CHAPTER 6
SHORT TERMISM - PERCEPTION OR REALITY
Such a culture of short termism not only permeates the funds management
industry, but its promotion through and by the mass media has resulted
in an increasing concern by the members of the funds about short term
financial returns on fund investments. [1]
The issue
6.1 The expression 'short termism' describes the practice of superannuation
funds taking a more than necessary short term position in their investment
spread. The definition provided by the Institute of Actuaries of Australia
(IAA) describes short termism 'as a preference for an investment policy
which seeks to minimise short-term fluctuations in the rate of return
on assets'. [2] There has been extensive
research and examination of short termism by a number of people and organisation
in recent times. There are differing views on whether, and the extent
to which, it is a problem.
6.2 The IAA believes 'that many superannuation funds are adopting a short-term
approach to their fund's investment policy':
... an overly short-term approach generally results in members
receiving superannuation benefits which are only a fraction of the benefits
which could be enjoyed under investment policies which adopt a long-term
focus. The result is a reduction in the level of savings in the community
and undue pressure on Government revenue in paying age pensions. Consequently
such short-termism is contrary to the national interest and should be
viewed with serious concern. [3]
6.3 There is a view, however, suggesting short termism might be beneficial:
A lot of the market players - I am not talking about the financial
people, but a lot of the analysts and the economic thinkers - seem to
believe that the pressure of short-termism actually leads to better
economic results and puts more pressure on directors to perform than
anything else. [4]
Competition and choice
6.4 Strong competition between fund managers has been one of the main
reasons for a short term perspective in superannuation investment. That
is because the measure of performance of fund managers is fairly well
confined to short term investment results. However, a proposition the
Committee finds difficult to dismiss came from the ASX, who said:
If a fund manager consistently performs quarter by quarter, that
has to be good for the owners of the fund. [5]
6.5 Competition does affect trustees and fund managers in their investment
outlook, in that:
- trustees and fund managers are preoccupied with short term returns
so as to look good and be competitive in the published comparative tables;
and
- members expect continually good results from their fund with no short
term losses. [6]
6.6 The general issue of choice has several relevant elements in the
context of short termism. First, there is the issue of the trustees' choice
of fund manager. Trustees will be heavily influenced by current performance
levels of fund managers. Secondly, there are those aspects of choice which
relate to members' choice of fund (which again will be influenced by current
returns and hence short term considerations), and member choice of investment
which is usually offered in the form of alternative investment portfolios.
6.7 Choice of fund may lead to a need for greater liquidity and therefore
a greater proportion of investments being held in cash. It was said that
in some funds where there is member choice there was no investment in
property for 'exactly those reasons'. [7]
6.8 Other things being equal, it is generally thought that members will
favour the more conservative options when they are given a choice of investments.
This is perhaps understandable given the sensitive nature of retirement
income savings, and the propensity of individuals to conserve (and also
keep liquid) their superannuation assets. Again this leads to a short
term approach to investment. Where choice of investment is offered, the
default option can often be the most conservative, although the Committee
notes with approval the more flexible default provisions, relating to
the age of the member, being offered by some funds.
6.9 The SIS legislation provides for beneficiary investment choice. [8]
The Committee considers that choice in this area need not necessarily
be exercised so as to maximise short term effects in contrast to the longer
term. Treasury said:
We have seen greater awareness of superannuation from the household
sector; it is one of the side effects of compulsory superannuation.
People now have to be thinking in terms of a collective investment that
is beyond just a bank deposit. If we start to introduce choice, they
have to realise that it is the long-term benefits that they are looking
at. [9]
6.10 The Committee considers the issue of choice is slowly and sensibly
being worked through by the industry. The Committee would stress, however,
the need for constant attention to the requirements of the members for
appropriately simple and accessible education to enable them to make informed
choices, particularly in relation to alternative investment portfolios.
The short term perspective
6.11 The Committee examined the underlying causes of short term orientation
toward investment. The IAA provided a comprehensive analysis of the factors
affecting superannuation investment and 'believes that some of the features
of the current superannuation environment are undesirable'. [10]
The more significant follow.
