Investment insourcing by big super funds has been a hot topic for the institutional segment of the industry for several years. But the insource/outsource topic is bigger than just investments. A paper by implementation specialist manager Parametric has weighed into the discussion.
The paper, written by Raewyn Williams, managing director of research in Australia, shows that the super ecosystem is being redefined by “foundational, strategic business decisions” to do with insourcing and outsourcing. The Parametric paper calls it the “make or buy” decision.
Williams said: “Superannuation funds are making the most of a push-to-pull paradigm shift where, instead of having structures and processes ‘pushed’ to them, funds have become the centre of gravity in the ecosystem and can ‘pull in’ what they want, how they want it and who they want it from.
“’Make or buy’ decisions have been transforming the superannuation value chain over the last few years. Just some examples: AustralianSuper, Equip Super, Cbus, First State Super, QSuper, MTAA, REST, UniSuper and Telstra Super decided to build internal investment teams.
“QSuper’s insourced their insurance capabilities. RBF outsourced its administration. Vision Super decided to insource operations. Telstra Super and WA Super both decided to switch custody to JP Morgan.
“Parametric’s research points out that with the power funds now have, they must make good ‘make or buy’ decisions,” she says. “Good ‘make or buy’ decisions are critical not only to the success of the fund, but the industry as a whole.”
In an interesting comparison, the paper suggests how super funds can measure the effectiveness of different make-or-buy configurations by reference to an SMSF investor who bypasses the institutional super value chain. There is a potential key trap that super funds can fall into.
“Too narrow a focus on real, measured interaction costs will artificially skew make-or-buy decisions towards funds building the capability themselves,” Williams said. “This can leave no room for niche entrants and thoughtful external partners in the superannuation value chain.”
In a practical sense for big funds, a focus on interaction costs, which the regulator and some recent Government inquiries have pushed for, leads to potentially sub-optimal outcomes such as:
- a custodian with a limited core of off-the-shelf capabilities will have the edge over a full-service custodian with flexibility and customisation competencies
- a passive or factor manager will have the edge over an active manager, and
- an insurance company with narrow claims definitions will have the edge over a more generous insurance company.
The research offers a capability sourcing decision-making tool that funds can use to navigate the possibilities, one which avoids a narrow focus on economic interaction costs which could skew funds’ decisions towards a ‘make’ rather than ‘buy’ decision.
The tool identifies three considerations which are key to a good decision: third-party interaction costs; internal notional costs; and a fund-specific view of the standard the capability must meet to be fit-for-mission.
Williams said unbundling was a healthy development in the super value chain, bringing buying power to funds, risk benefits, transparency and cultural alignment.
“Unbundling opens up make-or-buy options for all superannuation funds, not just large funds, and makes a make-or-buy strategy a precision instrument,” she said.