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Can you trust industry super fund valuations?

The financial year-end performance data of industry super funds was met with suspicion from investors, advisers, and even between super funds. The regulator's recent commitment to update its practice guide (APRA's SPG531) on valuation methods cannot come soon enough.

However, the reality is the industry has come a long way in recent years. Many funds have clear valuation policies that involve external expert reports, asset revaluations are conducted during heightened periods of volatility to support member equity and board valuation sub-committees have been established. But the debate over superannuation fund valuations of unlisted assets continues to rage.

Growth in allocations to unlisted assets

Many superannuation funds have embraced more use of unlisted assets recently. According to ASFA’s Superannuation Statistics, on average MySuper fund holds over 20% of assets in unlisted property, infrastructure, and private equity. Given the inflow profile and investment time horizon of some super funds, these large allocations to illiquid assets have remained manageable.

MySuper Funds’ Aggregate Asset Allocations

Source: ASFA Superannuation Statistics – May 2022

From the due diligence data Morningstar receives, the results for members have been impressive. Both AustralianSuper and Australian Retirement Trust's Private Equity programmes have generated returns in excess of 16% per annum over the last five years (as of 31 March 2022).

But APRA didn’t undertake their recent Unlisted Asset Valuation thematic review for nothing. The review highlighted:

“the need for considerable improvement in industry approaches to valuations and the need to conduct valuations proactively and regularly.''

Following the review and update of SPS530 – Investment Governance, APRA now intends to update SPG531 – Valuation. It is expected that the update will address valuation governance, valuation methodology (including independent assurances), frequency and monitoring of valuations and types of valuation risk.

Canva illustrates transparency need

Australia’s own start-up success story, Canva, is the subject of the most recent unlisted asset valuation controversy. According to U.S. SEC 'Statement of Investments' filing, Franklin Templeton Growth Opportunities Fund has written down the value of their Canva investment by over 58% already this year.

This write-down calls into question the valuation responses of the Australian superannuation funds that also hold this investment through their private equity programmes. 

The answer became obvious in a recent Morningstar discussion with a large super fund about how private equity managers need to be more transparent in a world of heightened standards around environmental, social and governance (ESG) considerations, with a focus on transparent disclosure.

Whether the write-down taken by Franklin Templeton is precisely right isn’t the point. The point is it was transparently disclosed. But under SEC regulations, Franklin Templeton didn’t have a choice. Revealing the holdings and valuations isn’t just good governance - it’s the law.

Here in Australia, Portfolio Holdings Disclosure at the security level for unlisted assets isn’t required. Instead, the industry and media are trying to back-solve based on the inadequate disclosure currently required.

For example, Aware Super has publicly stated they own Canva, but based on the Portfolio Holdings Disclosures posted on its own website, the best guess is that the investment is held through a Blackbird Ventures position. As to the carrying value of the investment, it is impossible to say, although to be clear, Aware Super’s disclosure is compliant and more than adequate under the current regulations.

Resistance to transparency of valuations

There are lots of arguments against increasing levels of transparency. After all, the Portfolio Holdings Disclosure regulations were watered down following significant industry criticism of the draft regulations. But wouldn’t sunlight solve the ongoing suspicion in relation to unlisted asset valuations?

It's good enough for many of the large listed real estate investment trusts. For example, Scentre Group clearly publishes Westfield Bondi Junction’s valuation. It’s good enough for our offshore counterparts, as Franklin Templeton publishes Canva’s valuation along with DataBricks and its other listed and unlisted assets.

Obviously, no valuation is perfect, whether listed or unlisted, daily or otherwise. We all know that the listed equity market in the short run is a voting machine. But it is a transparent voting machine and one that applies the same price consistently across market participants.

Funds need to disclose their unlisted valuations

It’s doubtful many super fund members would be venturing in to check valuations, but regardless, better disclosure would create enough industry scrutiny around who was taking what write-downs, when, and using what methodology that it would put to bed the cloud of doubt and suspicion that currently exists.

