Thanks for the opportunity to talk at the Ausbiotech Conference.
Today I want to talk about how the superannuation sector can invest in emerging innovations including biotech.
Before I start I want to talk a little about the superannuation sector.
ASFA is the peak body for the superannuation sector. Our membership comes from across all sectors of the superannuation industry including government funds, industry funds, corporate funds, retail funds and self-managed superannuation funds (SMSFs).
Depending on what day of the week you ask the question, the superannuation system invests somewhere in the order of $1.3 billion to $1.4 billion.
According to Deloitte, in the next couple of years the money in the system will reach $2 trillion. By 2028 we will have $7 trillion in the system.
When we talk about the superannuation sector we tend to think of it as a single entity. In reality it is not. Depending on whether funds are invested in a master trust, SMSF or a large industry fund, there is a difference in the way the investment decision making process is conducted.
The one common factor in the system, which has significant implications for the biotech sector, is that while superannuation is a long-term investment that aims to meet the liabilities of fund members in 20, 30, 40 or even 50 years’ time, we are also an incredibly short-term investment.
I want to use the time that I have today to talk about liquidity and what it means for superannuation fund investments in biotech and other areas.
On 1 July 2005 the Federal Government introduced choice of fund legislation. This legislation requires that within 30 days a superannuation fund member has the right to move their superannuation funds from one fund to another.
Superannuation fund members are also able to move their investments within a superannuation fund from one investment choice to another.
From talking to our funds we know that when markets are in turmoil a significant portion of a fund’s members may request to move to more defensive investments such as cash. In order to meet these requests funds may be required to sell out of assets such as equities.
When it comes to the question of liquidity of investments, this is not just an issue for super funds to consider as part of their investment decision making, it is part of the prudential regulatory framework that governs our system.
According to APRA an illiquid investment is an investment that cannot be converted to cash within 30 days or where conversion to cash within that period, by itself, would have a significant adverse impact on its realisable value.
Legislation has recently passed the Parliament that will provide our prudential regulator, APRA, with specific prudential standard making powers. Included in the proposed prudential standards that APRA will shortly finalise will be the formalisation of standards around investment governance and risk management. This includes the requirement that superannuation trustees must manage liquidity risk and formulate a liquidity management plan that incorporates a comprehensive stress-testing program that includes, at a minimum, the performance of each investment option against stress scenarios. Trustee board-approved liquidity management plans must also include what a trustee will do when a liquidity event arises.
When it comes to criticisms of why the superannuation industry does not invest in biotech, and indeed to maximise the potential for future investments, we have to understand the importance of liquidity.
Whether it’s SMSFs or APRA-regulated funds, the result of our legislative and regulatory environment is that Australia’s superannuation assets are predominantly invested in liquid assets such as Australian equities, international equities, bank deposits and fixed interest investments.
Liquidity is one of the reasons why venture capital funds in particular struggle in Australia.
The restriction on managing liquidity does not mean that superannuation funds cannot invest in traditional venture capital. The so called ‘illiquidity budget’ that superannuation funds have is a small part of their overall portfolio. Within this budget, venture capital must compete with other illiquid investments such as unlisted infrastructure and property.
It is important to understand that the structure of a venture capital fund is just that – a structure. The difficulty of investing in traditional venture capital does not therefore mean that the superannuation sector does not invest in innovation companies including biotech.
To take a look at the statistics, superannuation funds currently have around $2.3 billion invest in traditional venture capital structure.
According to the ASX there are currently 2,222 companies listed on the ASX with a total market capitalisation of around $1.2 trillion. Superannuation funds predominantly invest in the largest companies in the ASX, the ASX 200. According to Rainmaker Information, 95 per cent of superannuation fund investment in Australian Equities is in ASX 200 companies. Superannuation funds have around five per cent of their Australian equities funds invested outside of the ASX 200, equating to around $21 billion or around 15 per cent of the total small cap market.
