1 Decentralised portfolio management: analysis of Australian accumulation funds Hazel Bateman (UNSW) Susan Thorp (UTS)

2 There is increasing investment choice in Australian superannuation Investment choice offered by 78% industry funds, 76% retail funds, 60% public sector funds Av. 7 choices (industry funds), 59 choices (retail), 6 (public sector) 85% assets are in super funds offering investment choice (Source: APRA 2005)

3 Choice menu Not-for-profit super funds: multi-manager diversified portfolios (capital guaranteed, capital stable, balanced, growth etc….)  trustee boards (and their advisors) then choose specialised investment managers (mandates) on behalf of members - delegated choice of investment managers 401(k)s (US), Premium Pension (Sweden), Australian retail funds, offer members direct choice of specific investment managers  Av for 401(k) plans and up to 5 from over 650 for the Swedish scheme, av. 59 for Australian retail funds

4 Delegated funds management in superannuation Member contributions into investment options CashCapital stableBalanced Trustees (+ asset consultants) Investment mandates Dom stocksDom FIPropertyInt’l stocks Investment returns Crediting rates CashCapital stableBalancedGrowthAsset Classes Int’l FIDiversifiedCash GrowthAsset classes Taxes, costs, smoothing

5 Mandate trends  1 to 59 mandates per super fund (av. 12)  Av. 22 mandates per manager  Large super funds more mandates than small super funds  Diversified mandates becoming less popular (15% in 2004, down from 50% in 1998) (Source: Rainmaker 2004)

6 Does this additional layer of management create value for retirement savers? 1.What is the impact of using more managers (mandates)? 2.Do these delegated investment funds do better than a group of standard asset indexes? 3.Are trustees (and their advisors) able to choose managers with more skill than an uninformed investor? 4.Are the benefits, if they exist, passed on to members’ accounts via realised crediting rates?

7 Data Construct a monthly series of portfolio returns for nearly 200 not-for-profit super funds = Mandate weights from Rainmaker 2004 survey of mandates for not-for-profit super funds (90% not- for-profit sector, 1/3 superannuation assets) + 3 years of gross monthly returns for each investment manager (Jan 02 – Dec 04)

8 1. What is the impact of using more managers (mandates)?.

9 Mean return declines as mandate numbers decrease

10 Highest risk: funds with 6-12 mandates Lowest risk: funds with mandates

11 Av. return/risk for >12 mandates is 1.3 (1.0 for < 13)

12 Pooled data (4 groups) to allow additional analysis of fund vs fund Tested for significant differences in realised volatilities between the 4 groups  Least risky returns for super funds with mandates with no significant reduction in risk from adding more mandates  No significant reduction in risk when move from 1-5 to 6-12 mandates

13 Pooled data (4 groups) to allow additional analysis of fund vs fund Tested for stochastic dominance to investigate whether the differences between realised portfolio returns matter to a risk averse investor  Returns from larger mandate groups dominated returns from all other groups (and would be preferred by risk averse investor)  Except - no clear ordering over returns to 1-5 and 6-12 groups

14 Overall – fund vs fund Super funds with >12 managers (mandates) show significantly less volatility and overall higher returns than super funds using < 13 mandates No significant advantages to members of super funds who choose 6-13 rather than less managers Super funds with more mandates preferred by risk averse investors

15 2. Do these delegated investment funds do better than a group of standard asset indexes?.

16 Spanning tests to compare actual fund performance against a benchmark constructed from a set of asset class indexes Excess returns on =  (Excess returns on benchmark index actual super fund portfolio) Test null  < 0

17 Results: super funds vs benchmark Optimally diversified benchmark -> no super fund in sample spanned the benchmark Equally weighted benchmark -> 25% super funds in sample spanned the benchmark  Probability of spanning increased with number of mandates -> 50% super funds in largest group

18 3. Are trustees (and their advisors) able to choose managers with more skill than an uninformed investor?.

19 Spanning tests to compare random selection of fund managers (vs benchmark) to actual selection by super funds (vs benchmark)  Unconstrained selection of fund managers random choice more likely to span benchmark than actual funds in 1-5 and 6-12 mandate groups  Constrained selection – at least one manager per asset class Random choice more likely to span benchmark than actual funds in all except mandate group

20 Results: simulated super funds vs benchmark Delegated investment choice no better than an individual following a naive diversification strategy Except where super funds used many mandates (22-59)

21 4. Are the benefits, if they exist, passed on to members’ accounts via realized crediting rates?.

22 Funds with mandates appear to generate higher investment returns, but similar crediting rates

23 Conclusions Funds with few mandates performed poorly Funds with many mandates add value on risk adjusted basis and more likely to span an equally weighted benchmark Uninformed individuals with naive diversification strategy perform better than many actual mandate selections Unclear whether better investment performance of funds with many mandates translates into higher crediting rates

24 Coming up next…… Repeat for choice menu of Australian retail funds Use fund specific data to analyse characteristics of funds with superior performance Further investigate gap between gross investment returns and crediting rates Extend analysis to actual choices