The Australian contribution rate is set to increase by three percentage points, translating into A$500bn of new flows. Rachel Alembakis talks to experts about the pressure to invest those assets locally and their potential impact on post-retirement products
In May, the Australian government released a sweeping review of the tax system. Although there were 138 recommendations in the report, treasurer Wayne Swan only committed to acting on a handful immediately – and included a move to raise the employer contribution to superannuation funds from 9% of salary to 12% by 2020.
In releasing the report, colloquially called The Henry Tax Review after Treasury Secretary Ken Henry who led the inquiry, the government committed to increasing the so-called superannuation guarantee (SG) starting in the 2013 financial year with a 0.25% increase; a tax rebate for low-income workers to ameliorate the effects of the 15% contributions tax; leaving a cap of A$50,000 (US$41,300) annual contributions for those with retirement balances of A$500,000 or less; and extending the SG to age 75.
Increasing contribution
Although increasing superannuation contribution rates is broadly popular across Australia, it is not guaranteed to be passed. The government has tied the increase to the SG to cuts in corporation tax so as not to penalise employers, a move that will be funded by a controversial proposed 40% tax on “super profits” by companies in the mining and extraction industry. The opposition Liberal coalition opposes the super profits tax, and Labor government officials say they will not be able to justify the SG increases without offsetting tax revenue from mining companies.
However, if the SG increase does pass, it will represent the first and largest increase to superannuation contributions since the current 9% rate came into effect in the early 1990s. The superannuation industry responded enthusiastically to the recommendation, which is estimated at bringing in an additional A$500bn in contributions to the superannuation industry by 2035.
“We’re supportive of Henry,” said Mercer senior partner, David Knox. “One of the things that came out in the work we’ve done is that while there’s cost to government in the short term, it saves the government more than it costs them in terms of reduction on the Aged Pension. In terms of sustainability on the budget, it’s a good move. We also support leaving the over-50s $50,000 cap.”
The consensus around the industry is that superannuation funds have the appropriate architecture to handle the increased cash flows.
“The infrastructure is already scalable, so it’s just a question of having a bigger cheque that gets sent to us every month,” said National Australia Bank’s, director of client relationships for asset servicing, Peter Hele. “The actual infrastructure is there, but it will be in larger pools. It will give funds larger scale to negotiate harder back onto custodians, fund managers and administrators.”
In the immediate reaction to the government’s commitment, peak body representatives pointed to investments in so-called “nation building projects” as an outgrowth of the increased contributions. At the time the Association of Superannuation Funds of Australia CEO Pauline Vamos told Global Pensions, “It means that it will have more money to invest in infrastructure, particularly infrastructure that needs to be built, because it’s vital that Australia has ports, rail and road to really ensure that the economy keeps on going.”
But superannuation funds warned that investing purely for the sake of building the nation was incompatible with legal responsibilities and would not happen unless they represented a fair investment for members.
“The development risk of a lot of infrastructure must be borne by government,” said Tony Lally, CEO of the A$14bn SunSuper industry superannuation fund. “A superannuation fund will acquire established infrastructure from government, but in developing infrastructure, the risk is too great and there is too much interference. There are social costs for a lot of infrastructure projects, and the government has to pay that. Superannuation funds will pay the commercial cost. ... There are two ways of going forward – either the government co-funds it, or the government builds it and sells it when it finishes.”
Ian Silk, CEO of the A$30bn AustralianSuper industry superannuation fund said that the fund would most likely keep its percentage of assets allocated to infrastructure at 13%, but noted that as contributions increased, the absolute amount of dollars would commensurately increase.
State Street Global Advisers Australia managing director, Rob Goodlad said Australian superannuation funds are already sophisticated investors, and the resulting additional inflows would not present a large challenge.
“Australia has always punched above its weight when it comes to savings,” he said. “It’s important to understand the soft sell from the government to invest in infrastructure in Australia, and we need some very, very large funds to do that. I think that the trustee system that we have in Australia has worked very, very well for members in as much as they’re not going to be told what to do – their focus is to look after members’ interests and investigating opportunities in relation to the fund’s investment objective.”
Looking to the future – post-retirement products
A natural progression to discussions of potential greater savings is how to design products for the post-retirement phase. The superannuation industry is still grappling with the design phase.
“We do have to pay more attention to the post-retirement period,” noted Towers Watson Australia managing director Andrew Boal. “Depending on the products, and the methods used to help people manage their post-retirement period, that is a period that does lend itself to longer term investing. If you retire at 65 or at 67, to manage the longevity risk, do you give up access to the money, give up the right to liquidity, so that pool of assets can invest greater proportionally in long term investments and use the cash flow, the dividends?”
Institute of Actuaries CEO Melinda Howes said that before proper products can be released, the government has to update the Superannuation Industry (Supervision) Act to include more flexible annuity definitions, and taxation codes must be amended to make these products more acceptable.
“We’ve always had this lump sum mentality in Australia, which is why traditional pension products haven’t done well in Australia,” Howes said. “People like having access to their capital and managing it. The newer style products – account based products in younger years, with an income guarantee in later retirement years – would suit that. The government has been amenable. I think it’s only a matter of time. I haven’t heard any objection to changing the SIS Act.”
But even before post-retirement investment options can be discussed, superannuation funds have to find a way to assist members on making fundamental calculations like when to retire, said Steve Schubert, director of Russell Superannuation at Russell Investment Group.
“Really, the decision that gets overlooked quite a bit is helping people to decide when to retire,” he said. “We focus on the pension age being 65 to 67; a lot of people retire earlier than 65. For some, it’s not voluntary – their health isn’t up to it. But for a lot of people, this is a decision they have some means of influencing. The impact of one or two years extra in the workforce, for example. Just getting people to focus on some of those really important decisions is something we can do.”
Hedging currency risk on front burner for Australian schemes
Fundamental changes to superannuation architecture and the possibility of billions of dollars of new future cashflow are not the only issues the industry has to grapple with. The Australian dollar has been on a wild ride over the period of the global financial crisis. The swings against the US dollar alone have caused significant dislocations to hedges and concomitant demands for cash at times when asset owners could ill afford the liquidity pressure. Concerns over global markets recently sent the Australian dollar from highs of more than 93 US cents to below 82 US cents as Global Pensions went to press.
Unsurprisingly, there has been renewed interest in managing currency exposures. Given the background of events in the past two years, few Australian superannuation funds are thinking about possible opportunities in alpha exploitation – most are focusing firmly on the risk reduction side when it comes to currency fluctuations. Currency overlays have gained new popularity, with new superannuation clients and new service providers.
“Given the volatility of the currency, we don’t recommend moving to a zero level [of hedging],” noted Mercer’s head of dynamic asset allocation David Stuart. “We’re talking more about taking your hedging level from 40% or 30% from a strategic level of 50%.”
Out of chaos comes opportunity for some – National Custodial Services (NCS), the custody arm of NAB – has launched its first ever currency overlay service in Australia, aiming to capture funds from its custody clientele, over which it holds a market dominating position.
“The key for us was leveraging off the existing service that we hold for our clients,” said NCS’ regional general manager, Leigh Watson. “A natural extension would be to apply overlay in accordance to what’s being done in transactions. That’s why the service is limited to the client base for whom we hold the custody.”
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