Sent: 21-12-2012 18:27:03
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Fund Manager Remuneration
Throughout my entire working life and I presume for many years before then fund managers have been judged on the total return they receive from their investments. That is, by the income earned on their investments as well as the change in the price of those investments.
I think this approach is a mistake. You all know that investing takes time, patience and discipline. You also know that asset prices are highly volatile but the income from most asset classes is variable but typically not volatile and definitely not as volatile as the change in asset prices.
The obsession with total returns creates a false impression about investing and also a false understanding about the risks of particular asset classes.
Long term investors - which by definition superannuation investors are - need stable income which increases after all costs, at either the rate of inflation or the rate at which an economy grows.
How important do APRA regulated funds take the job of earning income from their investments? This is an important question. Do they spend their days buying and selling assets in the hope of generating a total return involving asset price fluctuations or do they invest to earn long-term income?
It is by measuring and assessing total return that an APRA regulated fund is judged. Given the volatility of asset prices is it any wonder that these large funds spend vast amounts of time, money and energy to manage this volatility?
I'm not aware of any industry prize for an APRA regulated fund that generates the best income return.
It's no surprise therefore to realise that the income earned by these funds is highly variable.
Early in 2013 I will publish some analysis of APRA super fund data for corporate, industry, public sector and retail super funds.
For now I will mention the income return of Retail Funds after all costs.
In the 2006/07 financial year the income earned by these funds was 70% higher than the income earned in 2005/06. In the 2007/08 year income was 4.5% lower than 2006/07. In 2008/09 it was over 55% less than 2007/08. The next year it was 34% lower and in 10/11 it was 77% higher than in 09/10. And finally in 2011/12 income was more than 11% lower than that earned in 10/11.
The bottom line - an investor who had placed money into these funds at the start of July 2005 would have earned 26% less income in 2011/12 than what they earned in 05/06. Over the same period inflation was 26%.
Let's think about this for one moment. If someone needed $100 in retirement income in 2005/06 then to maintain purchasing power they would need to receive income of $126 this year but the retail funds could only pay them $74. That is their income is 42% below what they actually need in 11/12.
Although the income investors were receiving as part of their investments total return was getting hammered on a nominal and real income basis, the fund managers didn't suffer.
Investment management fees of retail funds in 11/12 were 50% higher than what they received in 05/06 even though the assets they managed over this period increased by 25%. In addition their other fees increased by 34% over the same period.
The asset base in 11/12 was 50% higher than 05/06 but the income earned on those assets was 26% lower. Why is this? Is it that earning income from investments is so low down the pecking order of priorities that earning income is accidental as opposed to a deliberate strategy?
Another aside - there's not a lot of difference, in percentage terms, between the total fees paid by retail super fund and the fees paid by industry funds. In retail fund total fees were 83 basis points and in industry funds it was 79 basis points. This is from a percentage of income perspective not a change in asset price perspective.
There are some obvious caveats with these numbers. These results are for all retail super funds and for all investment options. The results also include the period during the GFC when income from all investments fell. Obviously the use of averages can be misleading.
However based on the analysis I've done thus far, public sector, industry and corporate super funds show similar levels of income variability from year to year.
The problem here is that by combining asset price fluctuations with this level of income variability to create a total return, you are asking investors to take on unacceptable risks.
On the whole these risks are something investors don't understand because no one talks about them or explains it to them. One of my colleagues, who is a couple of decades older than I am, has been waiting most of his working life for this to change. Will this change in my lifetime?
The Essential SMSF Guide
My book which I first self-published in 2009 is now published by Thomson Reuters as The Essential SMSF Guide. Thomson Reuters are responsible for distributing the book (which is now up to date to 30 June 2012). The book has been endorsed by the Institute of Chartered Accountants. Further details are available here:
Final ATC Email for 2012
This is out final email for 2012. Thanks for all your support. We'll send out our first email for 2013 on 29 January. We hope you and your families have a wonderful, peaceful and joyful Christmas and New Year.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.