract customers: that is what absorbed scale economies as the average Australian fund grew sixfold over the last decade.
Second, funds will claim that it is net returns that matter, not fees alone. But there is strong evidence that high-fee funds do not earn their keep. Brilliant or lucky funds can beat the market for a while, but repeated studies have shown that past performance has little relation to future returns and that fees are a better predictor.
In Chile, for example, the winner of the default auction has outperformed all other funds. In Australia, low-fee funds consistently provide better returns than most high fee funds. Third, funds will claim that running an auction would result in a race to the bottom, with only the cheapest assets in the mix.
ASSET ALLOCATION MATTERS
It is true that asset allocation matters a lot. The New Zealand scheme has been attacked for putting default accounts in low-return, low-risk assets. But it is straightforward to set, as Chile does, ranges for exposures to listed assets like bonds and domestic equities. Winning funds must offer exposures to these assets and typically do so via “passive” investment approaches. Unlisted assets, such as infrastructure or property that require active management, could be included in the mix: funds that already run large unlisted asset businesses would be well placed to win those tenders.
Fourth, it may be claimed that a government-run auction undermines the principles of private competition and choice on which the Australian superannuation system has been built. But the auction would intensify wholesale competition. Account holders would still have the full range of choices. And the Stronger Super reforms have already built much of the back office and product set needed for an auction system to operate.
Fifth, it may be claimed that an auction system will result in insufficient liquidity or insufficient market discipline. Running auctions could increase the share of the market held by passive investors a bit; but if that share proves excessive, it will create opportunities for the many remaining active investors.
So the prize from running auctions for default superannuation is large, and the arguments against are weak. “Wait and see” is not the right answer: Australia has been waiting for cheaper super for 22 years, as the industry keeps trotting out that price cuts are just around the corner.
Australia should not continue to tolerate a high-cost superannuation system when a proven reform can be bolted on, saving Australians billions each year.