Market volatility hitting superannuation fund returns

Hostplus’ David Elia argues that the focus should be on net investment returns.

As they say, every investment manager can look good when the market is booming.

But it’s only when the tide goes out that you can see what they are really like.

Industry super fund Hostplus, which now has assets approaching $90bn, is justifiably proud of returning a positive 1.57 per cent return over a tough financial year to June for its balanced My Super option — the product held by 85 per cent of its 1.5 million members.

A year ago, it was trumpeting its record return of more than 21 per cent for the same product.

But since then, equity and bond markets have been hit by major interest rate hikes by central banks around the world, rising inflation, fears of the longer term impact of the war in the Ukraine, and concerns about recessions and economic slowdowns in Europe, the US and China.

As its chief executive, David Elia said on Wednesday, Hostplus’ positive return comes at a time when many industry funds are expected to deliver a negative return for the latest financial year.

Researchers SuperRatings and Chant West are projecting a median loss on super fund balanced funds of between 3 and 4 per cent for the 2022 financial year.

The country’s largest super fund, the $260bn AustralianSuper, which has some 2.7 million members, last week reported a 2.73 per cent fall in its return for the year for its balanced option.

That fund’s chief investment officer Mark Delaney said the result reflected “challenging global investment conditions, heightened geopolitical tensions, rising inflation and interest rates over the past six months.”

If SuperRatings and Chant West are right on their estimates of the median, the results from AustralianSuper and Hostplus show that some funds are going to deliver some pretty poor results in the next few weeks.

Of course one swallow does not make a summer and even the best investment managers can have good years and bad years depending on their strategies.

Some fund managers who did well investing in high tech stocks around the world are now feeling the pain of the sharp fall in that sector.

Hostplus’ Elia was keen to remind the market that his fund’s relatively good return came as a result of the fund “employing active management strategies to navigate difficult investment markets.”

Hostplus chief investment officer Sam Sicilia said the fund had decided back in 2015 to cut back its exposure to bonds and set up its exposure to “mid range defensive assets such as infrastructure and unlisted assets.”

Being overweight in assets such as property and infrastructure, he says, “provided all important inflation protection.”

With more volatile markets ahead for the foreseeable future, Elia said the results were a reminder to super fund members to understand the investment strategies of their fund and not just to focus on cost.

Elia said he is concerned that there has been an overwhelming focus on the idea of reducing costs in the super fund sector in recent years and less on the idea that sometimes you have to pay investment managers for outperformance or alternative investment approaches, which are not linked with sharemarkets.

He warns that the rise of lower cost, passive superannuation products “where investors are more exposed to market movements” could see fund members hit by falling markets in the current volatile environment.

“We are seeing quite a number of funds effectively adopt a focus on reducing costs,” he said in an interview with The Australian.

“Anyone can cut costs, but it takes a real intellectual rigour to think through the opportunities around delivering strong, net, sustainable outcomes for members.”

Unlike some of the other major industry super funds, Hostplus is still sticking to its strategy of using outside managers and not bringing its funds management in house.

Funds such as AustralianSuper, which now manages a significant proportion of its investments in-house, say the strategy allows it to save millions of dollars in fees paid to fund managers a year.

Hostplus’ Elia argues that the focus should be on net investment returns, arguing that some fund managers might charge higher fees but can deliver higher returns in volatile markets.

He also points out that hiring in house fund managers with offices around the world can also be expensive.

He predicts that the differences in investment strategies will start to become obvious as this year’s super fund performance figures are announced.

“There’s going to be a real distortion around the type of returns that funds are going to generate,” he says.

“What is the purpose of a fund saying: ‘We are really low cost, but we lost your money’?”

“You can’t eat ‘low cost’. People only benefit from strong net positive outcomes.”

Hostplus critics, who had a field day in the Covid market downturn of 2020 — when some predicted that its origins in the hospitality industry would see its liquidity adversely affected by jobless members withdrawing funds — point to its venture capital investments, which have given it an exposure to high growth companies like the unlisted Canva which is now seeing its valuations downgraded.

Elia argues that while there has been much attention to its venture capital investments, they are a small part of Hostplus’ overall portfolio.

“We are not betting the house on it,” he says. “We are making very small long-term bets in start-up companies.”

“We’ve done a phenomenally great job and we can demonstrate a whole series of companies we have invested in which have gone on to list and delivered an extraordinary performance for our members.”

Elia also rejects suggestions that funds with a relatively large proportion of unlisted assets can inflate their performance with optimistic valuations.

“All our unlisted assets are independently valued. It’s a transparent process using independent valuations.

“Some are valued on a monthly basis, others on a quarterly basis and others on an annual basis depending on the nature of the investment.”

The elephant in the room for the big super fund players, of course — and the reason why both AustralianSuper and Hostplus are trumpeting their active management strategies at the moment — is the potential entrance to the market by the ultra low cost, US fund management and index fund giant Vanguard.

Vanguard’s Australian office, part of a global business which manages more than $US7 trillion, announced more than a year ago that it is applying to launch its own super fund.

Its application still appears to be working its way through the review processes of the Australian Prudential Regulation Authority.

Vanguard is saying it plans to launch its fund by the end of the year but is taking the time to get things right.

It is yet to be revealed what type of product or products it will offer Australian super fund clients.

But its ultra low cost global operation will certainly be a feature of its offering – and a potential attraction for some investors.

Of concern also is whether the new APRA administered superannuation performance test for MySuper products, which came into operation last year, is forcing some super fund managers to hug the index and adopt more conservative, passive investment strategies.

Given the potentially high cost of below average performance – being banned from accepting new members and their money — some funds are playing it safe.

But when markets go down, index hugging is not your friend.

Australian super fund members have had a good run in recent years thanks to global bull markets.

The sector itself is benefiting from the rise in the superannuation guarantee from 10 per cent of wages last year, to 10.5 per cent this financial year, rising to 12 per cent by 2025.

But more volatile investment markets will also add pressures on funds in a market which is already highly competitive.

With markets becoming tougher, members would be wise to heed Elia’s advice and pay more attention to their fund’s returns and their specific investment strategies.

The receding investment tide, it appears, still has a way to go.