Wealth Intelligence

Parts of the share-market feeling pain of massive funds’ shift

Assets flowing to industry superannuation funds.  Why and what next?

Australia has been experiencing the largest transfer of investment capital in its financial markets’ history. There has, and continues to be, a massive outflow of assets from retail superannuation funds to industry superannuation funds.

Whilst the media has mentioned the success of the industry superannuation funds in their booming assets under management, little attention has been given to the impact this has had on the Australian share market.

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 generally made the public wary of these large-scale wealth management models. 

Furthermore, a report conducted by the Productivity Commission (“Superannuation: Assessing Efficiency and Competitiveness”) stated 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 the larger industry superannuation funds have generally been amongst the better performers[1]

A combination of these factors led to an outflow of assets from retail superannuation funds to industry superannuation funds.  AustralianSuper, for instance, 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 for FY-19.  Furthermore, AMP saw an outflow of $4 billion of assets from its wealth management arm for the 12 months to the 31st of December. 

We can see below that this outflow of assets has accelerated post-Royal Commission.

graph1 

 To understand the impact this has had on the market, it is worth examining the superannuation industry, specifically: how retail and industry funds choose to invest the assets they have under management.

What impact has this had on the portfolio management industry?

Generally, retail superannuation funds outsource investment management to a variety of specialist portfolio managers.  These are, in turn, 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 investments “in-house” by directly employing investment professionals to invest and manage this capital.  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 having a sharp fall in assets managed, or, extremely, losing their investment mandates.

As a result, we have seen many specialist portfolio managers close over the past year or shrink in size as they lose a significant amount of assets.  We have been alerted by a broker that portfolio management funds (note that not all managed investments for superannuation funds) that have closed this year include:  Adam Smith Asset Management, JCP; Arnhem; Sigma; Concise, Gandel and KIS Capital and managers that have lost large mandates include: Kinetic, Janus Henderson, Celeste, Paradice, Eley and Novaport.  In many cases these events are not because of poor performance, but because of forced selling.

Consequently, these specialist portfolio managers have had to sell down their holdings to facilitate the transfer of capital to, mostly, industry funds’ management, as described above.

What impact has this had on the share market?

Many stocks have experienced significant selling pressure as a result of these specialist portfolio managers being forced to sell down their holdings.

The 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 forced and consistent seller in the market has a profound negative impact on their share prices, regardless of investment attractiveness. 

But what happens to the assets that flow to the industry funds?  Some of this capital flows into infrastructure projects and direct property.  Industry funds typically have a higher allocation to these type of assets (in comparison to retail funds) and also have the scale to invest in these larger projects.

Much of this capital also flows into larger companies on the share market.

This is because industry superannuation funds (particularly the large ones that have experienced the majority of the inflows) generally invest in larger, more liquid stocks that trade frequently.

For example, the weighted average size of a stock in AustralianSuper’s Australian shares' allocation is approximately $51 billion (Source: AustralianSuper, First Samuel).

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 Ordinaries Index) in FY-19.  And this is despite the ASX Small Ordinaries Index containing several booming small tech stocks (e.g. Wisetech Global, HUB24, Appen) and small mining stocks. 

graph2

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 portfolio managers of smaller companies are forced to sell down their positions and the resulting sale proceeds are not being reinvested in those companies, yet.

Historically, any disconnect between values and prices of this kind has not persisted for long as the share prices of companies revert to their intrinsic values over time.  This reversion will be because of either a return of liquidity/interest in these stocks (on-market) or as a result of them being taken private (off-market).

Note: Privatisation has recently become a very distinct possibility.  Private equity investors are currently operating in a “Goldilocks” environment where interest rates are at record lows and the capital they have available to invest is at record highs.

Until this reversion happens, there is an opportunity (a) to purchase these companies at a significant discount to their intrinsic value and (b) for these companies to purchase their own shares (through share-buybacks), which benefits current shareholders who recognise this.

Summary

The massive flow of funds from specialist fund managers to industry superannuation funds is having a considerable and detrimental effect on some parts of the share-market.  But the essence of long-term investing is not to be distracted by short-term mis-pricing, as concerning as it might be at the time.  

 

- Paul Grace

 



[1] This is not necessarily because industry superannuation funds are better at managing investments.  It is because they have (a) low fees; (b) economies of scale and (c) guaranteed inflows from compulsory superannuation contributions.

Of course, the downside of economies of scale is dis-economies of scale.  Industry superannuation funds are often too big to directly invest in smaller companies.