Australian superannuation funds’ ability to manage a pandemic-inspired market crash, far-reaching regulatory changes, rising competition, and ongoing merger activity suggests they still rank among the world’s best investors.

But being the best requires ongoing innovation.

Funds are adding new strategies to their investment portfolios and strengthening their operating models despite many delivering outsize returns above 20 per cent in 2020-21.

A key driver is scale. The biggest funds are getting even bigger at a rapid pace thanks to surging inflows and heightened merger activity. And new regulations, such as Your Future, Your Super (YFYS), appear to be acting as a significant tailwind.

About three-quarters of assets under management and member accounts are now managed by the top 12 funds, according to KPMG. Given APRA recently suggested that funds with less than $30 billion in assets will become uncompetitive, it is expected further mergers will occur.

Size can lead to economies of scale but only if funds can find a way to align their views across culture and strategy. Larger scale should lead to lower fees and better net returns to members, however, funds will need to focus on the process of executing the merger, to ensure the merger delivers the full range of expected benefits.

New investment strategies tackle low interest rate environment

Several funds have recently lowered their MySuper investment targets given ultra-low interest rates are expected to remain in place for some time as the world recovers from the pandemic.

It means they’ll also need to explore new asset classes and investment strategies. For some, this can involve a greater allocation to global assets or increasing the proportional allocation of unlisted assets. Boston Consulting Group predicts that Australian super funds will more than double their private equity exposure over the next five years.

Many mega-funds are internalising parts of their funds management activities to lower costs and increase their control. For example, many are undertaking co-investments in private market assets, cutting out intermediaries and giving them a greater say in the timing of a sale.

With the 12 largest funds now managing at least $50 billion in assets each, many are increasing their exposure to global investments.

While there may be tax advantages to being overweight in Australian shares, thanks to our franking credits regime, many other investment opportunities, including unique property sub-sectors, can only be found offshore.

The publicity surrounding super and a growing interest in environmental, social and governance (ESG) issues is also prompting members to become more active. One large fund recently adjusted its climate strategy after action by one member, while some smaller but high-profile funds are competing with highly specialised investment strategies.

The super industry has largely focused on helping Australians accumulate the biggest retirement savings pot possible, but decumulation is now grabbing more attention as the population ages.

The upcoming Retirement Income Covenant will reshape retirees’ investment portfolios. It presents one of the biggest challenges of all – building an investment strategy to help members balance the competing goals of maximising their retirement income, managing risks, while maintaining flexibility.

This will require new portfolios and strategies given retirees are highly exposed to sequencing risk (which describes the way a market downturn has a far greater impact on their savings than it does for younger investors).

Better use of data and increasing automation

The onset of the COVID-19 pandemic presented a new challenge for funds.

Markets plunged in March 2020 just as the Government unveiled an early release scheme. Funds had to revalue unlisted assets to ensure all members were treated equitably as billions of dollars were leaving the system through the super early release scheme.

J.P. Morgan worked with a number of funds to revalue their assets – in some cases, more than 160 assets within just three days at the height of the turmoil. Funds also had to ensure that the system remained secure and safe, with large transactions triggering certain controls such as anti-money laundering regulations.

This pressure has accelerated some key trends already underway around digitisation, automation and data use. A wide range of fund data is being amalgamated and combined with artificial intelligence and machine learning capabilities, creating new portfolio insights.

This requires new skill sets and large funds, like many other organisations, are grappling with a global shortage of data specialists, such as data scientists. However, the workforce is becoming more flexible with many asset owners not only making work from home normal but appointing remote staff they have never met in person.

Technology is also turning the focus onto automation of manual processes, freeing up staff to focus on higher value adding activities. This is becoming a stronger focus with several industry mergers underway. There is a fine balance between achieving scale that lowers costs while managing the added complexity that comes with growth.

Investors face a challenging environment, but these changes are set to keep Australian super funds among the best investors in the world.