What’s really driving the performance of industry funds?

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Conventional wisdom has it that industry funds have outperformed retail funds over the past decade largely due to their substantial investments in trains, planes and automobiles. Or rather, the infrastructure that supports them.

There’s some truth in this, but it’s not the whole story. To find out what drives super fund performance, you need to look beneath the bonnet.

“There are some misconceptions out there that funds are too peer aware and invest in a similar way, but there are major differences in their investment philosophy, portfolios, team structure and use of asset consultants,” says Mano Mohankumar, senior research manager at super funds ratings group Chant West.

To illustrate the point, Chant West recently compared investment returns and vital statistics of the five biggest not-for-profit super funds – AustralianSuper, First State Super (FSS), QSuper, UniSuper and Sunsuper.

As Table 1 shows, four of the five were indeed in the top quartile of performance over ten and 15 years to December 2019.

Table 1: Performance to December 2019

Note: Performance is shown net of investment fees and tax

As Table 2 shows, four of the five biggest industry funds also had meaningful allocations to unlisted assets of 20% or more. But here’s the thing. The funds with the highest levels of unlisted assets were not necessarily the best performers.

Table 2: Key statistics

*Unlisted infrastructure, unlisted property and private equity only

Source: Chant West

The role of unlisted assets

According to Mohankumar, the main driver of outperformance by industry funds has been unlisted assets, but active management has also contributed.

By investing large amounts in physical assets such as sea and airports, toll roads and shopping centres, and holding them for the long term, funds can avoid the short-term market volatility associated with listed investments such as shares.

As you can see from Table 2, unlisted assets account for between 20% and 27% of assets under management at four of the five biggest industry funds. These figures include unlisted infrastructure, unlisted property and private equity only. When unlisted alternative assets are included, the totals for some funds are even higher.

Of these four, First State Super’s relative performance lagged over ten and 15 years but has begun to improve more recently. According to Mohankumar, the recent improvement coincided with an incremental build-up of its unlisted asset exposure over the past five years to around 20%.

As you can also see from Table 2, UniSuper bucks the trend where unlisted assets are concerned.

Funds playing to their strengths

UniSuper is unique among industry funds with just 7% in unlisted assets. Mohankumar says the fund has a strong focus on actively managed listed assets as that’s where its 55-strong internal investment team’s expertise lies.

Like other industry funds, UniSuper takes large, long-term holdings in property and infrastructure, but it does so via listed companies such as APA Group, Transurban, Sydney Airport, Vicinity and Scentre. In other words, exposure to the same assets can be achieved via unlisted and listed investments.

“They have been able to build a high-quality property and infrastructure portfolio at a lower cost, which also allows them to take advantage of opportunities as they arise,” says Mohankumar. That’s because it’s much easier to buy and sell listed assets quickly than large unlisted ones.

And it certainly hasn’t held back the fund’s performance. UniSuper has been a consistently strong performer, ranking in the top seven funds over the past three, five, seven, ten and 15 years.

This is another reason why it’s so important to look below headline statistics. The important thing is not so much whether an asset is listed or unlisted, but whether a fund has skilled people selecting and managing the assets and a long track record of strong returns.

Different approaches to managing risk

Like UniSuper, QSuper is also a maverick. While it has one of the larger allocations to unlisted assets (27%), it has a much lower allocation to shares (about 29% versus 53% on average). But that doesn’t mean it has less exposure to risky assets.

“(QSuper) invests a meaningful amount in long-dated bonds (25%) that carry equity like risk but are a better diversifier against equity market falls than traditional bonds,” says Mohankumar. That’s because long-dated bonds are more sensitive to movements in interest rates and yields than short-dated bonds.

Super funds are, by their very nature, long-term investors. By investing in long-dated bonds, QSuper aims to deliver a smoother long-term journey for its members at the risk of short-term underperformance. This is borne out by its ten and 15 year returns in the top ten performers, while its 2019 returns lagged because of its relatively low allocation to shares in a year when shares did exceptionally well.

The lesson here is to keep your eyes on the prize and not be distracted by your super fund’s short-term performance.

While not in the top five in terms of size, Hostplus has different investment strategy again, yet it has also been in the top quartile of investment returns over five, seven, ten and 15 years.

Mohankumar says Hostplus has the advantage of a very young member base, mostly from the hospitality, sport, tourism and recreation industries. Because younger members have a long investment horizon, they have less need for low risk/low return defensive assets. “Hostplus currently has no exposure to fixed interest and cash but they have a lot (33%) in unlisted assets,” he says.

Balanced vs lifestage default options

Default MySuper accounts are designed for people who don’t choose a super fund or investment option when they start a new job. Most of these default accounts offer a single ‘balanced’ investment option for all members in the accumulation phase, up to retirement.

However, Mohankumar says around 40% of default MySuper assets are invested according to a lifecycle, or lifestage, strategy. Lifestage funds automatically reduce investment risk as members age and get closer to retirement, but there are big differences in the way they achieve this.

It’s often assumed that only retail funds use a lifestage strategy, but some industry funds do, too. It may come as a surprise that three of the five biggest industry funds – First State Super, QSuper and Sunsuper – have a lifestage default option. A quick look under the bonnet of these three also reveals three very different lifestage approaches.

• First State Super’s MySuper Lifecycle strategy puts default members in the growth option (75% growth assets) until age 60. Then they are automatically switched to the balanced growth option (55% growth assets) until retirement.
• QSuper’s MySuper Lifecycle strategy is the only one that takes into account both age and member balance. All members are in the same investment option until age 40 (and at various age-points thereafter) when those with a low balance are left in the higher risk option while those with a high balance are switched into a slightly lower risk investment mix. While this might seem counterintuitive, the rationale is that those with lower balances have increased risk of outliving their retirement balance and hence are likely to benefit from a higher risk/return strategy.
• Sunsuper’s MySuper Lifecycle strategy has members invested in the balanced option up until age 55. Then each month, between age 55 and 65, a portion of the member’s account balance is transferred into more conservative options. This means members have 70% growth assets up to age 55, which is gradually reduced to 45% growth by age 65. The aim is to provide a smoother glide path in the decade leading up to retirement.

Mohankumar says most retail fund lifestage defaults are different again. These typically put members into an investment option based on the decade of their birth and dial down risk as their birth cohort ages.

The wide variation in default funds’ asset mix and investment strategies makes it difficult to compare performance, reinforcing the need to understand how your money is invested.

One destination, many paths

Chant West’s comparison of the five biggest industry funds is proof that different investment models and philosophies can and do produce good outcomes for members. The challenge is to understand your risk profile, personal circumstances and retirement goals and then to find a fund that suits your needs.