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After decades spent unchallenged as lenders of capital, the major banks find themselves rivalled by union-run superannuation funds. Now big business is going to the funds for investment. By Hamish McDonald.

Big business chases industry super partnerships

The gathering brought much of Australia’s corporate and institutional wealth into one room.

There was Gina Rinehart, the iron ore billionaire. Lindsay Fox, the trucking tsar of the eponymous Linfox. John Fraser, the head of the federal Treasury. The heads of ANZ and Macquarie banks. David Neal, chief executive of Canberra’s $137 billion Future Fund.

Anthony Pratt, the heir to the Visy global empire of cardboard boxing and more recently country-club buddy of Donald Trump, had summoned them to his Sydney pad in that row of luxury apartments along Circular Quay near the Opera House.

The menu was suitable for such an assembly of red-blooded capitalists: “grilled Rangers Valley fillet of beef, hand-rolled baguettes, fresh burratini with heirloom tomatoes, Genoa fig, basil and aged balsamic”, all washed down with 2009 Penfolds Grange.

Yet there was an odd juxtaposition. Seated at the right hand of Rinehart were Linda Cunningham and Kristian Fok, two chiefs of Cbus Super Australia. Elsewhere round the table were Mark Delaney, chief investment officer of AustralianSuper, and leaders of other “industry” super funds. In a place of honour was former prime minister and present chairman of investment house Lazard Australia, Paul Keating, widely seen as the “father” of the superannuation system.

Here were the rugged pioneers of big business sitting down, not exactly cap in hand but laying out the lavish hospitality, for representatives of what the Coalition and the business dailies routinely blast as destructive trade union power, unfairly harnessed through compulsory super to big money, in the hope of getting cheaper long-term funding than they can get from the banks.

Cbus is the super fund set up by the building and construction trade unions, which are routinely singled out for opprobrium by Coalition politicians and the financial dailies. These unions were a particular focus of the Coalition-appointed Dyson Heydon royal commission to investigate trade union malfeasance. A building industry corruption watchdog is now permanently on patrol.

Like other “industry” super funds, those set up on a non-profit basis by employee and employer groups in economic sectors to receive and invest the 9.5 per cent super contribution are another perennial bugbear of the Coalition and the financial press.

In December, a week or so after the Circular Quay gathering, Prime Minister Malcolm Turnbull and Treasurer Scott Morrison felt forced by a backbench revolt into appointing a royal commission under former High Court justice Kenneth Hayne into the recent big bank scandals.

But they added a spiteful-looking twist: Hayne was also charged with examining any super fund that employs “members’ retirement savings for any purpose that does not meet community standards or expectations or is otherwise not in the best interest of members”.

The industry funds see it as yet another attack inspired by the big banks. “In a few years, we will be bigger than the banks,” one fund representative said privately. “The banks are trying to kill us before that happens.” Another saw it as “payback” for the financial advice reforms of 2013, obliging “independent” advisers to disclose their commissions from financial products such as insurance policies.

Pratt’s overture suggests it’s too late to try. With $2.5 trillion in funds under management as of last September, equivalent to 148 per cent of GDP, superannuation funds are closing in on Australia’s banks, which had $2.1 trillion in deposits in September plus some hundred of billions more in other capital. A recent Deloitte study forecast super funds reaching $9.5 trillion in 2035, about double expected GDP.

The point the funds overtake the banks may still be some years off. But already they’re providing an alternative source of capital to bank loans and the sharemarket. Tycoons such as Pratt, Rinehart and Fox are trying to tap it, and that was the point of the lunch.

All three are owners of unlisted companies. Unless they want to dilute their ownership and subject themselves to more scrutiny and supervision, they can’t raise funds by issuing public shares.

They apparently find it hard to get long-term loans at acceptable rates of interest from the banks either. “While most Australian home buyers can easily obtain long-term funding for their major asset, most Australian businesses cannot,” Pratt wrote later in a Fairfax op-ed. “This is in stark contrast to America, where a large and very active market exists providing long-term financing to growing businesses with the money coming from the US equivalent of Australia’s superannuation funds.” Pratt’s $US400 million in borrowing for his American operations comes entirely from 25-year bonds issued by Visy to such pension funds.

