“Annual fees exceed 1.5 per cent of balances for an estimated 4 million member accounts [holding about $275 billion]. Almost all of these accounts are in choice products offered by retail funds,” the report says.
Of these, it says more than 3 million accounts are held in so-called “legacy products” — which hailed from an era when fees were higher and which preceded the introduction of Future of Financial Advice laws that banned conflicted remuneration. The amount of money held in these legacy products is about $135 billion — or about one-twentieth of the country’s entire super savings.
But while the major banks and AMP have now capitulated to pressure and agreed to give up the trailing commissions that were grandfathered when FOFA laws took effect in July 2013, they’ve been tight-lipped about their plans to forgo billions of dollars in fee revenue by slashing the exorbitant fees charged on legacy super accounts.
Meanwhile, as the commission points out, some 3 million Australians who have kept their retirement savings sitting in these legacy super products inevitably will feel the pain from these high fees. “An increase in fees of just 0.5 percentage points can cost a typical full-time worker about 12 per cent of their balance (or $100,000) by the time they reach retirement,” the report says.
To date, no approach has been able to stop this widespread gouging of the millions of retirement savings accounts.
Economists argued that self-interest should provide a solution, as people realise they’re being ripped off and move their super savings to lower-cost options. But it’s clear that millions of people are not watching their super closely enough to even realise there’s an issue.
Lawyers argued that there would be no problem if trustees acted in accordance with their legal duties. But, as the commission’s report points out, the Hayne royal commission “has revealed evidence of conflicts of interest directly resulting in member harm, including many instances where trustees in vertically integrated retail groups have preferred the financial interests of related-party shareholders over those of their members”.
And regulation has failed to protect millions of members of super funds. As the report notes, “members would have a realistic expectation that government and regulators would ensure their fund is looking after them, but this expectation would have been sadly misguided — with no regulatory disposition nor effective mechanism in place for weeding out underperforming funds and products”.
Sill, the commission argues there is a way to rid the super system of these poor-performing funds, and that’s by using the approach that the commission itself developed when it tried to assess the investment performance across the super system.
The commission constructed “benchmark portfolios” to measure the investment returns across a set of asset classes (such as bonds and shares), with the mix of assets adjusted to reflect the particular investment strategy (or asset allocation) of the fund. The benchmark uses listed financial market indexes for listed assets, such as shares and bonds, but it can also be tweaked to include unlisted indexes to reflect some super funds’ exposure to unlisted assets.
The commission argues that the Australian Prudential Regulation Authority should adopt a similar approach, and use a benchmark of listed market indexes to measure the performance of the various investment options offered by super funds.
Annual outcomes test
Already, there are plans to strengthen low-cost, simpler MySuper products by introducing an annual outcomes test that would require super fund trustees to determine whether their MySuper product was meeting the best interests of their members, and to compare their MySuper product against others in the market in terms of fees, returns and risk.
But the commission argues the MySuper outcomes test needs to be even tougher. Funds should be forced to obtain independent verification — to an audit-level standard — of their outcomes test at least every three years, and to compare their MySuper performance against a benchmark portfolio with the same asset allocation.
What’s more, the commission argues, this same “elevated outcomes testing” should be extended to the super funds that people have chosen to join, and that tough consequences should apply to those super funds that consistently lag their performance benchmarks.
“The investment benchmarks should serve as a clear test for the right to remain in the super system. MySuper products and choice options that persistently underperform the benchmark would fail this “right to remain test’.”
To avoid super funds being penalised for adopting a longer term investment strategy, or for deviating too far from the market index, the commission argues for measuring the fund’s average annual performance against the listed benchmark, less a margin of up to 0.5 percentage points.
When a super fund fails to meet its benchmark, it would then have 12 months to improve its performance (for example, by cutting fees), or it would have to withdraw the investment option and move the affected members somewhere more suitable.
The commission argues that introducing an “elevated outcomes testing” regime is likely to trigger a round of long-overdue consolidation in the super system and cause the withdrawal of some investment products that have delivered chronic underperformance.
“Indeed, that is the raison d’etre of the changes: to significantly reduce the incidence of member harm by lifting fund performance and, where funds cannot achieve this, to encourage and, if necessary, compel mergers or exits (‘cleaning up the tail’ of underperformers’)”, the report says.
While the commission’s championing of an “elevated outcomes testing” approach will no doubt prompt howls of protest from the big, well-heeled players in the industry, it does offer some hope for finally ending shoddy misconduct that has long plagued part of the super system.
As the report itself notes, “while there may be an element of ‘rough justice’ for funds, this is unambiguously preferable to the ‘rough justice’ the system has frequently meted out to millions of members”.