Why the UK pensions market could learn from Australia

This Australia Day, we take learnings from Down Under and look at how UK pensions could benefit from the advancement of the country’s superannuation system.

This is highly relevant to the UK because the Australian Superannuation system is roughly 10 years ahead of the UK in its DC journey and policymakers often, but not always, look to Australia for inspiration.

The Your Future, Your Super policy package follows on from a series of inquiries into the performance of the Superannuation system. These, especially the final report of the Productivity Commission, made serious criticisms of parts of the Super system and have forced a heavyweight response from the Australian government.

The performance element of Your Future, Your Super, implemented last year, subjects funds to a pass/fail test based on investment performance. The regulator (APRA) examines 7 years (changing to 8 from 2022) of a registerable superannuation entity’s (RSE) investment performance and compares it to a benchmark portfolio. The benchmark is put together using the RSE’s asset allocation and a series of benchmark indices for each asset class.

If the RSE’s performance is more than 0.50 per cent lower than the benchmark, then it fails the performance test. If the annual test is failed more than two years in a row, then the RSE is banned from accepting new business into the product. This strongly incentivises “failing” funds to merge.

Australia’s Superannuation was already consolidating rapidly ahead of this regime coming into effect. Some analysts expect further consolidation and a dramatic shrinking of the market to far fewer funds. We see that as likely but are cautious about estimating how may funds Australians may have to choose from.

Value for money is key

There are both positives and negatives from this for the UK. We think the main lesson for the UK is that if the regulator, in this instance TPR backed by the Department for Work and Pensions (DWP), wants to increase the pace of consolidation in workplace DC then binding value for money tests are one way to achieve this. The current approach UK to driving consolidation based on value for money is focused on DC smaller schemes and allows trustees of the schemes in scope much more discretion in compliance than the Australian version.

One potential outcome of the recent TPR/FCA consultation on value for money metrics would be the strengthening of this regime and its application to more schemes. The Australian audit applies to all regulated funds, not just smaller ones.

Too much focus on past performance can be a negative

We do, though, see negatives to the Australian approach. The approach focuses only on past performance. There are two problems with this. First, past performance is not a good guide to the future. Poor past performance tends to persist while good performance may not. This limits its use as a decision-making criterion, even for regulators and professionals. The real value in a pension scheme is driven by the decision making around a scheme’s default fund, which is impossible to capture quantitatively. But it is also the key thing you would want to understand if you were trying to judge which funds are more likely to show value for money over the long term.

Second, performance next to a reference portfolio creates quirks. A conservative fund might outperform its benchmark and pass the test. A more aggressive fund might outperform the conservative fund but underperform its benchmark and find itself, effectively, out of business.

We look forward to seeing how a tougher value for money regime plays out in Australia and whether a consolidated market really delivers the benefits promised.