While many would question their pension savings going to Rinehart, who has made dubious forays into Channel Ten and Fairfax shares and funded fringe political causes, such private domains are also marked by more aggressive entrepreneurship, which when successful take the economy into diverse new fields.

Pratt’s Visy jumped outside the Australian pond in 2001, buying up an old US paper mill, to great profit. Rinehart has recently outbid Chinese and other groups for iconic cattle properties, to enter the “dining boom” with wagyu beef. Some years back, Fox started a supply chain in India with truck-maker Tata, while the nervous board of listed Woolworths kiboshed its nascent supermarket joint venture with Tata.

If the US example is going to be followed here, matching super’s long-term investment perspective with business needs for patient capital, it is the industry funds that will lead. Pratt himself demonstrated that last March when Visy raised $150 million in 10-year funding from AustralianSuper and IFM Investors, which manages $93 billion in investments for 27 industry funds.

The same goes for infrastructure. Most of the super fund investment in this category comes from Australian industry funds, with some from Canadian and other foreign pension schemes. The industry funds, which have about 22 per cent of the superannuation pool, put 9 per cent of their investments into infrastructure.

Government pension funds, which control about 17 per cent of total funds, have 5 per cent invested in infrastructure. The retail funds, run mostly by the big banks and one or two institutions such as AMP, have about 24 per cent market share in super, but put only 2 per cent of funds into infrastructure. Their profit motive drives them to maximising short-term gains by playing markets. The self-managed super funds (SMSF), which have 28 per cent market share with a total of $700 billion in funds, are hardly represented at all. With only two to five member-trustees running each of them, and an average $1.16 million in savings to deploy, these funds simply don’t have the expertise or scale to invest directly in large projects such as airports, railways and utilities.

Thus industry funds are the ones doing most of the lifting in the nation-building cited as a core objective of having a universal retirement scheme.

Retail and SMSF, the two sectors most favoured by the Coalition, and frequently applauded by The Australian Financial Review and The Australian, contribute the least towards filling the infrastructure gaps. Into the bargain, retail funds and SMSF are far surpassed by the industry funds in the rate of investment return to member accounts.

Started by the Howard government in 1999, the SMSF sector is distinguished mostly as a tax dodge for the better off, especially when combined with pre-retirement salary-sacrificing contributions taxed at 15 per cent at one end of the fund and tax-free “transition-to-retirement” withdrawals at the other.

In a final boost in 2007, Howard and his treasurer, Peter Costello, then allowed the self-managed funds to borrow to acquire assets, helping prime the housing bubble. According to economist Saul Eslake, this was “one of the dumbest decisions of the past 20 years”. “As if Australia needed to find new ways of allowing people to borrow more money in order to bet on further increases in property prices,” he says.

This month the Australian Bureau of Statistics found such SMSF borrowings added three percentage points to the average household debt-to-income ratio, now put at 199.7 per cent, one of the highest in the world.

The retail and SMSF sectors also account for a disproportionate share of the $31 billion in fees extracted from superannuation in 2016, says research firm Rainmaker Information, which also reckons the self-managed funds have lost $100 billion from fraud during the past 10 years.

From some of the questions now being raised by economists such as Eslake, rather than chasing phantom union rorts in industry super, royal commissioner Hayne might be better deployed looking into some of the structural questions about superannuation, 25 years and $2.5 trillion from its start by then treasurer Keating.

Former banker Satyajit Das thinks super fund members will be struggling to amass enough savings for a comfortable retirement off the government’s age pension books. Low interest rates and over-reliance on inflated asset classes threaten long-term investment returns. More and more of the workforce is being moved out of the compulsory superannuation net, as ABN contractors.

Eslake says the falling home ownership rate also threatens to torpedo one of the basic assumptions: that most retirees will have paid off their home, exempt from any assets test for a full or part government age pension. Many will be taking their lump sum to pay out an outstanding mortgage. Some might even be buying their first home.

