The Rise of the Mega Fund: How Super Funds Can Make Scale Pay

“ Their assets under management may be increasing, but the number of Australia’s superannuation funds is falling as regulatory pressure for lower fees and strong performance relative to peers drives consolidation in the industry. This has created even-bigger “mega funds.” Now, they need scale to work in their favour.”

BABLOO SARIN

Head of Asset Owner Segment, APAC

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The Rise of “Mega”

The asset pool of Australia’s regulated superannuation funds hit AU$2 trillion at the end of 2019, having more than doubled in the past seven years1. By contrast, the number of funds dropped by a third, as they seek better member outcomes and economies of scale to boost performance.

This has led to the emergence of so-called

mega funds and the phenomenon looks set

to continue, with the Australian Prudential

Regulation Authority (APRA) sustaining

the pressure on poor-performing funds to

“merge or exit the industry2.”

The consolidation momentum continued

throughout 2020 despite the turbulent year.

In August, IOOF Holdings Limited announced

its merger with MLC Wealth to create

an AU$173 billion mega fund3,surpassing

Aware Super with AU$130 billion under

management. The ongoing merger discussions

of QSuper and Sunsuper, meanwhile, would

result in an AU$195 billion fund.

Industry analysts predict that more deals are

imminent, involving an estimated AU$1.5 trillion

of assets4. To put that figure into perspective,

the market capitalisation of companies listed

on the Australian Securities Exchange stands

at AU$2.2 trillion5.

1 Myths and misconceptions should be no barrier to super consolidation, APRA 2 Ibid. 3 IOOF positions itself in ‘mega fund’ pack with MLC deal, Investment Magazine, August 2020 4 More mega funds on the cards, The New Daily, September 2020 5 Historical market statistics, ASX, December 2020

Total assets (LHS) APRA regulated funds with more than four members (RHS)

Billion

s

$2500

$2000

$1500

$1000

$500

Jun 2013 Jun 2014 Jun 2015 Jun 2016 Jun 2017 Jun 2018 Jun 2019 Dec 2019$0 0

300

250

200

150

100

50

Figure 1: Superannuation assets under management (AUM) and the number of APRA-regulated super funds

Source: APRA

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Consolidation brings economies of scale, which is the central objective with many benefits.

Industry data provider Rainmaker says that

member fees dropped by an average of

21 percent as a result of super-fund mergers

over the past three years6. The benefits may be

just as great on the income side of the balance

sheet: a larger pool of money opens doors to

other investment opportunities, particularly in

alternative asset classes such as private equity,

real estate and infrastructure.

Why Go Big?

Better member

outcomes

• Members can benefit from lower costs and potential for better

investment returns

• Ability to invest in technology and services to improve

the customer experience

Lower administrative

costs

• Lower per-capita cost of internal functions such as legal, marketing and

human resources

Greater investment

options

• Greater focus on product development, particularly on retirement solutions

• Positive net cashflow

Greater investment

control

• Increased access to alternative assets such as infrastructure, private

equity and real estate

• Ability to buy larger stakes in target companies and increase

engagement/stewardship influence

• Reduced use of agents and associated conflicts/fees

• Bring investment management of certain asset classes in house for

greater control of investment strategy and to reduce costs

Outsourcing

advantages

• Ability to access powerful solutions to achieve an optimal and efficient

operating model

The Benefits of Scale

6 Fees drop after super mergers, Rainmaker Information, September 2020

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However, these benefits do not happen

automatically. The Productivity Commission’s

2018 assessment found evidence for benefits

of scale related to administration expenses and

investment returns, but this was not clear in all

cases, and it indicated that “significant unrealised

economies remain7.”

The need for portfolio diversification means

that mega funds have had to become global,

multi-asset managers. As their portfolios have

grown in size and complexity, a robust operating

model is critical to providing effective and

efficient support.

Some super funds may yet resist consolidation,

seeking to avoid perceived unwieldiness it

could bring, but the many that are on the path to

mega-fund status must think long term to ensure

their scale pays off:

• How can they embed the resilient and flexible

operations necessary to support an increasingly

complex portfolio?

• Where will in-house investment management

be most effective?

• How can they keep pace with technology

advances that are redefining the industry’s

use of data?

7 Superannuation: Assessing efficiency and competitiveness, Australian Government Productivity Commission, November 2018

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Several of Australia’s super funds have already become global multi-asset investors, supporting highly diversified portfolios with global teams of fund managers across the world’s main financial centers. Others are just starting out on that journey. What lies ahead for them?

Internalisation of Investment Management — Look Before You Leap

As they grow their portfolio complexity and

size, super funds have to consider which

investment strategies to internalise as they

think about cost controls and management fees.

AustralianSuper, for instance, has set a target

of managing 50 percent of its assets in house

by June 2021, an increase from 40 percent

in 2019 which delivered AU$160 million in

savings for members8. UniSuper, which has

led this insourcing trend, manages almost

70 percent of its investments internally.

Areas such as domestic equities and fixed

income are obvious candidates for moving

in house. However, as super funds move

towards managing international strategies

and alternatives internally, there are big

implications for human capital and operations.

On the people front, they should deploy

a diverse array of investment professionals

globally, bring together different cultures and

upskill their teams.

Meanwhile, investment teams will demand

access to new markets, data and investment

solutions at a faster pace than middle- and

back-office support staff can accommodate them.

At the same time, opting to build and manage

all of the internal infrastructure to match the

fund’s expansion might undo the economies

of scale it was hoping to create.

