Can you buy an industry fund?

It’s a question that just will not die.

Can you buy an industry fund? Can you sell one? Who’s the seller anyway?

This question has been put to us pretty much every year that Tria has been around. We’ve been asked by retail competitors looking to build market share via acquisition, by stock analysts, and by fund managers.

Perhaps surprisingly, it also comes up from not-for-profit funds as one explanation for why we haven’t seen more consolidation in the market – particularly at the small end. Where is this thinking coming from?

It would be fair to say that the pace of consolidation has been a steady trickle rather than a flood, and that Stronger Super does not seem to have changed the pace to any great extent. The prospect of APRA scale tests does not seem to be scaring many into mergers either.

Some of the reasons for the limited progress are perfectly valid, such as:

– Quantifying benefits to members.
– Tax impacts, especially CGT.
– Compatibility of administration systems.

In fact, when you do a merger candidate analysis for any particular fund using a sensible set of criteria, it’s often the case that there are few serious contenders. It’s not as simple as it might seem at first.

Then there are the also understandable but less noble reasons for slow progress, relating to power and human behavior:

– There are winners and losers; sometimes prospective losers resist.
– No-one really wants to give up their independence unless they have to.
– Who is going to be CEO?
– Which board members are going to give up their seats?
– Are the sponsoring organisations – the trade unions and employer organisations – willing to see their influence diluted?

These problems (agency costs, essentially) are similar to those encountered in the private sector, demonstrating that the not-for-profit and commercial sectors are sometimes not that far apart. People are people regardless of the context.

A key difference however is that in the not-for-profit sector, these problems can be unresolvable until someone retires or dies, a hardly satisfactory situation. In the commercial sector, the market for corporate control can operate, bringing resolution to frozen situations, albeit sometimes in a bloody and brutal manner.

But there is another theory about why small funds won’t merge; that there is a potential windfall for sponsoring organisations in the event of a demutualization or sale of the fund. The theory works like this:

– Not-for-profits are often controlled by a trustee corporation. The shares of the trustee corporation are typically held by the sponsoring organisations; ie the unions and employer organisations behind the fund.

– In a demutualisation, the theory says that the fund’s reserves would be released – but to the sponsoring organisations rather than the members.

– Alternatively, the theory says that a not-for-profit fund could in fact be sold (for example to a retail competitor) via the sponsoring organisations selling their shares in the trustee corporation. The sponsors would retain the proceeds from the sales of their shares.

Let’s be clear – we do not advocate that either version of this theory holds water. It appears to be based on a demutualisation in the insurance sector many years ago, but which was subject to different circumstances and very different governance standards.

As far fetched as this theory may seem, the truth is that nobody really knows for sure if you can buy an industry fund. The important thing is that this theory still circulates out there. It might be more of an urban myth, but it still plays its part in slowing the consolidation process.