A maturing superannuation industry part II: no sign of an uptick in consolidation

We established in part I of this series that whilst the superannuation market will continue to grow for a long time yet, the organic growth rate (growth driven by flows, rather than investment returns) has almost halved over the last ten years, and will continue to come down.  We also showed that the spoils of success are increasingly concentrated, with just 12 funds sharing 80% of the inflows, and finished with a question as to why – given the industry is maturing – aren’t we seeing the consolidation one would typically find in an industry at this stage.

Classically, we’d expect the natural leaders to become evident about now – and in a drive to achieve scale, they would acquire their slightly-less successful competitors.  Other competitors would fail, falling by the wayside as they lose the unforgiving battle for market share.  Not so in superannuation – which appears to be abnormally forgiving to the industry’s poorer performers.

In fact, what we have seen is the exact opposite of what you would expect.  As today’s first chart shows, consolidation has ground to a halt, dropping from between 3-6 funds per year over the last 5 years, to just 1 meaningful transaction in 2015.

So what’s the holdup?

One of the downsides of the industry having a large not-for-profit segment is that the signals to consolidate that would now be flashing red (in the form of plunging share prices and bankruptcies for some funds) are muffled.  Small funds can convince themselves of the ongoing need for their existence, despite long term losses in market share of members and assets.

The problem is not just with the small funds though.  The largest funds, which should be the natural consolidation destination for small funds, face a dilemma in pushing hard for consolidation.  They can’t force small funds to merge and if they were to make a public case for consolidation or – better still – actively unleash their benefits of scale in competing directly for the employers and members of small funds, they risk the ire of their stakeholders and that the irked trustees of the smaller fund will choose to go somewhere else.

Finally it could be argued that the case to consolidate has not been as effectively made as it should have been by now. It should be obvious and expected that a $5bn fund cannot compete with a $50bn fund on costs, price, and net performance.  Whilst the largest funds do, in general, charge members less than smaller funds, the gap is not as large as it should be in our view.  A clear and unassailable cost advantage should make it difficult for reluctant trustee boards to defend the decision not to consolidate.  And whilst the alternative argument – that net returns are what really matters – is true, price is an indisputable fact, whereas promises of future performance are not.

In the absence of another catalyst (and consolidation doesn’t appear to be top of APRA’s priorities), cost to members has the potential to be an important driver – or barrier – to fund consolidation.  But to make it more of a driver will need a renewed focus from funds’ CEOs and CIOs.