Embedding Flexibility — Get Ready to Scale Up

Australia’s superannuation funds can learn

something from some of the world’s largest

public asset owners in the United States and

Canada, which have already been down this

road. Many first attempted to install their own

technology platforms, to build out back-office

support and create their own data warehouses

to maintain full control, only to realise it was

sapping resources from higher-value activities

and moving too slowly to properly enable

investment teams.

Institutions are now focused on a model

whereby more complex functions such as risk

management, market-to-market valuations,

and data analysis and management are being

outsourced, which allows them to focus on

what they do best. Outsourcing these functions

provides firms with access to the latest

technology and frees up in-house talent, allowing

them to focus on core portfolio management

responsibilities and other value-adding activities.

This model has been proven during the COVID-19

pandemic. Many finance professionals have been

forced to work from home, only to discover

How to Become an Effective Multi-Asset Manager?

8 AustralianSuper plans to bring 50% asset management in house, IPE, November 2019

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that compliance and cybersecurity protocols

have restricted access to their own proprietary

information and disrupted business processes.

The functions that had been outsourced to

a global provider, on the other hand,

remained accessible.

The market turbulence and spikes in trading

volumes as the pandemic has progressed have

reinforced the case for outsourced trading

models too. As average daily trading volumes

soared well above usual levels in March and

again in November 2020, some in-house

platforms struggled to cope with the additional

demands on capacity9.

Although keeping control of investment decisions

is crucial, institutions can use the expertise of

service providers for more of their non-core,

yet critical functions — including execution,

analytics and reporting.

Super funds have long-term demands to consider

too. As they expand their investment portfolios, it

will become more important to convert the higher,

fixed costs of internal trading platforms into

scalable variable costs. Also, they need to ensure

that they have extensive access to liquidity pools

and execution capabilities across markets and

asset classes.

Further, as compliance and regulatory processing

needs escalate, super funds will want to ensure

their investment teams can remain focused on

stock selection and other higher-value functions.

The Technology Arms Race — How to Keep Pace

As super funds expand their investment portfolios,

they need a flexible technology infrastructure

that can quickly and seamlessly onboard new

asset classes and supporting operations.

But that is only part of the story. The investment

industry is in the middle of a technology revolution

that is redefining how it consumes and applies

data — and this is not a race that super funds

can run on their own.

The data available to support investment decision-

making is growing exponentially. Consultancy

firm Opimas has estimated that the market

for environmental, social and governance data,

for instance, could reach US$1 billion globally

in 202110. Analysis by industry trade groups

suggests that there are now 445 alternative data

firms (and the number is still rising), providing

institutional investors with insights gleaned

from non-traditional information sources11.

These numbers imply that super funds will

need advanced data management capabilities.

This means increased migration to cloud and

access to centralised data warehouses that

can consume and process both proprietary and

external information sources in near-real time.

There is no one-size-fits-all approach to building

this kind of infrastructure, but it is becoming

increasingly clear that the pace of change

creates major resource and cost challenges for

firms that are wedded to a proprietary model.

9 Hargreaves Lansdown suffers system outage amid record trading volumes, Financial Times, November 202010 ESG data market poised to hit $1 billion in 2021, Pensions & Investments, March 2020 11 Industry stats, Alternativedata.org

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The power of size is about more than just economies of scale. In private markets, for instance, mega fund status offers a substantial competitive advantage.

A mega fund with close to AU$200 billion has

more freedom to co-invest with general partners

in private assets, which helps to cut fees and

improve returns and they have better control

over risk decisions. They can even bypass

general partners altogether — buying a building,

or even an airport outright — giving them

full control and a long-term income stream.

As super funds gain scale, they can also compete

with private equity funds in the public markets,

with the financial muscle to buy out a company

and take it private, rather than just invest in it.

Mega funds can also capture opportunities in

other markets that were previously hard to

access, such as long-term lending. Banks have

had to retreat here as more onerous regulatory

and capital requirements force their hand,

allowing super funds to step in and lend

directly to businesses. For a super fund, such

opportunities bring the added advantage

of supporting domestic businesses whose

employees are the contributors of their funding.

Rather than fearing the competition, some banks

are keen to partner with funds to help maintain

control on bigger deals they no longer have the

ability to take on independently12, while super

funds avoid the fees they would have to pay

as a client.

Similarly, taking the operational burden away

from an external fund manager can reduce fees

and improve efficiencies. As they can write bigger

tickets, mega funds can demand segregated

accounts from hedge funds and alternative

managers. If they then use their relationships

with their outsourcing partners to manage the

operations and administration of those accounts,

they can allow the hedge funds to focus on

providing alpha and demand lower fees

in return.

Benefits Beyond Economies of Scale

12 Should superannuation funds do more direct lending? Industry Superfunds, October 2018

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Debate rages about the exact endgame for the super-fund industry. For instance, a Right Lane Consulting report concludes that the ideal structure for Australia’s superannuation system would be no more than five generalist mega funds and 10 specialised funds13.

But others argue that a long-term analysis

of the impact on investment returns and

insurance cover is needed before this thesis

is fully supported14.

The debate is less about whether bigger is

better and more about how big is best. The onus

is now on super-fund executives, regulators and

outsourcing partners to make sure that mega

is used to its full potential and that members

reap the rewards.

How Big Is Best?

13 2020 Industry Super Forces at Work Report, Right Lane 14 Super fund mergers: Are you really better off?, Money Magazine, August 2020

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