Chapter 02 – Types of super funds

The APRA quarterly report notes that super assets in Australia totalled $2 trillion in the June 2015 quarter. The breakdown shows that the most popular forms of funds are small funds (mostly SMSFs), retail and industry funds.

The following graphs from the APRA annual report (2014) breaks down the trend in funds over the last 10 years:

member-accounts-by-fund-type super-assets-by-fund-type

The 2014 annual report noted that $970 billion of super assets are held by APRA regulated funds, $506 billion in SMSFs, $142 billion public sector and statutory funds.

The main types of super funds are summarised below.

Industry funds

Industry funds arose from the an agreement between the Australian Council of Trade Unions (ACTU) and the Hawke government in 1983. The idea was simple: the government would legislate for mandatory employee contributions for the previously un-superannuated union members, and the unions would establish super funds to receive these contributions. (And the unions would not go on strike.)

These early union funds were not for profit and adopted a “members-first” orientation which manifested in low costs and no commissions. Over time they grew, widened their membership criteria, and became more efficient, but never lost their members-first orientation.

Industry super funds are generally suitable to clients who do not have enough super, or the inclination, for a SMSF. They are generally the most cost effective fund for this kind of member due to low fees. Most have several investment options, the range of which will therefore suit most clients.

Why industry super fund?

Dover habitually encourages advisers to recommend industry super funds to their clients. It is one of the only AFSLs that do. The reason is simple: industry funds almost always outperform retail funds. Its mathematics; retail funds and industry funds invest the same way and in the same markets. They do so with equal competence, and thus achieve basically the same gross returns. But industry funds have lower cost structures, never pay commissions and are not for profit.

This means industry funds will usually always outperform retail funds. They have lower costs, and these lower costs mean higher net returns to members.

SuperRatings note that for 2014 industry funds produced a net return of 8.3%, as compared to 8% for retail funds. Over a 10 year period, the gap in returns was 1.5%. SuperRatings’ list of the top 10 super fund returns for the last 5 years is dominated by industry funds:

top-10-returns-as-at-31-08-2015

The non-industry funds in the table, are either corporate funds (Telstra Super) which are employer subsided super funds, or public sector funds (UniSuper). No retail funds make the top ten.

The Murray report released by the Grattan Institute last year reviewed the Australian super system and was critical of the high fees charged by funds stating that there is “little evidence of strong fee-based competition in the super sector, and operating costs and fees appear high by international standards”.

The report estimates that a 1 percent fee over a client’s working life can reduce retirement income by more than 20 percent and a 2 percent fee can reduce retirement income by up to 40 percent. The following table produced by Australian Super illustrates how much a client will be worse of as their super fund fees increase by a 0.5 percentage point increments:

how-fees-eat-into-retirement-savings

It is often argued by many advisers that the higher fees can be justified by higher expected returns. The Grattan Institute report refutes this argument stating that there is no evidence to suggest that higher fee funds are justified by higher returns.  The net returns of high fee funds are much lower and there is no reduction in investment risk.

Other than low fees and higher net returns the additional favourable features of industry super accounts include:

  • very cheap life universal life insurance;
  • extra life insurance can be arranged at low cost;
  • they usually have 5-15 investment options, which will match most client’s preferences;
  • most funds are accumulation funds, at least for new members;
  • they have never paid commissions;
  • they are not for profit; and
  • some offer MySuper accounts.

It is therefore hard to argue that a low cost industry fund will not be in the client’s best interest.Accordingly, when a Dover Adviser recommends a client make use of such a fund, from a compliance point of view there is rarely a problem. 

Retail funds

Retail funds are commercial funds which are run for profit, often by service providers such as insurance companies, banks, fund managers and investment companies. They are open to the public and provide administrative and investment services to their members for a fee.

They generally have higher fees, which some argue are offset by potentially higher returns. They generally have pre-mixed investment options, as well as more flexible investment options where the member can construct their portfolio.

Self-managed super funds

A SMSF is a small fund which has fewer than five members. Each of the members will usually be a trustee or director of the trustee company. It is a ‘do-it-yourself’ fund where the trustee formulates the investment strategy and has direct control over the investments.

SMSFs will generally be more cost effective for individuals who have large balances. This is because the administration and audit fees are mostly-fixed. That is, the costs of administering and auditing the fund do not vary according to the amount held within the fund. This is distinct from other funds, such as industry and retail funds, who typically charge a percentage of the balance for the administration fee.

Other types of funds

Public sector funds

Public sector funds are established by an Act of Parliament for government employees only. The liability for the benefits can be funded, unfunded or partially funded. The profits of the fund are put back into the fund for the benefit of all members. Long term members will generally have defined benefit funds, however most new members will have accumulation accounts.

Trish Power defines a defined benefit super fund as “a super fund that pays a final super benefit based on a formula that takes into account [the member’s] final salary and the number of years that [the member works] for [the] company or government department.”

Public sector funds have relatively low fees as the costs are subsidised by the government. The members are not always able to select investment options and the member must satisfy specific conditions to maximise the final benefit.

Corporate funds

Corporate funds are employer sponsored funds that offer membership to company employers. They are generally arranged under a master trust or fund which is provided by a retail financial institution. Generally each fund will have access to a wide range investment options and insurances.

The fees are often subsidised by the employer and some employers offer automatic insurances through group cover.

Retirement savings accounts

A retirement savings account (RSA) is owned and run by the member. They are primarily used by individuals with low balances. Banks, credit unions, building societies and insurances companies are allowed to provide these accounts.

RSAs are simple, low cost and low risk savings accounts which are invested wholly in cash. They are not designed for large balances (although there are no restrictions on how much can be contributed to an account) or for long term investing.

Master fund/trust and wrap accounts

Master funds/trusts are generally run by the large financial institutions and offer a range of super management services. Wrap accounts act as a custodial services to provide a range of investment options under one administration account.

The costs are comparatively high compared to other super funds, particularly if the member is not using all of the available features. These types of accounts are usually used by individuals who want control over their investments but do not want the responsibilities of a SMSF.

Types of accounts

Within each fund, there are different types of accounts that super benefits can be held in:

Accumulation account

This is the most common type of fund which member contributions are made into and earnings are held. Like an ordinary bank account, the member’s benefits will accumulate in the fund.  The value of the accumulation account will be equal to the member contributions and earning, minus any fees and tax payable. The investment risk is carried by the member.

Defined benefit account

A defined benefit account is a super fund which the final benefit that is to be received by the member is defined by the member’s salary at a particular date and a specified amount or conversion factor. The employer’s contributions to these accounts are not allocated to an individual member, rather the funds are pooled from which all the member’s benefits are paid.

The investment risk for funding the benefit is carried by the employer sponsor. These type of accounts are being phased out in favour of accumulation style accounts, to pass back the investment risk to the member.

Pension account

A pension account is a super account that is started from a lump sum transferred generally from an accumulation account. They can only be set up once the member has reached their preservation age. Based on the member’s age, a minimum percentage must be withdrawn every year as a pension payment. The advantage of the pension account is that there is not tax payable on earnings or capital gains within this account.

The Dover Group