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This content is produced by The Australian Financial Review in commercial partnership with Mercer.
Everyone in super knows the maths: the Australian Prudential Regulation Authority (APRA) has 183 super funds on its database.
Of these, says Warren Chant, principal of research firm Chant West, 156 are "small" funds, below $10 billion in size. And of these, 76 funds – 44 per cent of the small crowd – have negative cashflow: that is, benefits exceed contributions.
Looking at even smaller funds, those with less than $1 billion in assets, the proportion of shrinking funds increases.
According to Andrew Godfrey, senior partner, chief operating officer, Mercer Pacific and leader of the firm's financial services business in Australia and New Zealand, 56 per cent of APRA-regulated funds with less than $1 billion in funds under management – 45 funds – have experienced net cash outflow in the past 12 months.
The funds in outflow are "firmly in the spotlight," says Godfrey. "Boards of smaller funds can no longer resist action, and are obliged as trustees to make decisions that are in the best interests of their members. APRA's challenge is to ensure that fund members are not disadvantaged by weak investment performances, excessive costs and poor business models," he says.
Funds cannot ignore the rising threat of action from the regulator, says Godfrey. APRA has the capacity under the "scale test," introduced as part of the government's 2012 Stronger Super reforms, to decide whether a fund is acting in the best interests of its members, but the test has not yet been used to compel a merger, and APRA deputy chair Helen Rowell has stated that the regulator is "not pressing an amalgamation agenda," and that "the decision to merge or wind-up a fund is for the [fund's] board to make." But the market is braced for the scale test to be applied in some way, and mergers to follow.
"I think APRA would prefer it to be a market-driven process, but they will also be prepared to nudge funds along what will be presented to them as a logical conclusion," says Chant. "They'll engage with funds, and point to factors such as net outflow, and ask, 'what is your plan for the next three, five years?' They'll 'thought-manage' the process," he says.
Godfrey says the industry "can't sustain" the number of funds that it has. "There is a high level of denial: in our 2020 Super Fund Executive Report Change or Be Changed, 68 per cent of fund executives said they believed there would be consolidation between funds, but only 13 per cent expected their fund to be involved. We think consolidation will happen, as APRA makes its assessments of governance and what is a strong-performing fund, what is a poor-performing fund. Eventually they will probably move further along the curve of 'strongly suggesting' a fund merges, but they're going to leave that to the boards to decide."
The Mercer survey also showed that 71 per cent of funds nominated "organic growth" as their top source of new members. We're going to need a much larger population to satisfy that – clearly not every fund that thinks it's going to grow will be successful in growing," says Godfrey.
"Challenging conversations are happening all over the industry. In any industry, mergers can be difficult to integrate – you're not just merging funds, you're merging the cultures, the value propositions, the teams, the boards. But we're definitely going to see more," he says.
Going it alone is difficult for a smaller fund, but not impossible, says Godfrey. "Small doesn't necessarily mean unviable, if the fund can demonstrate that it has a very disciplined strategic and business planning process in place, it's investing in digital capabilities, it's got good products, it's got a post-retirement solution – and that it has the scale to be sustainable.
"You need a certain level of scale to provide the services and investment structures that are needed, and the technology advances you need to make. Small funds can access that scale economically through an outsourced provider like us, they can use white-label solutions – or they can merge. But they do have choices," says Godfrey.