Former Treasurer and now Chairman of the Future Fund, Peter Costello, regularly entertains the idea that Australia’s sovereign wealth fund could run the ‘wholesale management’ of one mega national super fund. For example, he said in February 2019:
"The Future Fund could be of assistance to a public default fund in working out asset allocation or recommending managers or maybe even having a wholesale role."
Then again in January 2019, he said:
“I’ve never said the Future Fund wants to be a super fund itself, but if the government wants to set up a default (super) agency, we could act as a wholesale fund manager.”
Encouraged by the critical findings of the Financial Services Royal Commission, especially relating to retail superannuation funds, some members of the Morrison government support the idea of a public entity directly accepting default super contributions.
Government purse to the rescue
With Australia’s total pension savings around A$3 trillion, and with government regulators continually vocalising their preference towards further consolidation within super, any one of a number of persistent uncertain investment, liquidity, and operational risks could trigger a moral hazard-like event. No democratically elected government, especially one with an outspoken baby boomer constituency like Australia’s, would ever allow a mega super fund to fail.
Facing the political reality of billions of dollars of retirement savings being lost by a government agency that was supposed to be protecting capital, ‘caveat emptor’ investment theory would be thrown right out the window.
Traditional government responses to rescuing financial institutions would not work under this consolidated mega fund model in an ongoing volatile market. At the moment, if a bank runs into trouble (such as the Bankwest and State Bank bailouts), a takeover by a larger bank is engineered. However, the larger the super assets under management by one provider, the less probable that another one or two unaffected super funds could bail another out given fiduciary responsibilities.
The government would be forced to use a taxpayer-sourced bailout and nationalise the fund, thereby making Paul Keating’s idea of Defined Contribution (DC) obsolete. Under the current DC approach, with superannuation run by the non-public system (including industry funds), performance risk has been passed from the institution to the investor, replacing the old Defined Benefit (DB) system.
The precedent of ‘daiko henjo’, or handing back liabilities
While the collapse of a national super fund is obviously hypothetical, it would be equally wrong to assume that there is no precedence. Japan offers such an example, having an economic circumstance with uncertain market direction, negligible cost of capital (and corresponding anaemic government bond yields), and rapidly ageing demographics. And while the majority of Japanese pension funds are Defined Benefit, the majority of Japanese people retiring (and Japanese corporations funding such a retirement income) find it difficult to operate under the uncertainty of the ‘Three D’s’ - Deficit, Deflation, and Demographics.
CFOs of publicly listed Japanese companies were complaining that while they sustained their business under difficult economic conditions, through fault not of their own, pension liabilities would influence their total debt (and balance sheet) under current international accounting standards.
So nearly 20 years ago, the Japanese government introduced ‘Daiko Henjo’, a Japanese word which loosely translates to ‘hand-over’. Under Daiko Henjo, corporations could take pension liabilities off their books and hand back their pension liabilities to Japanese taxpayers. By implementing Daiko Henjo, Japanese corporations could effectively take their pension liabilities off balance sheet. For this to happen, however, the Japanese government required two things: that the pension fund be fully funded, and that the payout to each employee/retiree be quantifiable.
While there were a few notable exceptions, this free exit was too attractive for Japanese CFOs to pass up. The Japanese government set up GPIF, arguably the largest global pension fund with assets near A$2 trillion. The number of actual corporate pension funds shrank by more than two thirds, and the nationalisation of Japanese pensions has never looked back.
From its peak in 1990, the number of people employed within financial services similarly shrunk by over two thirds, including from institutional funds, brokers, administration, custody and asset consulting. And while the Japanese retail funds market remains robust, it is a shadow of what it once used to be.
Market extremes, strange at the time
While living in Japan, I observed how in the early 2000s, investors could buy a flat in Tokyo, mortgage the purchase at an interest rate of 1.5% and yet access a rental income of 10%! Coming from Australia, the obvious reaction was “How could this be?” Surely this will eventually be arbitraged away.
A decade later, this positive spread has fallen but remains significant. Following 30 years of real asset deflation, investors adapted housing pricing expectations under such extreme market conditions. The income was the compensation required for falling property prices, the complete opposite of Australia where miserable rental yields are the cost of buying into capital gain.
Yes, extreme conditions yield unexpected results. Like cutting interest rates in our demographic world no longer correlates with increased spending. Like negative bond yields in many countries.
In Japan, traditional monetary policy was already ineffective 20 years ago, whereby interest rate cuts were no longer followed by a commensurate rise in consumer spending. With a large population of retirees in Japan, continued cuts in interest rates actually saw a drop in consumer spending as retirement income fell. Sound familiar in Australia now?
Don’t assume these things will not happen here
Before anyone wrongly assumes that I am prognosticating the same outcome for Australia, I’m not. What I am flagging, however, is that to write off the threat of a national pension system would be equally naive given our persistent economic and market uncertainties. A government entity accepting default contributions from shop assistants, apprentice bricklayers, coal miners and factory workers would be forced to top up savings in the event of a severe market crisis. We seem to forget the stockmarket receives a 50% crash about once a generation.
Furthermore, with more mega funds capturing economies of scale by moving towards internal manufacturing (whose threat of operational errors are funded by member capital), the risks within super is commensurately rising.
The government should be careful what it wishes for as every action is followed by a set of new reactions.
Rob Prugue has over 30 years in funds management, from market regulator to investment analyst and manager, to pension manager, to asset consultant and, most recently, as a CEO of Asia Pacific at Lazard Asset Management. These opinions are his own. Now at the end of his recent sabbatical, Rob would be an ideal resource for any business considering a broad range of investment and planning issues.