Waves of investment menu reviews

The Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2018 passed in April 2019 changes the game in product design and disclosure.  It requires many financial services organisations, including superannuation funds, to ensure that products are targeted and provided only to the customers for whom the product is appropriate and designed for.  For superannuation funds this ties to member outcomes, with APRA focused on ensuring that funds deliver strong outcomes to members through products which are appropriate for them. This includes the consideration of investment strategy of MySuper, Choice and retirement products to determine whether they are promoting the financial interests of members. These recent legislative and regulatory changes have increased community expectations and have led to a wave of funds undertaking formal reviews of their investment strategies, including the construct of their default option, the choice investment options available to members and the overall investment menu design.

The investment options review focuses on assessing the appropriateness of the investment strategies of an individual option, for the purpose for which they were designed. An investment menu review can help trustees assess the degree to which the available range of investment options is meeting members’ needs.

How many investment options are funds currently offering?

Table 1 provides a snapshot of the number of investment options offered by different types of funds in the market. The majority of funds provide a range of investment choice options other than default MySuper.

Industry superannuation funds have traditionally offered relatively simple investment menus to accommodate the vast majority of their members who do not actively engage with the fund around investment choice. Corporate and public sector funds have also typically offered much simpler investment menus (with on average eight and 10 investment options, respectively) beyond the default.

By contrast, retail superannuation funds typically offer much more comprehensive investment menus, with 518 investment options on average. While these funds typically offer more than one product, so all 518 options are not being offered to each member, the fact remains that on average retail products include significantly more investment options than products from other types of funds.

About 25% of assets within the retail funds space are in relation to employer plan products. These funds normally offer a smaller number of investment choices (on average 44 investment options with a range from 10 to 367) compared to the other public offer personal retail products. Retail funds that offer their products through platforms and distributed by financial advisers tend to have relatively more comprehensive investment menus (on average 577 investment options with a much wider range from 2 to 3,711). This is mainly to serve financial advisers and the more diverse needs of their clients, as well as their more financially sophisticated members, rather than the vast majority of members for whom the default will remain appropriate.

Table 1 Investment choice offered by different types of funds – FY2018^**Source: APRA Annual Fund-level Superannuation Statistics June 2018

Benefits of scale

From the simplest investment menus with about 10 options to the most comprehensive investment menus with more than 500 options, there is a wide range of the sizes of investment menus offered by different types of funds. A lot of funds have benefited from a simplified investment menu with most of their assets invested in default MySuper, which can lead to lower costs of investing. However, we also know that both sides of the spectrum exist to serve the different needs of different memberships.

We consider that some products that currently occupy a middle ground may not be satisfying the future needs of members. These products provide a larger and more comprehensive investment menu designed to meet the investment needs of a wider variety of members but fall short of the range and flexibility of a platform offering the full spectrum of investment choice. In adopting this approach, these investment menus may have become unnecessarily complex for the needs of the majority of their members. Potential problems arising from this complexity include:

• Smaller pools of investable assets, which may compromise scale benefits and can potentially increase investment management costs.
• Too much choice can make it harder for members to discern between the investment options, which can lead to confusion and uncertainty and increases the risk that members make sub-optimal decisions.

We observe that some funds choose to offer simple investment menus to serve the majority of their memberships and provide a broader menu on another platform as an associated vehicle to accommodate the needs of more financially sophisticated members. These funds offer a direct investment facility (effectively a mini wrap platform) to allow members to invest directly in ASX 300 stocks, a selection of Exchange Traded Funds (ETFs) and Term Deposits. To access the direct investment facility, individual members pay an additional administration fee. Offering the menu extension in such a manner allows the broader group to benefit from retained scale in investments while addressing the needs of more financially sophisticated members.

Best practice

When considering whether an investment menu is appropriate, we would typically seek to assess whether an individual member of a fund is able to construct an investment portfolio to suit their own risk profile and preference. Typically, this means the investment menu should comprise:

• For those members who choose to not make a choice or who are simply not engaged, a well-constructed default option that takes into account the varying needs of different cohorts of members.
• For those members who are engaged and want to make an investment choice, a range of multi-sector and single-sector investments that the member can use individually or in combination to construct a suitable investment portfolio, or shape one to better suit their needs.

Based on our analysis and observations in the market we consider that best practice in investment menus involves:

• Simplicity by providing options that are clear in terms of their risk profile and that are distinct relative to the other options available. This may include removing less distinct options that may cause confusion to members.
• Access to scale benefits such as lower fees and sophisticated investments that would not usually be available.
• Tax effectiveness through investment options which are well constructed and have mechanisms to allow a member to transition to a pension product without incurring significant additional cost.