Canberra may be forgoing some $30 billion a year in tax concessions for super plans, and still have to shoulder the bulk of support for the growing percentage of aged people.

As it is, more is being taken out in lump sum payments, $39.2 billion in the year to September 2017, than as pensions, $35.2 billion. The Australian Prudential Regulation Authority (APRA) doesn’t report the numbers of retirees involved, but it is a safe assumption that the pensions are shared among a relatively small number of better-off people.

Typical superannuation balances on retirement, for average earners, are still too low – at about $200,000 for men and $100,000 for women – to generate much of a lifetime income stream. In addition, such extra income brings a savage effective tax. Age pensioners are allowed to earn only an extra $168 (for singles) or $300 (for couples) a fortnight before their pension is cut 50 cents for every extra dollar.

The Department of Human Services says it does regular reviews to establish pensioners aren’t being overpaid, using both data matching and tipoffs. If the overpayment results from honest mistakes, it is quietly settled by paying it back. If deliberate deception is involved, the cases are referred to the Commonwealth Director of Public Prosecutions. There have been 72 such referrals of age pensioners in the past three years.

Much of the personal finance correspondence in the business press, meanwhile, comes from SMSF owners wondering how to work the asset and income limits so they can still get even a tiny part age-pension and thereby retain the government pensioner’s card that entitles them to highly subsidised pharmaceuticals and other benefits. With all their tax subsidies and lurks such as this, they still like to think of themselves as “self-funded retirees”.

Such a narky, rule-bending approach reflects the Australian culture perhaps. Contrast it with the New Zealand system, where the age pension is paid to all retirees without a means test and fully taxed, as is any extra income from work or super schemes such as the government’s voluntary KiwiSaver fund.

“New Zealanders have less reason than Australians to try to game the retirement system,” wrote Griffith University economists Ross Guest and Kirsten MacDonald in a recent comparison for The Conversation. “The lack of means testing also means New Zealanders have more incentive to work and save throughout their working lives.”

Garry Weaven, who was a young official at the Australian Council of Trade Unions in the 1980s when it first agreed to convert part of wage increases into super, says the original aim was not to get people off the age pension, just to get them a bit more. “If someone has a very low lump sum and they’ve worked their whole life and they get to 65, 66, 67 – whatever – and take that money and pay off their house and have an overseas trip, good luck to them,” he said.

But Weaven, now chairman of IFM Investors, agrees more work needs to be done on “meshing” the superannuation and age pension systems, and moving from lump sums to income streams.

A review could also look at how Canada’s pension funds, which have few lump-sum options, have become big players in infrastructure worldwide, including here. One of them, the Caisse de dépôt et placement du Québec, is even planning to construct and operate Montreal’s rapid-transit system .

Weaven says the Australian funds haven’t yet had the chance to match that. “I think we would but we didn’t really get a chance to here,” he said. “The way in which the contracting and everything was developed for the Melbourne Metro didn’t really offer an opportunity for us to be involved.” However, IFM’s chief executive Brett Himbury insists it is still out in front, citing funding of Brisbane airport’s third runway, a new hospital in Adelaide, and German wind farms in the North Sea. “We’re not short of capital,” he said. “Show us the deals.”

Banks, meanwhile, will gravitate to the role of intermediaries in super fund lending to companies less well known than Visy, helping with risk pricing, in a valuable extension of Australian capital markets.

With infrastructure projects, they may not be needed at all. “Funds now have a capability where they don’t necessarily need investment banks to interpose in significant infrastructure deals,” says Matt Linden, of Industry Super Australia, the lobby for the non-profit funds. “Investment banks, if anything, actually strip value from those deals.”

Meanwhile, the industry funds are happy to assist royal commissioner Hayne. “Our funds have got nothing to hide, at all,” said Linden, suggesting the “litany of scandals” hitting the banks in the areas they now dominate will help argue against encouraging the banks and other retail fund operators to take a larger share of superannuation.

This article was first published in the print edition of The Saturday Paper on Jan 27, 2018 as "Super’s canny, realistic investment funds precocious". Subscribe here.

Hamish McDonald
is The Saturday Paper’s world editor.