Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Mercer predicts mega-mergers as fund competition heats up
In its inaugural “Shaping Super” report, Mercer has predicted the superannuation industry will soon see one or two ‘large’ mergers above $100 billion, involving either existing megafunds or the union of two funds to form a new megafund, as well as a commensurate reduction of around 10 per cent per year of funds with less than $30 billion FUM.
And to survive in that period of heightened competition, funds will need to have a laser focus on growth – either organically through member flows, or inorganically through more mergers.
“Over the next five years, we expect the total number of funds to reduce by another 30 per cent,” the Mercer report says. “We predict the number of smaller funds (with assets of less than $30 billion) in the system to more than halve with regulatory pressure to consolidate small funds and seek economies of scale. This will likely spark more mega funds from a combination of organic growth from new members and investment performance, and inorganic growth from fund mergers.”
While most commentators refuse to be drawn on what they believe the ‘final’ shape of the super industry will look like, Mercer predicts that around 10-15 megafunds and 10 to 20 ‘niche’ providers and platforms will ultimately serve Australian superannuants.
“The Australian superannuation system is moving toward a market state similar to the Australian banking system,” the report says. “The banking sector has a few large participants and a handful of smaller, competitively differentiated banks and other financial institutions, such as building societies and credit unions, that have maintained long-term market position.”
Asset allocation changes
And while funds have evolved their asset allocation “considerably” over the last decade, with chunky allocations to equities and alternatives, Mercer expects that going forward they’ll likely focus on variation within asset classes as they search for new sources of return that differentiate their performance from their peers.
“Within this, we expect a reduced focus on domestic equities, given opportunities available internationally and the size of APRA regulated superannuation fund equity investments (of approximately $1.3 trillion) relative to the market capitalisation of the ASX (approximately $2.5 trillion),” the Mercer report says. “Through this we expect funds to increase allocations to emerging markets and private equity to capture growth opportunities.”
Meanwhile, funds are taking a “blended” approach to who managers their investments, using internalised functions to retain control of investment decisions and reduce fees while outsourcing some of their requirements – like manager assessment and niche strategies – to third parties.
But regardless of whether a fund pursues a heavily outsourced model or not, good investment outcomes are fairly evenly dispersed across the spectrum of funds, suggesting that “outperformance is viable in either model” and that best practice is “fund specific”.
“We expect funds will increasingly adopt a hybrid approach, using internal resources where there are capabilities and third parties to provide independent challenge and fill gaps,” the report says. “This will require a focus on governance relating to both internal teams (for instance, how internal teams are monitored, and, where appropriate, ‘terminated’) and third parties (for instance, in relation to separation of duties).”
