Australian Pension Funds in an Era of Financial Repression

On almost any conceivable metric, Australia has a world class pension system.
Known locally as Superannuation, it was recognised as the second best in the
world in 2014, according to Mercer, whose Global Pension Index looks at the
systems operating in 25 countries.

The system is huge too, now controlling more than $2 Trillion in assets,
according to the latest research by Rainmaker. Thats a sum of money more
substantial than entire year of Australian economic output. As every Australian is
forced by law to put at least 9.5% of their income into this system, and generally
cant touch it until they turn 65, it will grow and grow and grow in the years
ahead, with forecasts predicting the total pool will hit $9 Trillion in coming
decades.
Its a huge component of the entire Australian economy now too, with
contribution inflows already equivalent to a staggering 18% of national wages
and salaries.

Why then would current Australian Prime Minister state that compulsory
superannuation is one of the biggest con jobs ever foisted by government on the
Australian people, which he did nearly 20 years ago, back in 1995 (admittedly
when a junior minister in the then federal opposition).

Could it be that the industry isnt really doing all that it could to foster economic
growth in Australia, or provide a more secure financial future for those forced to
put money into it? And is it really structured to protect capital in a world of
financial repression and negative real interest rates?
Who are the Players?

There are a handful of major players in the Australian Superannuation industry,

some of which are for-profit retail funds (often owned by banks), and not for
profit industry funds (often run by the union movement). Collectively, according
to the latest data, these industry and retail funds control just over $950 billion.
There are also Self Managed Superannuation Funds (or SMSF for short). These
are the fastest growing component of the Superannuation landscape, and there
are now roughly 1 million Australians who have elected to look after their
retirement money themselves, rather than leaving it to the experts.

Collectively, these SMSF Trustees have more than $570 billion invested in this
system. Theyre generally older, wealthier and more engaged, though pleasingly,
the average age of an SMSF Trustee seems to be falling, as more and more
younger Australians get more actively involved in their finances.

Where is the Money Invested?

The chart below breaks down the asset allocation of all the retail and industry
funds, as well as the public sector and corporate funds (which arent as big). It
does not include SMSFs.

Source: ASFA Superannuation Statistics, February 2015

As you can see, roughly half the money is sitting in equity markets, the majority
of which are trading at or near record highs. A further 35% is sitting in cash and
bonds, a reasonable portion of which is earning negative real yields. There is also
about 12% of the money sitting in infrastructure and property. These are
effectively quasi equity or quasi-fixed income plays.
Due to the fact a lot of it is unlisted, they do help minimise portfolio volatility,
though its questionable that they truly diversify a portfolio. In the GFC, the
average balanced fund in Australia fell by over 25% peak to trough, with the 7year returns to end 2014 just 4.3%, barely in line with cash, nor ahead of
inflation.

As is evident from the chart above, there is no allocation at all to physical gold, an
asset one might expect Australian portfolio managers to have a natural affinity
for, what with Australias golden past, and our current status as the worlds
second largest gold miner.
The lack of allocation is even more perplexing when it offers a natural currency
hedge in an Australian portfolio, something that is highly relevant now that the
broader commodity boom seems over, and the fact that Australian dollar gold
has outperformed all major assets since the turn of the century, as the following
table highlights.

Over this 15-year period, superannuation funds with a growth tilt returned just
5.5%. Clearly, an allocation to gold would have bolstered returns, as well as
minimised portfolio volatility.

Self Managed Superannuation Investors dont follow the same investment

strategy that the professional funds management community do, with very little
international exposure, and a much higher allocation to cash and term deposits.
Whilst the broader industry has 34% of its money in fixed income and cash, this
is heavily tilted toward the bond market. SMSFs on the other hand largely dont
own bonds (though this is changing), instead holding on average some 30% of
their portfolios in pure cash.

The latest interest rate cut in Australia, and the forecast of more to come this
year is causing serious pain for these SMSF Trustees, and is forcing many of them
to buy up even more shares in higher yielding Australian equities, especially our
major banking stocks.

There is some irony in the realisation that financial repression Australian style is
forcing investors to take their money out of the bank, and instead buy shares in
the bank itself, hoping for a dividend payment to maintain their lifestyle.
Again, SMSF investors have on average very little of their money in gold, though
they are allowed to invest in precious metals should they wish. Those that have
done so in the past several years (provided they didnt pile in during 2011) have
done very well, and at ABC Bullion, weve seen huge growth in the number of
SMSFs purchasing and storing physical gold and silver with us.
Protecting Capital in the Coming Years

So what is next for the Australian Superannuation industry, and investment in

gold and precious metals. From our perspective we see two very obvious
developments.

Continued growth in the SMSF space as a whole, as more and more

Australians choose to self direct their retirement portfolios
A substantial increase in the number of SMSF trustees who allocate a
portion of their retirement portfolio to physical gold and silver, as a
natural choice in a low to negative real rate environment, and as the
ultimate portfolio protection in an era of financial repression.

Finally, whilst it will take some time yet, we also expect the larger institutional
players to eventually adopt a strategic allocation to precious metals, though we
doubt this number will ever get beyond 3-5% of an overall portfolio.

Record low bond yields, stretched valuations in certain sectors of the equity
market, and the prospect of further interest rate cuts will force these funds in
this direction. One need not be a raging gold bull to recognise that a more robust
and prudent asset allocation strategy for the coming years simply cant continue
to completely overlook the asset at the bottom of Exeters Pyramid.