If we are really going to resolve this once and for all, funds need to be regulated to disclose their holdings at the security level and associated valuations following quarter end. I’m not suggesting that this is a 10-business day post-quarter end proposition. But following an appropriate lag, this information should be made available to investors and the broader industry.

This will be the only way to quell the doubt that exists. Instead, the industry remains under a cloud of suspicion as to who really was the best performing fund of the year.

 

Annika Bradley is Morningstar Australasia's Director of Manager Research ratings. Firstlinks is owned by Morningstar. This article is general information and does not consider the circumstances of any investor. This article was originally published in Morningstar on 16 August 2022.

 

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14 Comments
Annika Bradley
September 06, 2022

Thank you Cam – appreciate your feedback. I think transparency would solve many issues for our industry (across both the industry super funds and managed investment schemes!).

Rob
August 31, 2022

Annika - here is your challenge and I hope you take it up. My view, at best, these unlisted asset valuations are flawed and at worst, they totally distort reality and benefit one Member vs another Member.

Stay with Canva - written down post June 30th - convenient and no other conclusion that the particular Funds that held it overstated their 2021/22 performance. Now they have a number of choices:

1] Restate their performance for 2021/22 which is the correct thing to do but no sign they agree with that
2] Retain those inflated valuations for 2022/23, thereby deflating their 2022/23 performance - good luck!
3] Quietly rebase the 2022/23 Start Point to the lower valuations, so they can look like heroes come 30th June 2023 - that would be totally immoral and should be illegal. I do not have the resources to track that behaviour but Annika, you do!!

Brent
September 01, 2022

Interesting thoughts Rob.

When I worked in fund administration overseas, if there was a material error in a NAV price, the investors had to be made good by the party that made the mistake whether they were the fund administrator or the fund manager. A material error was seen as 0.1% of NAV and it has to be said I remember there being plenty of errors that were immaterial, but the one or two occasions a mistake was material, the problem was massive.

So a scenario there where investment valuations were overstated whether in error or knowingly, would have been a horrific situation for the fund administrator and/or fund manager. All investors suffering a material loss in this scenario would have had to be reimbursed and this could have run into the millions.

In industry fund land, with unlisted valuations running into the billions, the issue is amplified massively. What happens if existing prices are inflated and should have been written down already? Investors redeeming before the prices are corrected, have benefited while any investors remaining have been penalised (hmmmm sounds like a Ponzi scheme).

There are so many issues here around unlisted valuations in massive industry funds, that I fear that were there to be a major error/fraud identified on the fund, the repercussions for big super would be massive. The industry fund trustees, administrators, directors and managers are not going to have sufficient funds to make good the problem. The government would have have no choice but to use taxpayer money to fix the problem and trust in the super system would be in danger.

There are greater minds than mine (Annika?) that I am sure understand this problem and could explain how this would be managed. I'd be very interested to hear what would happen if major issues arose in future.

Annika Bradley
September 06, 2022

Thanks for the comments Brent and Rob. I’m hopeful that the updated practice guide on Valuations will provide some further clarity on their (APRA's) expectations in relation to unit pricing as a result of large unlisted asset holdings. There is definitely scope for an investor equity issue. As an aside Brent, in the Australian market, the FSC released guidelines many years ago (2004 - which ASIC adopted), that a unit pricing error for 0.3% is material (i.e. requires correction / compensation). In practice, I believe many groups work to a much tighter threshold than this.

Tony Dillon
August 29, 2022

It’s been a bit of a lark with large industry super funds for a while now. To keep pumping those large inflows of member funds into illiquid infrastructure type assets that are hard to value. And then use gung-ho valuation assumptions to pump up their performance to attract more funds, and on it goes. The cynic might also say that overstating performance, works well for industry fund asset manager bonuses. Then when Covid hit, and emergency government policy allowed members to withdraw funds, the industry funds had the hide to lobby the government to bail them out of their liquidity problems, as a rush on withdrawals eventuated. All those member balanced funds were exposed to be not so balanced after all. Thankfully, the government did not oblige, and left those funds to sort out their own mismanagement.

