The largest transfer of investment capital in Australia's history
As clients would have read in our monthly update, Australia has been experiencing the largest transfer of investment capital in Australia’s financial market's history. There has, and continues to be, a mass outflow of money from retail funds to industry superannuation funds.
Given the significance of this, we thought it is worth exploring why this is occurring, the impact it has had on the fund management industry and the implications this has for the future.
Why is this occurring?
In 2018, there was a thorough and very public examination of the superannuation industry.
Firstly, the Royal Commission revealed that several large “wealth hubs” such as AMP and IOOF, as well as the big four banks (ANZ, NAB, CBA, Westpac) had acted in a manner that was not aligned with clients' interests (improper conduct, delivery of inappropriate advice, fees for no service, conflicting interests and incentives).
This has generally made the public wary of these massive wealth management models.
Furthermore, a report conducted by the Productivity Commission (“Superannuation: Assessing Efficiency and Competitiveness”) revealed that a large number of superannuation 'products' have underperformed markedly, with a majority of these being retail funds (i.e. sold through the big distributors such as the banks and AMP as well as through suburban financial planning companies). The results of the report also showed that larger, industry superannuation funds have generally been amongst the best performers. (This is not because they are better at managing investments. This is because they have (a) low fees; (b) economies of scale and (c) guaranteed inflows from compulsory contributions).
The combination of these factors led to an outflow of assets from retail superannuation funds to industry superannuation funds. AustralianSuper, for instance, has stated that its assets under management increased by $8.3 billion for the seven months to February and is forecasting a $16 billion increase in inflows in FY-19. Furthermore, AMP saw an outflow of $4 billion of assets from its wealth management arm in FY-18. And that was before the Royal Commission fallout.
The graph below demonstrates this phenomenon in aggregate:
Source: APRA, First Samuel
To understand the impact this has had on the market, we must gain a broader understanding of the superannuation industry and how retail and industry funds choose to invest the assets they have under management.
What impact has this had on the fund management industry?
Generally, retail superannuation funds outsource investment management to a variety of specialist portfolio managers, who are responsible for achieving performance within specified risk, return and other metrics. These portfolio managers are typically classified by a particular investment style or focus (e.g. large cap; small cap; 'core'; emerging companies; value; growth; dividend-income, etc.)
Industry superannuation funds also use specialist portfolio managers to manage their investments. But recently many larger funds have chosen to manage those investments “in-house” – that is, to directly employ the investment professionals that manage that money. In some of the larger industry funds, more than half of all assets are managed “in-house”. The move of assets away from retail superannuation funds has thus resulted in many specialist portfolio managers losing their “investment mandates” and having to sell down their holdings to facilitate the transfer of cash to industry funds, as described above.
This loss of mandates has had a significant impact, with several well-established specialist portfolio managers losing business. As a result, we have seen several specialist portfolio managers close over the past year (for example: JCP Partners, KIS Capital, Janus Henderson), or shrink in size as they lose significant assets.
What impact has this had on the share market?
As a result of these portfolio managers losing their mandates, many stocks have experienced significant selling pressure.
This impact of this has been particularly pronounced for smaller stocks. These generally trade less frequently and in smaller values (i.e. are less liquid). Thus, the presence of a consistent seller in the market has a profound negative impact on their share prices.
Conversely, we have seen more assets flow into the larger end of the market. Due to their size, industry superannuation funds (particularly large ones that experienced a majority of the inflows) typically invest in larger more liquid stocks that trade frequently and in larger values, as well as in large illiquid investments, such as infrastructure.
For example, the weighted average size of a company in Australian Super’s Australian shares' allocation is approximately $51 billion (Source: Australian Super).
This may present an explanation why larger, more liquid companies (as represented by the ASX 50) have outperformed smaller companies (as represented by the ASX Small Ords) in FY-19. And this Small Ord's performance includes the booming small tech stocks (e.g. Afterpay) and small mining stocks.
Source: IRESS, First Samuel
What are the implications of this for the future?
This phenomenon may explain why in some areas of the market, particularly smaller companies, there has been a growing divergence between (a) the value of the business performance and prospects of a company and (b) the share price the market is attributing to that company. This divergence is because of selling pressure as smaller portfolio managers wind down their positions.
Historically, any disconnect between values and prices of this kind has not persisted for long as the share prices of companies ultimately revert to their intrinsic values. Ultimately this divergence will close, either through a return of liquidity/interest in these companies (on-market) or as a result of them being taken private (off-market).
As an aside - the latter has become a very distinct possibility. Private equity investors are currently operating in a “Goldilocks” environment where interest rates are at record lows and their assets under management are at an all-time high. Private equity investors in Australia alone have $11 billion of ‘dry powder’ to invest over the coming years (Source: - AVCAL). This figure does not include their ability to borrow money.
As such, it is not unreasonable to assume that some of these companies may have their value realised through corporate activity. That is, that share prices will increase to reflect their intrinsic value.
- Paul Grace