Sent: 10-04-2013 11:24:02
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Pension Funds Fail to Tap Corporate Success
Recent market investment returns have underperformed the growth in Australian corporate profitability leaving Australia's pension funds without access to potential investment benefits from Australia's economic success.
According to the Australian Bureau of Statistics (ABS), Australia's pool of pension fund financial assets grew by 14.5% or $176 billion over the year to December capping off an annualised growth rate of 12.3% since the beginning of 1990. Over the two decades, pension fund equity holdings grew by $784 billion, including a $215 billion increase in the holdings of overseas equities.
In the December quarter alone, the value of Australian pension fund equity holdings, including a 27.5% allocation to overseas shares, increased by $36.5 billion to $815.9 billion, according to the ABS. Of the reported increase, $22.8 billion came from inflows and the remainder from investment performance.
After adjusting for flows, the implied investment return on the overseas component was 8.1% compared with the MSCI increase of 2.5% in the quarter. The implied investment return on the Australian share component was 1.7% compared with an increase of 6.9% in the S&P/ASX 200 accumulation index.
Over the four quarters to the end of December, the implied return from the Australian equity component of the pension fund assets was 9.2% compared with a market gain of 20.3%.
The pension fund returns seem disappointingly meagre even taking into account the tendency for the funds to forego return in favour of reduced volatility.
Since the June quarter of 1988, when data series for the ABS financial accounts commence, the correlation between returns from the Australian equity holdings of pension funds and equity market index returns has been 0.90. The pension funds have generated an annualised return of 3.9% on Australian shares with a 15.2% standard deviation. The S&P/ASX 200 index has delivered an annualised 9.1% with a 13.8% standard deviation.
More important than the comparison with an artificially constructed equity benchmark is how the pension funds are performing against the broader Australian economy. This measure determines whether Australian savers are maintaining their share of Australian wealth, an important strategic investment consideration, or are losing ground in the quest to sustain their post retirement living standards.
Since 1988, the gross operating surplus generated by Australian non-government businesses has grown at a 6.6% pace. The return on the Australian equities portfolios of pension funds has slipped below this growth rate by 2.7 percentage points.
Unfortunately, the gap seems to have been widening. Since 2000, the pension fund return of 4.0 % compares slightly less favourably with the underlying macroeconomic income growth rate of 6.9%. Since the end of 2007, pension fund negative returns have been running at a 5.1% annual rate while underlying business profits have grown at 5.5%, a spread of more than 10 percentage points.
Australia's overall economic performance should represent the bounds of sustainable returns for Australia's pension funds investing in Australian shares. To the extent funds are doing worse than this potential, they should be deploying assets toward those parts of the Australian economy (whether listed or not) capable of improving investment outcomes.
Historically, this may not have been an issue for investment strategists. Since stock market returns have been running ahead of the growth in national corporate incomes throughout the working lives of most current strategists, there has been little incentive to stop using the ASX indices as investment targets.
Over time, however, the stock market returns have been decelerating while the measures of corporate economic performance have been relatively steady. Over the five years since the end of 2007, Australian equity market returns have been negative (-1.6% per annum) while growth in business operating surplus has been running at 5.5% a year.
Quite possibly, the swing in outcomes is an aberration partly explained by the cyclical positioning of the resources industry. To this extent, as the cycle subsides, the benefit of investing with an eye to the stock market indices will again become evident.
Even if true, however, the relative returns over the past five years raise another troubling question. If the equity market indices cannot capture the underlying performance of the Australian economy, are pension fund investors destined to permanently miss the benefits of such cyclical occurrences whenever they occur?
If so, it suggests a structural flaw in investment decision making processes with consequences for long term living standards.
If pension fund managers cannot access income being generated because it happens outside the ASX indices, disparities in wealth could also grow.
Pressure for government intervention to draw resource sector profits, for example, into the retirement savings pool will grow stronger if decision-making rigidities among the pension fund advisers prevent adjustment to changing cyclical circumstances.
And, worst of all, Australian savers will forever be falling short of their potential retirement living standards.
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