Annika Bradley
September 06, 2022

Appreciate your views Tony. I think some of the large industry funds are providing sound investment solutions for their members and access to assets that can be very difficult to access. This is reflected in our ratings and commentary on these funds.

Charles Coffrant
August 28, 2022

Great article, beside the valuation which is the crux of this excellent article, it brings other points:
. it looks like that there is a 2 regimes policy, an SMSF can invest in listed securities only, while the managed funds can invest in unlisted securities
. is there a statutory limit in the mix ('MySuper fund holds over 20% of assets in unlisted property, infrastructure, and private equity'), could that be 30, 40% or even more ?
. fund internal control in the selection of unlisted securities (statutory reporting of listed securities is far more stringent than unlisted ones), the door is wide open to 'preferential selection'
It looks like statutory reporting and checks needs to be in place to avoid any nasty surprise to funds members

Graham Hand
August 28, 2022

Hi Charles, thanks for the comment, two points:
1. "an SMSF can invest in listed securities only": Not so. And SMSF can invest in almost anything as long as it's done at an arm's length, is not for personal use and conforms with the investment policy.
2. There is no statutory maximum on a MySuper fund owning unlisted assets although the trustees have responsibility for the fund which requires adequate liquidity, etc.

SMSF Trustee
August 28, 2022

As well as the fact that SMSFs can invest in managed funds which can invest in unlisted assets. The best example is property funds. My fund invests in commercial property via a few different managed funds.

Natasha
August 25, 2022

Hostplus has an interim unit price on 30 June, and then they declare a final unit price usually mid July. 30 June 2018 saw a 0.74% increase between the interim and final unit price. 30 June 2019 saw no difference, noting the interim unit price increased 0.9% from that on 28 June (29th being a non trading day) 30 June 2020 saw a 1.09% increase between the interim and final unit price, noting the unit prices increased by a whopping 2.47% in the previous two days. 30 June 2021 saw a 0.51% increase between the interim and final unit price. 30 June 2022 saw no change - none whatsoever. All of these unit prices can be obtained from the Hostplus website. So the question is - how does a super fund with a set valuation policy have the ability to mark UP their valuations but curiously not mark DOWN. Is it related to the fact that the annual performance to 30 June is used in industry surveys, APRA heat maps, APRA annual performance test, super funds Annual Member Meetings (like an AGM) and most importantly, member's statements.

Marc Le Mire
August 27, 2022

My SMSF invested in Hostplus infrastructure the valuations of which which remained surprisingly stable post Covid share market drop of 30%. I considered selling out and deploying the cash elsewhere with bargains aplenty but decided to stay invested long term.
There appears to be nothing to stop people in large super funds moving from one investment choice to another if they consider certain assets incorrectly valued. Eg move from a “balanced” investment choice including unlisted assets to all listed shares. The shares bounce back and the investor comes out in front albeit at others expense.
Has anyone modeled this approach?

Steve
August 25, 2022

It's funny how certain mega-Industry funds just pip the post at the right time, but when you look at their medium-term charting, they are all pretty much of a muchness. Morningstar's fund charting is far more reliable in assessing funds than the so-called 30 June "winners"

Peter Higgins
August 24, 2022

Well said Annika. Host Plus' positive return (and I imagine the returns of other funds claiming to have earned gains in 2021/22) defies logic and mathematics. The bulk of their allocation was well in negative territory, yet their minority undisclosed allocations made such huge gains as to overcome this and generate a positive return. Members in 10-20 years will pay for all of this. The Canva story is but the tip of the iceberg. There are promissory notes and fees blended into net income returns as well. How can anyone trust these numbers?

Cam
August 24, 2022

Great article. Without transparency we'll continue to be left with plausible, logical and persuasive theories that may be psot on, completely wrong or somewhere in between.

 

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