Written by Robin Bowerman, Head of Corporate Affairs at Vanguard/Board Director of the SMSF Association
The superannuation system exists for a sole purpose – to provide Australians income in retirement.
The release this week of the Productivity Commission’s report on the efficiency and competitiveness of the super system provides a comprehensive analysis – a three-stage process three-years in the making – on how well the system is delivering against that straightforward objective.
It is akin – albeit with considerable more academic rigour – to those high school reports parents are familiar with – doing well but could do much better with more application, focus and hard work.
The Productivity Commission report –which is in final draft form – is recommending some far-reaching changes to the architecture of the system. Super fund members may well be surprised by some of the findings because the Australian system is often held up as a leading example of defined contribution pension systems around the world.
That the Australian system is world-class is not under challenge. But as the Productivity Commission report states the high rankings the Australian system has on world pension system stage is based on measures of adequacy and sustainability of the system rather than the efficiency and competitiveness in the way it delivers member outcomes which is the lens that this inquiry has been looking through.
The commission’s report is a powerful critique of the system’s performance on member outcomes. It highlights the wide range of performance results by super funds and the impact poor performance and/or high fees has on the retirement savings of everyday working Australians. It calls out major inefficiencies such as multiple accounts and zombie insurance policies and fees.
The Productivity Commission terms it the “unlucky lottery” and has made 22 draft recommendations to structurally realign the super industry with the objective of providing better outcomes for members. A number of these recommendations are far-reaching and deservedly will be the subject of much public policy debate before decisions are made by government to either implement or reject the recommended changes. The architecture of the super system is more than 25 years old so it should be no surprise that it needs to be modernised to reflect the needs of a modern workforce and a growing pool of retirees.
One of the novel things the commission’s work has done is develop benchmark portfolios to assess the system’s relative and absolute performance. While more of interest to industry technicians it will allow comparable performance assessment across funds and products.
For fund members what it points to is that being in an underperforming fund over long time periods really hurts. The commission’s analysis shows that for a typical full-time worker being in a fund that underperforms its benchmark by a seemingly modest 0.25 percentage points can reduce their retirement balance by about 6 per cent (or $54,000).
The more real-world example the report gives is that of a 21-year-old worker on a $50,000 starting salary and what the difference in retirement balance is if they are in a top quartile performing fund versus a fund at the bottom of the performance results.
The answer is a dramatic $635,000 difference in retirement account balance – $1.2 million versus $568,000 – or 53 per cent less to fund your retirement.
Just as performance matters so do fees – a lot.
The commission report says it well: “Fees are not only the biggest driver of long-term net returns across funds but are also a more predictable indicator of a funds’ investment performance than gross returns.”
The same 21-year-old example shows that paying higher fees of 0.5% will cut $100,000 from your account balance at retirement.
One clear issue the Productivity Commission has identified is the lack of an adequate way for prospective fund members to benchmark the performance of super funds in order to make informed choices.
In the financial services industry consumers/investors are disadvantaged by the clear asymmetry of information or knowledge. It is unrealistic to expect every worker in Australia to have the financial skills (or interest) in selecting a top performing fund.
So one of the ways the Productivity Commission proposes to address this is through the establishment of a “best in class shortlist”, which would filter the members’ selection decision down to a small range that had been pre-vetted for expected delivery of good long-term returns after fees and other expenses (such as insurance) were deducted.
This is one response to our super system where mandated super contributions and default fund arrangements have no doubt contributed to investor apathy or disengagement and it is sure to be one of the hottest topics of industry debate.
While that debate plays out and against the background of the Royal Commission into financial services that could stretch over several years there are three simple questions investors/fund members can ask themselves:
- Do you have multiple super accounts?
- Do you know how your fund has performed over the last five years?
- Do you know how much you are paying in fees each year?
The answers to those simple questions may provide the motivation to take advantage of one feature the super system already provides today for most fund members – the power to choose a different path.
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