Super funds are reducing their exposure to local equities amid uncertainty about the outlook, instead favouring cash and searching for yield elsewhere including offshore, in infrastructure and unlisted property.
Research by Deutsche Bank found flows into the equity market had softened through the first half of 2016, primarily from a pullback in allocations from superannuation funds and foreign investors.
Yet super funds continue to receive strong inflows, with Deutsche strategist Tim Baker estimating mandatory contributions will top $65 billion in the 2016 financial year, plus $15 billion in discretionary contributions, albeit slightly lower than the average $20 billion.
"Net inflows are matched by net corporate raisings and the lack of raisings may be due to uncertainty and lack of confidence, which could pass," Mr Baker said.
"If it does, we see scope for money currently on the sidelines to readily move into the equity market."
While super funds are pulling back from the sharemarket, they are building up their cash levels. Cash and deposits made up 17 per cent of total super assets, up from the long-run average of 12 per cent, Mr Baker said.
But there are good reasons the biggest super funds in the country are shying away from local shares. David Bryant, chief executive of Australian Unity Investments (AUI), said funds had turned conservative towards an uncertain sharemarket.
"No one is really sure where the equity market is going," he said. "There's a hesitation about when is the right time to be putting money in."
It's an observation shared by UniSuper head of equities Simon Hudson.
"Super funds have been quite cautious investing in listed equities, particularly domestic, for some time," he said.
"However, they're certainly not being cautious about investing in the unlisted space."
Much of the caution stems from the outlook for the financial sector, which makes up 37 per cent of the S&P;/ASX 200 Index by weighting.
The banks are enduring the "double whammy" of rising bad debts and pressure on their margins.
With super funds increasing in size, they are also hitting the limit of their allocation into the sharemarket without putting liquidity at risk.
Superannuation had funded the bulk of the big four banks' equity raisings in 2015, Mr Baker said, noting domestic investors were overweight, compared with foreign investors who were largely underweight.
As a result, they were looking elsewhere for yield, including overseas markets, which are deeper and more liquid, commercial property and infrastructure projects, such as the Port of Melbourne sale and Ausgrid.
"There may be a sense that as governments struggle for revenue, more of these deals may be in the pipeline," Mr Bryant said. They also required higher levels of cash to deploy.
"We've been increasing allocations into unlisted property and infrastructure, together with international equities," he said.
"We've been decreasing cash and fixed interest."
At its current level near 5400 points, Mr Bryant said the market looked reasonably priced, however, it would take a decent drop, of about 300 points before AUI would seek to allocate more capital in the market. Conversely, a push higher towards 5700 points would result in some profit taking, he said. In the interim, the fund was holding pat.
"This is where as an investor you need to keep things in sync a little bit, it's too easy to find a reason to rush out of the market."