BREAKINGVIEWS-Australia struggles to flex $3 trln Super powers

By Antony Currie

MELBOURNE, March 27 (Reuters Breakingviews) - Australia's "no worries" ethos is becoming increasingly worrisome from an investment perspective. The country's A$4.5 trillion, or $3.1 trillion, of retirement funds in theory gives it significant clout. Instead, a broadly conservative and scattershot approach has created something of an identity crisis.

When Canberra made employer superannuation contributions compulsory more than three decades ago, armies of money managers were recruited to serve as passive custodians, largely enlisting outsiders to buy stocks and bonds of domestic companies. Years of consolidation helped mould AusSuper, UniSuper and others into something vaguely resembling Canada's Maple 8, led by the Canadian Public Pension Investment Board. And yet despite punching far above its population weight, Australia is struggling to make the most of its clout.

The largest retirement fund managers Down Under are big enough to run their own portfolios, but also expanded overseas, dabbled in pressuring CEOs, acquired infrastructure assets and invested alongside accomplished buyers such as Macquarie MQG.AX and Blackstone BX.N. Being both active and an activist is the most obvious sign of their heft, at least at home.

These shifts make sense. Australia's pension pools are growing quickly as the government orders Australian employers to contribute more and more, now 12% of staffers' gross income. Even with about half of the industry's money deployed abroad, superannuation funds, as they are known locally, dominate share registries of companies with some A$3.5 trillion of market value traded on the ASX.

What's problematic is the half-hearted or half-baked efforts to flex. The aggression tends to be narrowly focused, an obsession with expenses makes it hard to hire the best fund managers, and an abundance of capital is leading to cautious decisions.

A recent example encapsulates some of these dynamics. Buyout shop KKR KKR.N wants to take Pepper Money PPM.AX private five years after floating the non-bank lender, by increasing its nearly 60% stake to 75% at a A$1 billion valuation and bringing in A$5.6 billion domestic annuity seller Challenger CGF.AX to own the rest. AusSuper, which owns an 11% stake, scuppered the deal, according to local media, when Challenger trimmed its offer after looking at Pepper's books. It also suffered a 10% hit to its own stock price following the initial bid.

Although the pension funds periodically lobby for better corporate governance or environmental stewardship, it usually occurs behind the scenes. Like most traditional long-only funds, they rarely if ever push for breakups, acquisitions, buybacks or management shakeups. Supers typically only become vocal during a deal.

One method is to buy more of the target, either to squeeze suitors for a higher price or to wangle their way into an acquiring consortium. UniSuper used the tactics to join both the A$32 billion Sydney Airport buyout in 2022 and Macquarie Asset Management's A$11.5 billion acquisition of logistics company Qube QUB.AX last month.

By contrast, AusSuper, under CEO Paul Schroder, torpedoed Origin Energy's ORG.AX A$20 billion sale to investment firms Brookfield and EIG in 2023. It argued that the offer undervalued Australia's second-largest power generator and retailer. The fund raised its stake to 17% from 12% and rallied enough support from other shareholders to prevent the buyers from locking up the 75% approval needed.

Origin's shares have rallied 60% since then to sit 30% above the offer price, suggesting opposition was warranted on that occasion. There's always a nagging suspicion, however, that other factors are at play below the surface. The 12% employer contribution guarantees an enviable stream of investment and fee-generating money. It also means the funds are awash in cash, especially since memberships skew younger. In a sense, the last thing they need is more hard currency for which to find a new home generating returns.

Tax breaks on dividends are another powerful force. Australia's so-called franking credits make it alluring to just hold stocks and deposit the payments, especially since they help with another important consideration: performance tests. Benchmarks are the bane of long-term investors everywhere, but they come with extra irritation Down Under.

Regulators assess superannuation returns and then name and shame the worst performers. Repeat offenders risk losing the ability to sign up new members. Since costs are part of the calculation, there's incentive to keep the fees they charge and pay as low as possible. On paper, the practice should benefit retirees. In practice, it can encourage sclerotic short-termism.

Keeping expenses down is a particular challenge when it comes to unlisted assets. They're a perfect match for funds with pots of cash and a long time horizon. Hostplus, with A$150 billion under management and members younger than 40 on average, is a good example. Chief Investment Officer Sam Sicilia and his boss David Elia are so keen on private equity and other alternative assets that they hold a conference every year to hear from Wall Street titans. This year's event, held in Melbourne on Thursday, included BlackRock BLK.N co-founder Robert Kapito, Blackstone co-CIO Kenneth Caplan, Blue Owl OWL.N boss Doug Ostrover and Apollo APO.N President Jim Zelter, who pointed out to the gathering that the massive capital needs of infrastructure from transmission grids to ports to defence are where super funds should be playing.

The higher fees and longer time horizons for such assets sit badly within the performance test, however. It's a big reason why Aware, AusSuper, UniSuper and a few others have preferred co-investing. The obvious next step would be to lead the deals. A handful have tried, but they suffer from an additional cost disadvantage: compensation. The Hostplus and Aware chiefs each earned about A$2 million last year, 30% of what Lazard's LAZ.N recently departed asset-management boss Evan Russo was awarded. Blackstone's 5,300 employees, on average, took home more than $1 million each last year.

This discrepancy is one reason for Australian stumbles. AusSuper's A$1.9 billion acquisition of a majority stake in Optus telecom towers, for example, took a bad turn. Within a couple of years, the company was losing money, and its new owner was at odds with the old one, which still uses the assets.

Pay is a big constraint in a cutthroat business. Even so, Supers have encouraged their managers to explore a variety of investment strategies. With Australian pension funds on track to climb to second from fourth-most such assets worldwide by 2030, there will be no shortage of opportunities to pursue. Their weaknesses are becoming clearer, however, and the trick will be to either address them or invest accordingly.

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