Super investing – best in show is not best practice

One of the more controversial recommendations of the Productivity Commission’s December 2018 Report on Superannuation: Assessing Efficiency and Competitiveness is its “Best in Show” recommendation. This is designed to be a shortlist of up to 10 superannuation products which where members new to the workforce, or do not have a superannuation account, can choose.

Its aim is to improve investment performance for those in funds with below par returns.

So why not directly address that issue, by focussing instead on eliminating bad management and perennial poor performers?

The dangers of a best in show approach

There are potentially very real dangers in a “Best in Show” approach, which promotes only 10 funds and is not linked to, notwithstanding their past great performances:

  1. Past performance is not a guarantee of future results – as all investment-related promotional material should point out.
  2. Anti-competitive – those in the top 10, will potentially receive significant inflows, and if the simultaneous recommendation to “staple” (i.e. link) a member to a fund at commencement for life, this will see the rest of the market receive a reduced number of new members.
  3. Difficulty in determining an unconflicted panel – there would be some actual or perceived conflict if the member on the panel responsible for selecting the “Best in Show” top 10 is truly a superannuation expert. If the panel member is not conflicted in any way, then it is likely that they are not deeply aware of the superannuation market and they shouldn’t be part of the panel.
  4. Volatility of future cashflows – should a fund fall out of the top 10 shortlist, there is uncertainty around the movement of members between funds.  Funds will potentially require a greater level of liquidity, limiting their ability to invest in high yield, long term investments such as private equity and property development. As a result, members may no longer benefit from the returns produced by these illiquid assets.
  5. Increased unknowns and inevitably risk – how many existing members will choose to switch?  Behavioural finance has shown us that members may switch funds at the wrong time resulting in locking in past investment losses following investment events such as the GFC.  The effects of the “Best in Show” shortlist could have many unknown effects resulting in some unintended consequences.
  6. Could drive the wrong behaviour – funds could become more focussed on making it into the top 10 rather than providing the best possible member outcomes. The super industry may develop a herd mentality, reducing innovation.

Driving improvement in poorly performing funds

Better practice would be focus on improvement in poorly performing funds:

  1. Since April, APRA has greater power to directly intervene and take action against Trustee Boards who are not.
  2. APRA’s SPS 515 Member Outcomes requirements provide an excellent framework to make funds accountable for poor investment performance.
  3. Allow the “good” part of the market to continue to innovate and bring new investment and service ideas to the marketplace, and people to join them.  It is these innovations which help to increase competition, pressure reduction in fees and improve services, including communication.

Let’s concentrate on the core issue: eliminate the poorly managed and perennially underperforming funds.

Let’s not introduce a “Best in Show” approach which adds more risk and complexity, both of which add frictional costs and reduce the quality of communication to, and understanding, of members.