David Haynes knows that the superannuation funds are conservative investors and with good reason: its members’ money; money that has to be contributed to long-term investments that can’t be accessed until retirement. So when the discussion turns to the role of superannuation investment in ‘innovation’ and, more specifically, start-ups and venture capital, super funds understandably get nervous. This is especially the case when proponents of such investment suggest that super funds should be required to invest.
It’s inevitable that super funds will be investing much more in innovative technologies in coming years, but the model for this is still a work in progress. Government support is needed but there’s plenty that funds can be doing now.
While the mandating of super funds to invest in innovation is often argued with considerable passion, such advocates are rarely able to explain how the risk/return tradeoff would be sufficiently attractive and appropriately structured to ensure that the best interests of super fund members are looked after.
The negatives are not hard to find. Average returns in venture capital are not good, fees and costs can be very high, survival rates are not high and investments in start-ups don’t look like a good risk-adjusted bet.
It’s a question of when not if
Despite these objections there are major structural issues that have to be addressed. These will change everything – and soon:
- The Australian superannuation system is outgrowing the Australian listed economy.
- The majority of industries – including financial services – are in the process of being either transformed or eliminated by technological change.
- 40% of existing jobs may be replaced by automation in the next 10 to 20 years (Ceda: Workforce).
- The superannuation industry seeks high-returning quality assets in which to invest.
There is already over $2 trillion in super, with over $100 billion of contributions and even greater investment earnings growing the system each year. The Deloitte estimate of growth to $7 trillion over the next 15 years is widely accepted. The market capitalisation of the ASX is $1.5 trillion, and its capacity to absorb increased superannuation investment is finite. Funds have the equity alternatives of overseas markets and direct property – with unlisted equities and increased asset flows subsequently going into each class.
Super funds will be investing greater proportions of their assets into overseas equities in the interests of greater diversity and in response to Australian capacity constraints. Australian property is also subject to capacity constraints.
Unlisted equities are not stock exchange traded and so tend to be less liquid than listed equities. Their operations and pricing can be less transparent and so can present both quality and risk issues. On the other hand, unlisted equities play a role in ensuring super funds have a well-balanced and diversified investment portfolio.
All of this mean that superfunds will be making larger investments into innovation. The question is how and when?
Access to capital has been identified as a barrier to innovation but super funds would love to invest in venture capital and start-ups that meet their return and risk requirements.
A holistic solution to super fund investment in innovation has not yet been fully described – although we now have the foundations growing from the Financial System Inquiry and the clarification of taxation issues in the Turnbull Government’s innovation statement. The FSI addressed how financial institutions can harness innovation to make themselves more efficient (more on this below) but did not cover innovation as an investment opportunity, other than suggesting public-private collaboration committee, so we have to look elsewhere. What the FSI did do was make a number of important technology recommendations on technological neutrality and digital identity.
Using infrastructure as the model for investing in innovation
The answer might be found in how super funds have approached investment in infrastructure. Many of the barriers to investment in infrastructure are now being faced as barriers to innovation investment (e.g., liquidity). According to the ASFA’s 2014 report to the Productivity Commission, Australian superannuation funds hold around $63 billion in infrastructure. This is, on average, 5% of their total assets in infrastructure, compared to less than 1% in the rest of the world.
It should be possible for there to be a bi-partisan approach to innovation investment, that the Government, the superannuation industry and the innovation sector work together on the development of a framework to facilitate confident investment. And here are a few ideas about how it might happen:
- Within private equity, there should be a clearly identified asset class for start-ups and venture capital.
- Every observer notes that Australia’s world-class research stumbles at the commercialisation stage. So large research-focused corporations could be given incentives to drive investments in start-ups, thus providing a sounder basis for super fund investment.
- Choice of Fund means that super funds have to be able to transfer super to another fund at a member’s request and SuperStream means these have to be processed within three days. Encouragement could be given for particular superannuation products, where members don’t have immediate access to their superannuation, but have greater access to higher-performing unlisted assets, such as those with higher levels of innovative investments).
- Regulatory support could also be given for the establishment of secondary markets, supporting the trade in unlisted assets.
Executive Superannuation Policy Advisor, VIC