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Wednesday, 21 March 2012
Page: 2422


Senator SHERRY (Tasmania) (12:44): During this matter of public importance I wish to speak on the current debate concerning the investment strategy of our $1.3 trillion superannuation sector. This debate has been occurring vigorously, particularly since the global financial crisis, and has crystallised over the last week as a result of commentary by the former Treasury secretary, Dr Ken Henry, in a speech to an Association of Superannuation Funds of Australia event last Friday, with further commentary from a range of participants including supporting comments for Dr Henry from Mr Jeremy Cooper, former chair of the review into the operation of our superannuation system, and outgoing Future Fund chair, Mr David Murray.

It is a matter of great public importance not least because the underlying investment strategy substantially impacts on both the final retirement savings for millions of Australians—it is a major social policy—and, critically, on the Australian economy, with a savings investment pool of some $1.3 trillion and almost $1.4 trillion if the Future Fund assets are included. As I am sure many senators are aware, my interest in this issue has been longstanding. My 25 years involvement in superannuation, first as a founding trustee of two funds between 1986 and 1990 and then, on entering the Senate, as chair of the Senate Select Committee on Superannuation overseeing development and passage of the superannuation guarantee, the SI(S) Act, and other inquiries, including on investment. I was shadow minister for superannuation for most of the period 1996 to 2007 and then Australia's first superannuation minister from 2007 to 2009.

It is important to note that earlier this week the parliament also passed two major superannuation measures: an increase in the superannuation guarantee, which will go from nine to 12 per cent by 2020, and a rebate of the 15 per cent contributions tax for low- and middle-income earners earning less than $37,000. Combined, this will see superannuation assets grow from the current approximate $1.3 trillion to approximately $3.3 trillion by 2026 and $6 trillion to $7 trillion by 2035. To put this into perspective, $1.3 trillion is approximately the size of the Australian economy.

Responsibility for the investment of these assets is placed with trustees. This was confirmed by statute in the Superannuation Industry (Supervision) Act 1993—the SI(S) Act—which codified the prudent person principle: invest the assets diversified for the long term as if they were your own to maximise the return to the member. In Australia government does not direct superannuation investment in any way. It is delegated at arms length to independent trustees. This is almost unique in the world for a system of such size. There has been reference to examples of other countries with pension fund assets with a significantly greater percentage in fixed income. I think it is important to note that in some of these cases this is a consequence of government direction. Indeed, some governments go even further, with direction for investment in housing and infrastructure and a range of restrictions, including on overseas investment.

According to the Australian Prudential Regulatory Authority data, as at June 2011 the asset allocation of the default investment strategy—that is where the trustees make the decision for members who fail to make one—was approximately 43 per cent of total assets. This was composed of 29 per cent in Australian shares, 24 per cent in international shares, 10 per cent in listed and unlisted property, 16 per cent in Australian and international fixed interest, eight per cent in cash and 14 per cent in other assets. Despite the GFC, which has led to the proportion of investments in shares moving down and that in fixed interest and cash going up, the primary investment is still in shares. Dr Henry and others' argument is that, given recent losses and market volatility, trustees and their advisers—fund managers and asset managers—have tended to invest too heavily in shares and not enough in bonds and that shares are too risky and volatile.

According to media reports:

… Dr Henry said a strong ''average'' performance of shares over time had not prevented many fund members from losing out when markets tanked.

''Depending upon when they enter the system and when they retire, some fund members will benefit enormously from a portfolio weighted heavily toward equities while others will lose big time,'' … ''And nobody knows, in advance, who will win and who will lose.''

I have the greatest respect for Dr Henry, Jeremy Cooper and David Murray. I have had many positive interactions with them over many years and agree with them on many of their policy observations. However, on this issue I fundamentally disagree, and strongly so. Where they have identified some weaknesses—and I will refer to these—there are alternative solutions.

Fundamentally it would be a serious mistake for government and/or trustees and fund managers to shift the base investment away from diversified shares, because over the long term that strategy provides the highest rate of return. Over the 20-year period to 2010, returns per annum were 11 per cent for shares, 8.2 per cent for the bond market index and 4.3 per cent for cash. In a defined contribution system, which is what we have in Australia, contributions minus tax, fees and charges, plus returns from underlying investments determine the final outcome. Effectively, the member carries the risk of that outcome. Given that we know on the evidence of diversification—and the SI(S) Act requires diversification—that shares outperform bonds and cash over the long term, this should remain the fundamental asset class that the superannuation system should be based on. Yes, we know on the evidence that there is a risk of greater volatility in equities; however, the even greater risk for members is a lower return over the long term if those assets were invested in bonds and cash rather than equities. This would result in a lower level of final savings. So, yes, there is greater volatility from shares, but we know on the available evidence that the final outcome will be higher.

