Segregating pension assets: a fund’s ‘enterprise’ decision

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With more than 2.8 million individual members, and more than $500 billion in assets, likely over the next 10 years to move into the pension phase of big funds, or out of them altogether if they’re not careful, the question is how to treat those assets, and their owners, in and around the process. It is a big and complex question.

Raewyn Williams, managing director, research, at Parametric Australia, has taken on the task of looking at the issue. As with most things to do with super, and increasingly with pensions, tax plays an important part in what is a right or wrong choice for the member. What is right or wrong for the fund, as a business, is a separate important question.

Williams says in her latest research paper, ‘Should Superannuation Funds Segregate Their Assets’, that funds often approach the question as being impacted by scale. If you hive off 10-15 per cent of your portfolio into a separately managed structure, for instance, what will that do to the economics of the fund?

Williams calls this: “the scale myth” and aims to “debunk” it, as well as discussing the finer points of implementation. She also shows how it relates to the broader strategic question for the fund as to whether it sees its enterprise as one of ‘mass production’ of investment returns or ‘mass customisation’.

She says in her introduction to the research paper: “Beyond the scale myth, we identify certain ways in which asset segregation decisions can end up being suboptimal, including an overreliance on the quantitative business case and the temptation to address the important question of how to implement segregation only after the decision is made rather than up front.

“We also sound the alarm about an aspect of the Government’s imminent rules around retirement product design: If these end up being too prescriptive, funds may be forced down the asset segregation path rather than being able to determine whether it’s truly the right fit for their fund. A decision about asset segregation closes off, or opens up, particular pathways to delivering good retirement outcomes for members. Funds should use their best thinking, and devote adequate resources, to ensure they get this decision right.”

At the asset allocation level, a partial segregation of assets is simplest. This means the members are segregated at the account level but the assets in various pools are effectively co-mingled at the portfolio selection stage, enabling continued supposed scale benefits of using the same managers, although it can introduce a broader range of products within the manager line-up.

“However, asset allocation stops at the shoreline of investment portfolio management; it cannot wade into the portfolios themselves to address the different investment preferences of the underlying accumulation and pension members,” the paper says. “The only way to pursue ever-finer customisation for these different investor preferences is to consider segregating some of the underlying portfolio assets themselves.”

Pension options are tax exempt, but accumulation phase investment options are subject to capital gains tax. Williams notes that a handful of funds, including QSuper and HESTA, have spoken publicly about the benefits of carving out and managing separately some assets specifically for pension members. But she suggests this may not be the right course for all funds.

With respect to the question of scale, the paper says: “Segregation does, in our view, require a minimum amount of scale, but it need not be anything like the $10 billion pension pool that anchored QSuper’s decision.”

Williams says: “Beyond portfolio construction considerations, segregation’s siren call to a fund may be just as much about the messages a fund can deliver to what is, after all, its most engaged, sensitive member cohort. A fund can deliver important investment assurances to pension members in an unsegregated structure about returns, cost savings and broad risk management.

“But segregation, as part of a fund’s broader (mass) customisation, brand appeal and narrative, can unlock powerful new messages to members about how the fund is addressing specific concerns like salary replacement expectations, tax efficiency, capital protection, fit with homeownership, access to capital and life expectancy. Some funds will value this while others may not.”

– G.B.

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