6.12 Historically, most large funds were defined benefit funds where
the employer bears the investment risk. With the rapid growth in superannuation
savings, particularly through compulsory superannuation, the trend has
been toward accumulation funds where it is the members who effectively
bear the risks of the funds' investments. The argument is that 'the members
are generally more risk-averse and have a shorter time horizon than the
employers'. [11]The IAA provided a comparison
of the investment policies of accumulation and defined benefit funds and
set out the evidence of short termism among the accumulation funds. [12]
6.13 In terms of performance, the direct implication of this evidence
was that the returns from defined benefits funds exceed those from accumulation
funds. The submission went on to highlight the trend toward accumulation
funds in Australia:
Over the six years to 1993 private sector fund
membership of defined benefit funds grew by 670,000, but this is outweighed
by almost eight times as many new members of accumulation funds over
the same period
... The trend is even more pronounced for public
sector funds ... [13]
6.14 Appendix F contains three graphs presented to the Committee depicting
both the historical decline in long term assets held by superannuation
funds, and projecting forward on the basis of three different assumptions:
(a) the status quo without policy changes;
(b) if wrong policy changes were made - especially further compulsory
vesting of employer benefits, and member choice of investment or fund
without adequate education; and
(c) where IAA's policy proposals were heeded - especially the need
to focus on adequacy of projected retirement benefits rather than contributions
or vested benefits, and encouragement of members to take at least part
of benefits as a pension or annuity instead of a lump sum. [14]
6.15 Other IAA policy proposals, apart from those included in (c) above,
include the following:
- trustees should be educated about the dangers of short term investment
policies and encouraged to think about long term effects;
- there should be education for members, especially where members are
given a choice of investment, and choice should not be compulsory;
- funds should allow those members who resign to preserve their benefits
in the fund instead of transferring a lump sum to rollover or some other
fund (UK evidence shows this allows the trustees to adopt a much longer-term
investment horizon);
- members should be given adequate information about projected benefits
in order to allow them to plan for retirement, and the government should
promote member communications which focus on expected retirement income
rather than lump sums or vested benefits;
- the taxation and regulation of superannuation should not be designed
to make more difficult the operation of defined benefit funds;
- preservation and portability rules should be designed so as to encourage
longer term perspectives;
- there should be no compulsory vesting of voluntary employer-financed
benefits beyond the requirements of the Super Guarantee system; and
- as well as members, trustees should receive intensive education before
the introduction of member investment choice. [15]
6.16 The Committee requested that the Retirement Income Modelling Task
Force (RIM) assess the IAA's propositions. RIM advised:
The Task Force's views on differences between investment returns
by type of fund have been influenced by essentially the same data sources
and research as quoted by the Institute of Actuaries. [16]
6.17 RIM emphasised that projected levels of aggregate assets of superannuation
funds 'are particularly sensitive to economic assumptions such as the
level of return achieved by various funds'. They cited an example of an
annual difference of one half of one per cent in return for the period
to June 2005 changing the grand asset total by plus or minus $17 billion.
[17]
6.18 The advice also made the following points in relation to the 'substantial
potential effects of variations in long term earning rates on the accumulated
benefits of individuals':
- for most persons the effects are cushioned because of the impact of
the age pension (and assets) tests, and to a lesser extent, the taxation
system; and
- to some extent the government, through the age pension and taxation
systems, bears part of the investment risk, and conversely shares in
the benefits of higher than average returns. [18]
6.19 In this way the benefits of longer term investment strategies, with
their higher overall returns, can be seen to benefit the whole community
in terms of the lower demand on taxation revenue.
6.20 The Committee considers the changing face of the work force, and
the difficulty for defined benefit funds in accommodating a growing army
of temporary and contract workers, is also relevant. [19]
As Dr Diana Olsberg, Executive Director of the Australian Institute of
Superannuation Trustees (AIST), said:
[T]he nature of the work force is just not compatible any longer
with defined benefit funds. It is not only in those areas where we have
considered there to be a high labour mobility but virtually across every
area now. The short-term contract employment means that it is just impossible
to operate a defined benefit fund.
... [i]t is just not possible to any longer have defined benefit
funds that are realistic in terms of the administration and the proper
apportionment of benefits. [20]
6.21 The Committee is persuaded that accumulation funds are increasingly
the more appropriate vehicle to receive the super guarantee. Furthermore,
the Committee recognises:
... that there is a great need to encourage voluntary contributions
by members so that people, at times in their life when they actually
have got some surplus money ... can actually contribute into their fund.
That is only possible in an accumulation type fund. [21]
6.22 The requirement that member representatives constitute half the
trustees has resulted in a great number of inexperienced new trustees,
many of whom could reasonably be expected to lack investment expertise.
