Investment by super funds in high quality private assets, such as infrastructure and private equity, creates large benefits for their members, along with some problems. Unfortunately, recent commentary by Richard Holden (Opinion Nov 10 & 23) and others has overstated those problems and largely ignored the very substantial benefits of super fund investment in private assets.
There is an inherent problem for super funds in how to maintain fairness across the member base as some members are contributing and others are withdrawing super through time. What ownership stake should be given to the investors bringing new capital? And, how much capital should the leaving investors take with them?
This problem, of how to assign to each member an exact claim on the assets of the fund as members come and go, will always exist because the value of long-term risky assets can never be known with objective certainty. Moreover, the problem is not unique to super funds. Partners come and go from partnerships. Companies sell shares to new shareholders, and at other times buy back shares from existing shareholders. Each change in collective ownership, inevitably and unavoidably, involves some imprecision and therefore inequity.
In super, the equity problem is lessened by the very long cycles of contribution and withdrawal. Super members make hundreds of monthly contributions over the decades of their working life and then drawn down (or don’t drawn down) their balances over a similarly long span of time. In those hundreds of transactions they sometimes win and sometimes lose in the imprecise calculation of each member’s stake in the fund.
Holden notes that publicly traded assets, such as stock market listed shares and public debt, are valued more accurately than private assets. He then jumps to the assertion that a very large equity problem has been created by super funds investing in private assets.
This assertion is not accompanied by supporting evidence, but instead by hyperbolic language such as ‘savings are being stolen’ and ‘a valuation swamp’. What is the evidence that the inevitable inequity problem created by imprecise valuation of super fund assets is large and not small? We have had the GFC and the Covid19 crises as testbeds in which this problem should have been magnified to observable scale. Where is the evidence of substantial inequity?
There is plenty of evidence for the large benefits of super fund investment in private assets. The Productivity Commission’s inquiry into the super system found that industry funds out-performed retail funds by 2 percent per annum in the period 2005-17. About half of that large difference was due to the higher allocation of industry funds to private asset classes – especially infrastructure and private equity.
Super funds, along with university endowments, sovereign wealth funds and the offices of wealthy families are, for two reasons, the natural holders of illiquid assets like infrastructure, private equity, venture capital and real assets (such as farmland). They have long investment horizons over which the high round trip cost of buying and then selling illiquid assets can be amortised. And, they have less need to quickly liquidate assets.
So, super funds can bear the problems of holding illiquid assets at low cost, while still receiving the return premium that holders of illiquid assets enjoy.
In addition, there is the benefit of the greater diversification across asset classes that private asset investment affords to super fund investors. Diversification is large because public and private asset classes have different exposures to systematic risks. In particular, private asset classes have lower exposure, than publicly traded assets, to rising inflation and unwinding of QE.
Investment in private asset classes has become more and more important to investors. If ordinary households don’t invest in private assets through their super, then how will they do it? They have no other high quality, low cost option.
It used to be said that industry super funds help ordinary Australian households to invest like millionaires – an observation usually attributed to Garry Weaven. But now, in 2021, it is more accurate to say invest like billionaires because the members of the largest industry super funds participate in a set of private investment opportunities that even the wealthiest family offices cannot easily access.
That is the real equity story in the growth of super fund investment in private assets — the closing of the gap between the investment opportunities of the wealthiest Australian families and ordinary Australian families.
It is true that investment by super funds in private assets creates a tension between equity and performance. But, these are not equal considerations. The problem with equity is far smaller than the improved performance that higher allocations to private assets brings.
Commentary that exaggerates problems with super fund investments in private assets, and understates the very large benefits, neither advances public discourse nor acts in the interests of ordinary Australians.
Copyright 2021 Sam Wylie
This article was published in the Australian Financial Review on 29 November, 2021