Productivity Commission super report: How to game the ‘best in show’ super rules

Productivity Commission super report: How to game the ‘best in show’ super rules

But the real opportunity to game the commission’s new system only comes down the track, when the best-in-show shortlist is shuffled, with some new super funds being added while others are removed.

Obviously, when super funds are fresh to the shortlist, they’ll enjoy a surge in inflows, making their performance measures appear even rosier. But the converse is also true. Those funds that are dropped from the shortlist because their performance is not up to scratch will post even worse results when they lose the hefty funds inflows that previously helped to lift investment performance.

As the fund reports increasingly dismal investment returns, some members will withdraw their super savings, leaving the fund no choice but to sell assets, such as shares or bonds. This leaves the super fund at risk of becoming trapped in a nasty downward spiral as funds outflows force them to sell assets, which undermines their performance even further.

Fast mover advantage

So savvy investors who want to get the highest possible returns will move their retirement savings into super funds as soon as they’re included on the shortlist, because this will allow them to take advantage of the favourable investment tailwinds. But they’ll also move quickly to withdraw their super savings whenever a fund is dropped from the list.

Meanwhile, the patsies the commission is trying to protect — ordinary super fund members who aren’t even aware that a shortlist exists, let alone that their super fund has just been pushed off it — will keep their retirement savings in the fund, oblivious to the risk that their returns are about to fall.

Of course, those super funds fortunate enough to make it onto the best-in-show list will be aware of these deleterious consequences of losing their privileged position. And their anxiety to remain on the shortlist is likely to cause them to eschew riskier investment strategies, which could hinder their performance in the short term, even if it produces exceptional longer-term returns.

Instead, these super funds are likely to try to maximise their chances of remaining on the list by closely mimicking the investment strategies being pursued by others funds on the list, so that they don’t stand out from the crowd.

Meanwhile, those super funds hoping to make it onto the top-10 shortlist will have a strong incentive to try to boost their performance — either by adopting a riskier investment strategy or by shrinking the services offered to members, which would allow funds to cut their fees.

How to judge returns

This leads to the very thorny question of just how the expert panel will go about deciding which 10 super funds deserve to occupy a coveted place on the shortlist.

The commission’s somewhat facile answer is that the 10 super funds should be chosen based on their ability to deliver high returns, after fees, over the long term.

Most seasoned market players believe that the expert panel’s expectations about the likely future performance of super funds inevitably will be heavily influenced by whether they’ve delivered high returns in the past.

The commission, however, takes a different view. It argues that past performance will be “only one factor” in calculating the likelihood of producing high future returns. It sees the expert panel probing much more deeply into how the super fund is run.

But, its report says, “when determining likely future performance, the expert panel would be expected to have insight into the investment strategies employed by funds, their risk tolerance, and the relative merits of their trustee board and key staff, rather than naively extrapolating past performance”.

Market professionals, however, point out that it is notoriously difficult to gauge objectively the respective merits of different investment strategies, let alone the qualities of different trustees. What’s more, investment success invariably casts a glow over all aspects of the super fund, burnishing its investment strategy and making its key executives appear more sagacious.

This halo effect quickly disappears when the fund’s investment performance stumbles. Then, the warts in its investment strategy, and the shortcomings of its senior management, are obvious for all to see.

Even the starry-eyed commission accepts that “it would be unrealistic to assume that every fund that was ever placed on the best-in-show list would continue to outperform rival funds throughout the lifetime of members”.

This leads to another major problem with the best-in-show approach. Those august individuals who are selected to serve on the expert panel inevitably will be concerned about the damage to their professional reputations if they put Australian workers into what turns out to be a dud super fund. As a result, when it comes to picking a shortlist, they’re much more likely to choose established super funds with a long track record of delivering respectable returns, rather than taking a chance with more adventurous choices.

And that will frustrate the Commission’s fondest hope that its new, best-in-show shortlist approach will increase competition in the super industry.

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