Superannuation funds are able to get exposure to innovation companies on listed markets in a variety of ways: investing directly in Australian shares via SMSFs or APRA-regulated fund ASX investment choice options; via small cap and micro-cap investment managers in master trusts; or via diversified funds in default superannuation funds.
The challenge as the total funds that the superannuation sector manages increases, is to maximise the opportunity to invest in innovation companies. In this regard ASFA has been focusing our attention on structural issues in the ASX.
We have concerns that while some parts of the ASX are highly liquid, this liquidity is not evenly spread. The bottom half of the market in particular can be illiquid. The ability for superannuation funds to invest in illiquid markets, even if listed, will be constrained due to the issues I have described in terms of our regulatory environment.
Our focus is therefore on how we can increase liquidity.
There are a number of things that we are investigating.
The development of the Joint Ore Reserves Committee (JORC) provides a very useful case study. JORC is a mechanism through which resources companies report exploration results, mineral resources and ore reserves.
The background to the development of JORC goes back to 1969 when Poseidon NL made a discovery of nickel at Windarra in Western Australia. The company’s share price rose exponentially on expectations of the ore reserves the company had discovered. When the company began mining it soon became apparent that the quality of the ore was less than had been promoted and the company eventually delisted in 1976.
The market failures at the end of the 1960s in the mining sector, including Poseidon, spawned the Senate Select Committee on Securities and Exchange, more commonly known as the Rae Committee, to inquire into the regulation of securities markets. The Committee’s report led directly to greater regulation of Australia’s securities market.
The Poseidon bubble also led the mining industry to come together to investigate how they could work together to address the investor concerns around assurance of ore reserves. The JORC was initially a voluntary code which eventually became part of ASX listing rules.
According to market experts, JORC is one of the reasons why mining and resources companies are strongly represented on the ASX. JORC has provided investors with confidence around their investments in the resources sector. Today the depth of understanding of the resources sector among ASX investors has resulted in the market attracting international resources companies to list on the ASX.
The question is whether there are any lessons that can be applied from the example of JORC – and its impact on the development of Australia’s resources sector – on the potential to develop the market for innovation companies on the ASX.
Specifically, is there the potential for the ASX to develop an assurance approach based on the model of JORC that would address one of the significant issues for investors, which is to be able to verify the science behind an innovation company?
Already the ASX has a Code of Practice that was developed by ASX and AusBiotech. We believe a lot more can be done to support this code. Addressing investor concerns around assurance is one way we can add confidence to the market.
We are also concerned about changes to the ASX including the proliferation of trading in Dark Pools and proposed changes to ASX Clearing and Settlement that can have an impact of reducing liquidity in a market through fragmentation. On the positive side we believe that changes to capital raising for small caps and the introduction of a trial broker research scheme have the capacity to ultimately increase liquidity in the small cap part of the ASX.
I will close by commenting on why it is important that superannuation funds are able to invest in innovation companies such as biotech.
Over the last 10 years the influence of the resources industry on the ASX has steadily climbed. The materials sector is now over 30 per cent of the ASX 200. Outside of the ASX 200 over half of the market capital consists of resources companies. Over recent years we have seen the plethora of new listings that have focused on the resources industry.
The structure of the ASX is of material interest to superannuation funds. It is in the interest of the superannuation industry to encourage the diversification of the ASX. A diversified ASX provides superannuation funds with a broad range of investment opportunities that funds can invest in according to their different risk and return objectives. By contrast if the ASX continues to concentrate around mining and resources company stocks, then this is ultimately likely to impact on the allocation by superannuation funds to Australian equities.
Promoting market liquidity and diversification are the areas ASFA is currently focused on which we believe will be important in providing opportunities for the biotech industry.
We do not believe there is a silver bullet when it comes to the issues we face but we are very interested in working with the biotech sector to understand your challenges and work towards developing a better investment environment.