Restrictions on Pension Investing: An Australian Perspective

1
Restrictions on Pension InvestingAn Australian
Perspective

• 2008 06 04 ICPM
• Leo de BeverChief Investment Officer Victorian
  Funds Management Corporation

2
Australian Pension System

• No Public Plan (e.g. Canada Pension Plan)
• Required pension savings 9 of salary
• Contributions taxed at 15 instead of marginal
  tax rate
• Fund income taxed _at_ 15, capital gains
  _at_10,dividend tax credit is deductible from
  taxes
• Tax Free withdrawals on reaching age 60
• Incremental growth largely in DC super funds
• Small size generally means high management costs
• Do it yourself accounts (e.g. Canadian RSPs)
  have gt1 overhead for balance ltA200,000
• Audit fees can be 2000 or more

3
Australia Pension Savings Global Context
4
High Growth Rate of Pension Assets
5
Only Top 25 of Funds Have Index Returns
An extra 1 above index for 10 years would have
been stellar
6
Investment Costs Fall With Asset Size
Better Australian Retail Funds
Australian Super
Victorian Funds Management Corp
Alberta Inv Mgt
OTPP
7
Funds Merging, More Individual Accounts
Source Australian Prudential Regulatory
Authority (APRA)
8
Larger Funds Have Greater Return Potential

• Tend to have better systems that can assist with
  better implementation
• Risk management
• Cash management
• Implementation error detection
• Larger funds make better investment partners
• Better internal staff
• Access to better alternatives on better terms
• Cooperation with other funds can be substitute
• Requires strong alignment, similar decision
  process

9
What It Takes to Be Exceptional

• Independent Board
• Must be willing to help push boundaries of
  comfort
• Empowered internal investment team
• Quality and pay must be commercially competitive
• Pragmatic internal - external management balance
• Focus on maximising return/risk
• We are risk managers more than asset managers
• Long term investment horizon
• Willingness to invest in unusual opportunities
• Doing the basic better
• Strong risk and back office systems

10
Better Mix of Internal External Management
11
Asset Allocation Issues

• Home country bias still strong
• Dividend tax credits used as justification
• Endowment envy encourages uncritical imitation
  of what worked in the nineties
• Taking big risks in inefficient markets had a
  payoff
• Tendency to fill alternative asset class buckets
• Not enough focus on managing return/risk
• May need to create new alternatives
• Also should not disregard traditional assets

12
Only Long Term Focus Justifies Short-Term Risk
VFMC Risk Profile at 40 Billion
Most Shareholders and Boards want good long term
resultsAs long as it does not interfere with
making money in the short run Expected long-term
payoff from taking risk 2.5 / year
13
Governance Challenges

• Independence of Boards not always clear
• Public sector shareholders control strategy,
  regulation
• DC Funds Consultants support blame avoidance
  regime
• Boards often act like management
• Few funds have strong internal investment team
• VFMC is one of handful of exceptions
• Funds lack the scale for internal management
  possible
• Manager of Manager model costly
• Freedom to switch funds creates peer
  pressure,encourages short-term management
  horizon
• Practical significance of clients moving is
  questionable
• A good management team would stay the course

14
Other Systemic Issues

• Pension adequacy
• Low average savings balance for larger of
  population
• Saving 9 of salary is not enough
• DC lack of Longevity insurance implicit in DB
• Funds are discussing collective insurance
• Not clear clients would be willing to pay
• Lump sum distributions out of DB plans
• At 54 years and 11 months
• Fear of legislative change
• E.g. tax free withdrawals at age 60

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Direction of Change

• Fund Consolidation
• Best thing trustees can do in many cases is vote
  themselves out of a job
• Fewer, stronger and more independent Boards
• Need more degrees of separation
• Stronger internal teams empowered to act
• Better delegation from the Board
• More cooperation among funds on alternatives
• Industry fund efforts have not been totally
  effective