This lack of experience in itself would naturally lead to a less than
adventurous investment outlook, especially given the strict fiduciary
obligation of trustees to act in the best interests of their members.
6.23 The Committee acknowledges, however, the valuable work in trustee
education and training being conducted by a number of organisations in
the superannuation industry.
6.24 More generally on the position of trustees and investment, the Committee
notes the view of Mr Michael Costello of the ASX:
... we think that there are trustees who believe that the law
as currently structured poses a fiduciary duty on them that leads them
down the short-term path. We think as a matter of law that that may
well not be a correct perception on their part, but if you are a trustee
you are probably not going to take the risk. [22]
6.25 One of the consequential obligations of trustees is the need to
ensure, as a matter of financial management, that the fund has sufficient
liquid assets to meet its outgoings. Accordingly, to the extent that a
fund requires additional liquidity to provide for the withdrawal of benefits
on retirement or transfer to another fund, or for any other reason, there
will be a need for greater conservatism in investment by that fund.
6.26 Therefore it is appropriate to recognise that different funds may
require different investment policies quite independent of any underlying
bias or conservatism. This may be due to their differing age profiles
or current popularity. Also, the same fund may change its investment strategies
from time to time in response to the changing profile or needs of its
members.
Policies to combat short termism
6.27 The Committee considers there needs to be attention paid to situations
of undue short termism, bearing in mind that not all aspects of short
term investment are undesirable.
6.28 The Committee welcomes the consistent acknowledgment throughout
the evidence presented to it that the primary purpose of superannuation
is to provide for retirement income. The objective of maximising retirement
incomes, therefore, should be the primary consideration when trustees
are framing their investment strategies. The Committee agrees with Dr
Michaela Anderson of the Association of Superannuation Funds of Australia
(ASFA), who said:
ASFA believes that the government should continually monitor
and review its policies and legislation so as to ensure that the prime
objective of maximising retirement income is not upset by short-term
considerations. [23]
6.29 The Australian Society of Certified Practising Accountants (CPA)
made a recommendation that a think tank or forum be established, to meet
every two or three years to focus on the long term direction of superannuation.
Such a forum would comprise the government and relevant stakeholders.
[24] The Committee thinks this could
be a useful way of monitoring developments in superannuation investment.
Recommendation 6.1
| The Committee recommends that the government review
and monitor its superannuation policies and legislation to ensure
the maximising of retirement incomes is not being unduly affected
by short term investment considerations. |
6.30 The payment of lump sums versus pensions was mentioned by the IAA
in relation to the issue of conservatism by members:
Much of the concern about members bearing the full risk of fluctuation
in asset values is that they may be 'forced' to take their benefit at
time of depressed values (eg when the sharemarket is at a relatively
low point). [25]
6.31 The IAA says this view by members 'focuses on the capital value
of the benefit being paid, rather than the future income which that benefit
may generate'. [26] It is interesting
to note that of total superannuation benefits paid by the funds in 1995-96
excluding transfers, lump sums accounted for 79% ($12.7 billion), while
the remaining 21% ($3.4 billion) were paid as pensions. However, the proportions
are reversed when the capitalised value underlying the pensions paid is
calculated: $45 billion (77%) compared to the $12.7 billion (23%) paid
in lump sums. [27]
6.32 There is still something of a 'lump sum mentality' in Australia,
but the Committee considers that with the increased education of members
of superannuation funds, especially in relation to matters of choice of
superannuation product, a slow trend toward annuities and pensions can
be expected.
6.33 The Committee also noted the views of the Insurance and Superannuation
Commission (ISC), that 'one of the Commission's long-standing concerns
has been to avoid the situation where trustees, fund managers and members
place undue emphasis on short-term returns'. [28]
The ISC provided some different emphases in listing some of the factors
it saw as contributing to a short term outlook. These factors included:
- the highly competitive but imperfectly informed private investment
market;
- SIS information disclosure requirements which place pressure on trustees
to declare stable positive annual returns;
- members lack of understanding of the long term nature of superannuation;
- the short to medium term of trustee and fund manager appointments;
and
- the SIS penalty regime which may lead to greater trustee caution and
investment conservatism. [29]
6.34 To assist members to assess the performance of their funds, the
SIS regulations require trustees to report annually their compound five-year
returns, as well as individual returns for the past five years. The SIS
also has in place a requirement for a balanced investment portfolio for
superannuation funds. [30]
6.35 Other initiatives being undertaken to encourage the recognition
of the long term nature of superannuation include improved communication,
and education campaigns promoted by the ISC and other industry bodies
[31] to encourage longer term investment.
