19/02/2019

In recent E-News articles a number of issues in relation to Industry Superannuation funds have been raised.  Whilst they have been many and varied they can generally be characterised under the term ‘lack of transparency’.  Some of the more notable areas we have focused on have been;

• inaccurate definition of growth assets as defensive to ‘game’ the returns tables
• non-disclosure of bond credit risk
• non-disclosure of alternative assets use
• difficulties in understanding the specific assets invested in
• use of performance fees and the inaccurate reporting of true costs
• and finally how unlisted assets are valued

The union dominated sector has been in the news again recently with serious questions being raised as to how the funds are valuing unlisted property assets in their portfolios.

Rest Super reported in December 2018 that they had lowered their discount rate from 8.45% to 8.29%, effectively with a stroke of a pen, increasing the value of illiquid property assets in their portfolios. Asset values rise as discount rates fall.

A Discount Rate is comprised of a ‘risk free’ rate of return (usually based on an Australian Government bond return) plus a ‘risk premium’. The first component is easy to identify and is publicly available and independent. The second component is to a great extent quite subjective and, in the worst case scenario, is open to manipulation.

Sean Collins, lead partner for valuations at KPMG said “If you look back to 2015-16, we certainly went through a period of declining discount rates. As 2017 unfolded and we flowed into 2018, I think rates have bottomed out. They’ve stayed relatively flat over that period.”

The decision to lower their discount rates puts Rest Super at odds with this assessment. Most Industry Super funds do not disclose their discount rates and are not legally required to do so. Given the extent to which values can be ‘gamed’ this regulatory omission is quite astonishing.

The Industry Super fund, Australian Super, used to disclose its discount rates however in its 2017-18 financial statements this information was omitted. However it did disclose that it held 15 assets worth $9.16 billion. This compares with 2016-17 where it held 18 assets worth $9.03 billion.

The remainder of the main Industry Super funds, First State, QSuper, Unisuper, SunSuper, Cbus, Hesta, State Super and Host Plus, do not disclose their discount rates.

Industry Super public affairs director, Matthew Linden said “Trustees are required to comply with relevant superannuation laws and prudential standards and guidance on the valuation of assets”. He added “this involves valuing unlisted assets at arm’s length from the trustee by independent valuers”. But it begs the question, who employs the valuers? In this situation, the Industry Super fund, employs the valuer to value assets that are included in the Industry Super fund’s portfolios.

This arrangement is clearly a conflict of interest.

KPMG’s annual valuation practices survey found that most valuers adopted a risk-free rate of 2.5% – 3% and the majority of respondents adopted a market risk premium of between 6% and 6.5%. This implies a Discount Rate of between 8.5% and 9% which is materially higher than the rate declared by Rest Super.

Why is this such an issue?

As we raised in our last E-News article entitled “Do Industry super fund investors know what they’re investing in?”, major Industry Super funds hold between 26% and 45% of their member portfolios in unlisted assets. With such a large allocation, getting the assets valued accurately takes on significant importance.

Add to this the fact that performance league tables are used to promote and market funds (think the ‘compare the pair’ ads) and one can easily see why the direct employment of valuers by Industry Super funds (or any super fund) should be banned.

Sunlight is the best disinfectant

In the interest of transparency, investor awareness and a complete removal of the current conflicted scenario that exists in the valuation of unlisted illiquid property assets, super funds should not directly employ the valuer to value these assets and all discount rates should be published on an asset by asset basis. One would hope that regulators would see this as an obvious course of action however nothing to date has occurred to suggest this is the case.

With it highly probable our next government will be Labor, it is unfortunately even less likely.