High super fund equity allocation is good


Twice today I came across bogus arguments for why the high level of investment by superannuation funds in equities is causing a big problem in the Australian economy.

First there was an article in the AFR reporting on a talk given by Treasurer Wayne Swan on Tuesday.  The Treasurer is quoted as saying “What I have been concentrating on is trying to get the superannuation funds to invest more in domestic infrastructure because they have a particular fixation with shares.  The Government is working on a set of tax incentives for super funds to increase their investment in superannuation.”

Second I heard the following argument made on the ABC’s PM radio program.  Because of the tax advantages of superannuation, most of the savings of Australian savings flow into superannuation rather than bank deposits.  As a result Australian banks, unlike banks in other countries, cannot fund their loan portfolios without large issuance of bonds.  Because Australian super funds mostly invest in equities (rather than bank bonds) the banks have to issue huge amounts of bonds oversees.  Consequently, Australia is at critical risk of that flow of foreign capital being cut off.  The downgrade of the long term bond ratings of Australia’s big banks by Moody’s from AA1 to AA2 was held up as a warning of the danger.   The ABC commentator did not advocate a reduction of income tax on deposits but you should expect the big banks to argue that the downgrades demonstrate the need for a extra deposit tax breaks.

So, apparently the high allocation of super funds to equities is causing both under-investment in infrastructure and massive funding risk for the banking system.  For these two arguments I have two names — bunkum and balderdash.  

Consider the Treasurer’s comment.  Surely, a high allocation of super funds to equities is what we want.  Who is going to absorb the residual risk of new projects if not long term investors like super funds?  Don’t we want super funds to take high expected return investments to increase the expected wealth of future retirees?

In any case, why are equity investment and infrastructure investment at odds with each other?  We should want a high proportion of the funding of infrastructure projects to be equity funding to make them financially stable.  If the infrastructure projects are owned by publically listed companies then they will be mostly financed by public equity, just as Sydney airport is owned by Macquarie airports (MAPS) or the eastern freeway in Melbourne is owned by Transurban.  I hope Treasurer realises that.

The bank funding argument is equally spurious.  There is nothing to stop super funds from putting money in the bank.  In fact self managed super funds (SMSFs), which are the biggest sector of the industry, have about 25% of their funds in cash.  If deposits are low relative to loans in Australia, that is mostly to do with liquidity preference.  Investors want high yielding, risky, long term investments, rather than low yielding, low risk, short term investments.  Why is that a bad thing for the economy?

There is a danger that international capital markets will close to Australian banks.  That actually happened in late 2008 and the Federal Government responded with a temporary wholesale funding guarantee that completed solved the problem.  In any case Australian banks have restructured their funding since October 2008 to increase deposits, increase long term bonds and decrease short term funding in the money market.

We should be happy that our super funds absorb a lot of risk and have high expected returns and not make up bogus arguments for why Government tax breaks are needed for non existent problems.

6 Responses to "High super fund equity allocation is good"
  1. The main distortion in Australia’s financial system is Australia has a big bank market and a small wholesale debt market. The equity market isn’t an outlier compared with other countries. If the bank funding costs rise, wholesale debt markets will be more competitive, and debt funding will become more diversified. Infrastructure will have more options in sourcing debt finance if there was a deeper domestic debt market.  

  2. No, the main distortion in Australia’s financial system is the attempt at forced saving through compulsory superannuation, which very predictably created a demand for offsetting loans by the household sector as households compensated.  Goodhart’s Law rules.  That’s the root cause of that big bank market.

    My own view is that the wise advice for super fund is to invest offshore more – there’s too much correlated risk when they all buy Australian equities.

  3. Ken
    You are saying that the massive growth in bank credit is in part a result of the growth of compulsory super.  It is an interesting point.  

    If an investor has high tax and low tax savings vehicles, then the risky assets should be held in the high tax vehicle if taxes are convex or if there are portfolio value limits.  Super taxes are convex and portfolio limits have only been recently removed.  

    Then there is the effect of super on the rate at which households repay their mortgages.

  4. Household leverage growth started with financial deregulation, a few years before the introduction of superannuation. Household gearing is probably an expression of household risk preferences. Most household debt is house debt not consumption financing. So I don’t see how households can offset forced savings by borrowing to buy houses. There consumption doesn’t increase if they do this.

  5. Their consumption doesn’t increase … – Roger
    Well yes, but it doesn’t decrease either.  Given unchanged income that must mean their net saving doesn’t increase.  Given compulsory super means compulsory gross saving, that must mean offsetting dissaving. As just one example bigger and later mortgages then happen because both banks and lenders know that the loan no longer needs to be paid off before retirement.

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