Should we use the Future Fund as a national retirement scheme?

Lately, there have been several calls to improve our maligned superannuation system by using the Future Fund as the vehicle for all investments, making it a nationalised fund manager.  Some have even suggested it be used to manage all superannuation on the grounds that members would be better off in one large fully nationalised pension scheme.  The support for these ideas has gained traction due to the ongoing poor media publicity endured by the superannuation industry, and the apparent need for major changes.    However, evidence-based analysis of this opportunity quickly shows that the concept is not sensible.

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The demise of defined benefits and the launch of the Future Fund

There was a time when all public servants received generous defined benefit (DB) superannuation.  Politicians were not concerned about paying for these benefits as they accrued, and built up unfunded liabilities for future generations to worry about.  Queensland was the noble exception – it started QSuper in 1912 and has always avoided any deficit in the fund.

When Australia’s superannuation revolution began 35 years ago, DB funds became less popular for employers.  Gradually, almost all employers and every government switched to accumulation funds.  The shift was gradual as the change was usually made for new employees and existing employees received grandfathered benefits.

The Federal Government closed its fund (PSS) in 2005 when the defined benefit contribution rate was 15.4% – and that rate was kept for members joining the new accumulation fund (PSSap) – which is, of course, a rate much more than the targeted 12% SG which Grattan and others believe is too high as the compulsory level for private sector workers.

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Purpose of Future Fund

The Federal government’s unfunded liabilities were large and expected to grow, so the Howard Government decided to legislate for future Budget surpluses to be put into a fund to meet these liabilities.  The decision was taken not to use the existing defined benefit schemes to invest the money, but to set up a new entity.  Accordingly, the Future Fund was created in 2006 with the proceeds from a Budget surplus and the later transfer of Telstra shares.

The goal of the Future Fund was to grow at a rate faster than the growth in unfunded liabilities, so the impost on future Budgets could be reduced.  The government has also set up five other trusts which hold about $35 billion and these are also managed by the Future Fund

The funds were locked up until 2020FY, giving it a long-term investment horizon (15 years).  A few years ago, that period was extended by 7 years.

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Performance of Future Fund

Initially, the Future Fund had an ambitious target investment return of CPI + 5/6% (which was higher than any superannuation fund).  The fund was able to earn this high rate, but the target was reduced two years ago to CPI + 4/5% recognising the secular shift downwards in interest rates.

Over the ten years to June 2019, the Future Fund earned an impressive 10.4% a year.  Consequently, the assets held against unfunded liabilities are now $163 billion.  However, the unfunded liabilities are now over $400 billion, so the gap has widened considerably!

In the same way that discount rates are impacting on the valuations of real assets, they have the same effect on liabilities.  The unfunded pension liabilities have grown due to a reduction in the discount rate rather than any blowout in wages.  If the Future Fund continues to deliver strong returns, and public sector wages don’t inflate more than expected, the gap will narrow again in future years.

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Comparative performance

Many commentators have pointed out the Future Fund should earn high returns relative to the superannuation industry.  However, this needs to be considered alongside the risks and the different investment structures, including taxation.

Before making any comparisons, we should note that superannuation funds have a few disadvantages:

• They pay tax on investment earnings for accumulation members.
• They offer investment choices to members, and members can join other funds at any time. Therefore, they must monitor their liquidity closely.
• Members are skittish about negative returns and trustees are conscious to minimise these in any financial year. The Future Fund does not have members and need not be concerned about temporary changes in market prices.
• Superannuation funds lack the scale of the Future Fund and this means they pay higher fees and have a different asset allocation.

Despite these disadvantages, and more modest investment objectives than the Future Fund, many superannuation funds have done very well over the same 10-year period.  Three high-quality funds with different investment strategies and asset allocations are AustralianSuper (10.9% p.a. in tax-free pension phase), Hostplus (10.4%) and QSuper (10.4%) compared with the Future Fund at 10.4%.

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Asset Allocation

Table 1 shows the asset allocation of these three funds and the Future Fund.  The differences are remarkable, but all are heavily exposed to growth assets and have performed exceptionally well.  The Future Fund has a much higher percentage of Private Equity and Alternatives than the superannuation funds, which is logical for the Future Fund but would be difficult to reconcile with superannuation funds’ requirements for:

• Liquidity to ensure that benefit payments and investment switches can be honoured.
• Frequent pricing of units (daily or at most weekly) to make sure that these investment switches and benefit payments are made based on asset valuations which are accurate and equitable between members.

AustralianSuper and QSuper have in-house teams for some investments whereas external managers are selected for most of the investments of Hostplus and all of the Future Fund’s investments.

Table 1.              Strategic asset allocations

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Control?

Infrastructure has been a major driver of returns for superannuation funds, which own much of Australia’s infrastructure on behalf of their members, in addition to holding a significant part of the ASX.  Imagine if a small team (ultimately responsible to the government of the day) ran all superannuation assets under a nationalised structure!

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Should we change?

Much of the Future Fund’s success has come from following investment strategies that are not suitable for superannuation funds, which could not hold 30% of their assets in private equity and alternatives.  Even with these advantages, the Future Fund has not done any better than leading superannuation funds.

Further, success in its overall purpose of closing the funding gap in Federal Government defined benefit liabilities remains elusive.  From 2007 to 2019, Commonwealth defined benefit liabilities net of the Future Fund have increased by a factor of five, from $50.3 billion to $252.6 billion.

This is not to take anything away from the Future Fund.  It has done very well with the assets entrusted to it.  However, this does not give any reason to believe that it would be the right vehicle for an entirely different purpose.