There is one important caveat to this outcome and where it is possible for bonds to outperform equities, and that is if fees and charges are excessive and/or if a fund has insufficient fund scale to purchase a mandate with the lowest possible fees. To the extent this is an issue, and it is for some—and I applaud and support Jeremy Cooper for the vast majority of his recommendations; indeed, I appointed him as chair of the review into superannuation—higher than reasonable fees and charges are resulting in a lower outcome for investments in equities than bonds or cash.

The government has initiated important reforms, MySuper, SuperStream and related FoFA reforms—it is a subject for debate on another day in the Senate—and these will reduce the costs and fees and charges in the long term. That set of issues is being dealt with by government. Mr Murray, the outgoing Chair of the Future Fund, gave some supporting comments to Dr Henry. As Mr David Murray knows and has explained on many occasions that, if the underlying assets of the Future Fund were predominantly in bonds and cash, the Future Fund would be unlikely to achieve its targeted rate of returns and certainly less likely than with a predominance in equities and shares.

Australians will be in the superannuation system for an average of 40 years pre retirement and an average of 15 to 20 years post retirement. During that time there will be a number of market peaks and troughs—volatility. This is unavoidable in a capitalist market economy. The example Dr Henry gave—which he admitted was extreme—was of a 59-year-old in 2007 planning to retire at 60, seeing perhaps a 25 per cent plus decline in their account balance because of the GFC. Presumably this individual, given their age, would have been in the system since at least 1987, the date of the introduction of the initial three per cent compulsory superannuation, then added to by the SG. Their account would have experienced strong positive growth in all but one year up to 2007. So what we have to do, in looking at this debate, is to take into account the long-term positive growth from equities year on year as well as the negative down years.

I illustrate this with my own experience. I have a defined contribution account. I have had it since 1990 when I entered the Senate. It is invested predominantly in equities. The account peaked on 30 June 2007. Every dollar was then worth $8. Then at 31 December 2008 the dollar value went from $8 down to $6 and, as of 31 December last year, it had gone back up to having a value of $7. If that had been invested in bonds, it would not be worth the $7 as of December last year; it would be worth $6 at that date.

I do accept that it is difficult, particularly for those who are older and value predictability and certainty, to explain the concept of long-term returns. I had to do this when I was Minister for Superannuation and Corporate Law during the GFC to hundreds of people who engaged me in conversation about their super account going significantly backwards, often for the first time. It is possible to minimise volatility with a share base if funds adopt a reserving strategy, putting aside some of the positive returns in good years to offset the negative in bad years in order to smooth returns. Indeed, some funds did take that approach in the past. However, Choice of Fund ended this approach. Funds could no longer continue to adopt the smoothing strategy.

A major defect in our system is the lack of focus and highlighting consistently, in an understandable way, the long-term return and its value. Most funds in the lead-up to the GFC enjoyed double-digit rates of return each year they highlighted and, indeed, many boasted, with front-page headlines, increases of 10, 12, 15 and 18 per cent. This was a serious error. Funds should highlight the long-term rate of return. Further, it is possible with robust actuarial standards to provide a projection on contributions or a forecast to not just retirement age but also average life expectancy. However, as I have mentioned, many elderly Australians dislike volatility and prefer a predictable income stream. That is understandable. This highlights a major gap in our superannuation system, the lack of post-retirement annuity pension take-up. This is the last major policy reform gap in our system.

The superannuation sector is keen to find an effective solution. In a well-designed retirement income system, rather than a lump sum savings system, which is what Australia has—and that is in contrast to most other countries with a defined contribution system—a well-designed post-retirement annuity pension is a vital necessity. Any effective solution in this area almost certainly will lead to a higher investment in bond assets. The need to design a much more effective annuity pension post-retirement system has been recognised by both the Treasurer, Mr Swan, and the Minister for Financial Services and Superannuation, Mr Shorten. They have appointed a panel of experts to a superannuation roundtable charged with finding solutions in this area.

Notwithstanding my arguments about preferring an equity base for superannuation, it is very necessary to strengthen and deepen the public and private bond market. I agree with Mr Johnson, the chair of a committee who made recommendations to assist developing a local bond market, that it is an urgent issue. These reforms are necessary to remove operational and structural impediments that he identified. They need to be acted on and, indeed, the government has commenced work in this regard. Whatever the arguments and conclusions reached on the equities versus bonds debate, a more effective bond market will be an absolute necessity, not only given the necessity to support an effective post-retirement system but in order to help deal with the strong growth in savings that I highlighted earlier—$1.4 trillion at the present, including the Future Fund, forecast to reach $3.3 trillion by 2026 and $6.7 trillion by 2035. But, whatever the concerns are about the operation of our superannuation system, unlike most comparable advanced economies, Australia has a modest sustainable defined benefit base—the age pension—supplemented by a funded, income related, compulsory defined contribution system.(Time expired)