6.36 A more technical and direct initiative has been to provide in the
legislation for the smoothing of interest rates credited to members' accounts.
The regulations allow trustees to increase the minimum guaranteed benefits
by amounts in excess of fund earnings to an extent which would make the
fund technically insolvent, provided this is in accordance with a plan
designed by an actuary to ensure solvency within five years. [32]
6.37 An industry based Working Party on Investment Performance Measurement
has also been set up which, among other things, is assisting the education
of members and trustees of funds in taking a long term perspective in
assessing investment performance. The ISC is represented on this Working
Party along with the IAA, Australian Investment Association (AIMA), Australian
Custodial Services Group, asset consultants and administration systems
firms.
6.38 Probably the point most forcefully made to the Committee by the
IAA was the need to disclose the retirement benefit:
It is quite incredible that we have a set of regulations that
goes into great detail about the need to disclose the current resignation
benefit of your plan but ... there is nothing in the regulations that
requires a superannuation trustee to quantify or disclose the retirement
benefits. [33]
6.39 Of course, in relation to accumulation funds, certain assumptions
need to be made to indicate what retirement benefit a member could expect
to receive. The IAA suggested that whenever a superannuation plan prepares
an estimate of retirement benefits the standard basis could be used, at
least as one illustration. [34] The
'standard' referred to here is that standard set of investment earning
assumptions used in disclosures in the life office area and set by the
ISC.
6.40 The IAA considers that, in the first place, funds should be encouraged
rather than required to produce such an illustration of retirement benefits,
and have put this as a recommendation to the ISC. [35]
The Committee supports this view.
Conclusion
6.41 Recognising that a certain degree of short termism is a desirable
and necessary part of a fund's investment strategy, the Committee believes
the issue of short termism is of concern but that it is being appropriately
addressed by the relevant industry players. Provided awareness of the
potential for problems is raised, no special response by the government
is required.
6.42 The Committee believes that its conclusions and recommendations
throughout this report will have the positive effect of moving superannuation
fund investment toward a stronger and longer term perspective. This will
assist the slow but steady progression to greater levels of annuities
forms of retirement income rather than lump sums. In turn this will benefit
the members by enhancing the prospects of satisfactory retirement incomes,
and benefit the nation by lessening the burden on the taxpayer and by
encouraging healthy domestic investment.
[Return to Table of Contents]
Footnotes
[1] Submission SI-18 (AIST), p24.
[2] Evidence (Mr Grenfell), pS65.
[3] Submission SI-6, p1.
[4] Evidence (Mr Costello), pS47.
[5] Evidence (Mr Roche), pS47.
[6] Submission SI-19, p13.
[7] Evidence (Dr Gray), pS17.
[8] SIS Regulation 4.02 prescribes how this
choice is to be offered.
[9] Evidence (Mr Callaghan ), pS6.
[10] Submission SI-6, p8.
[11] Submission SI-6, p8.
[12] Submission SI-6, pp14-19.
[13] Submission SI-6, p20.
[14] Evidence (Mr Grenfell ), pS65.
[15] Submission SI-6, p30.
[16] Submission SI-24, p2.
[17] Submission SI-24, p2.
[18] Submission SI-24, p2.
[19] In its 17th report, Super and Broken
Work Patterns, the Committee examined in detail the situation of workers
with non traditional working lives.
[20] Evidence, pS111.
[21] Evidence (Dr Olsberg), pS111.
[22] Evidence, pS47.
[23] Evidence (Dr Anderson), pS16.
[24] Submission SI-22, pp1 and 6.
[25] Submission SI-6, p29.
[26] Submission SI-6, p29.
[27] ISC Bulletin, June 1996, p30.
[28] Submission SI-13, p7.
[29] Submission SI-13, p7.
[30] Section 52(2)(f).
[31] See, for example, LISA's Get Rich Slow
campaign.
[32] Submission SI-13, p8 and see SIS regulations
9.37 to 9.39.
[33] Evidence (Mr Grenfell), pS71.
[34] Evidence (Mr Grenfell), pS75.
[35] Evidence (Mr Grenfell), pS75.
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