Superannuation fund governance: An interpretation

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Recent Regulatory Research Initiatives
Like many countries around the world, the
Australian pension (superannuation) system is a critical part
of the national economy, particularly for funding the retirement
of an aging population. It is projected (Rothman, 2007) that by
2046 only 35 percent of retirees will totally depend on pensions
provided directly by government revenue. The rest will rely
partially or entirely on individual pensions that are self-funded
(with tax subsidy) through the Australian pension system.
As an institutional pension regulator, the Australian Prudential
Regulation Authority (APRA) has undertaken considerable
research and statistical analysis over time in the pension industry.
In recent years, it has become increasingly evident (Coleman
et al., 2006, APRA, 2007) that retail funds earn about 2 percent
a year less than other institutional funds on average over a ten
year period. Similar observations have been made in the United
Kingdom for retail unit trusts (Sadler, 2002) and in the United
States for mutual funds relative to defined benefit pension
funds (Bauer and Frehen, 2008 and Bauer and Kicken, 2008).
In 2006, APRA conducted a pension governance survey
to study trustee policies and practices, and an investment
performance survey of the largest funds representing 85 percent
of institutional pension assets. The surveys, meant to examine
trustee practices and identify factors that could influence
investment performance, were compulsory for all the funds
with assets greater than AU$200 million in June 2005. They
followed an initial pilot study and received input from industry
representative bodies and other government agencies. The
final surveys were streamlined with data validation to enable
trustees to efficiently provide a significant amount of useful
information.
APRArecently published comprehensive reports on its statistical
findings (APRA, 2007 and Sy et al., 2008), with the fund
governance survey coverage shown in Table 1.Acomplementary
report on the investment performance survey will be published
at a later date. APRA classifies superannuation into four major
types or sectors: corporate, public sector, industry and retail.
Their findings revealed that in some areas of pension governance,
there was little difference between sectors, but in other areas,
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P e n s i o n G o v e r n a n c e i n A u s t r a l i a :
A n A n a t o m y a n d a n I n t e r p r e t a t i o n
The Australian pension system is evolving, driven by changing regulation, financial
innovation and changing political climates. This article offers a snapshot of its current
trustee policies and practices and shows that industry funds and retail funds have
different historical origins, leading to different governance practices. One example
is the task of portfolio construction involving asset allocation and manager selection.
Many retail trustees within commercial conglomerate structures have passed the
portfolio construction task to related service providers, increasing services and fees
for fund members, whereas the portfolio construction task is an integral part of the
service provided by industry funds themselves. Another example is the negotiation
of investment management fees. Industry funds and their trustees do not appear
to have the same level of conflict of interest in negotiating best possible terms for
investment management services for their funds. Unlike most industry funds, many
retail funds have high recognition due to their associations with reputable brand-
name conglomerates and due to their history of easy access by the general public
for managed investment products. They offer a sense of stability and security that
is attractive to many investors. The article concludes that all funds should have
default options tied to a few low-cost, well-diversified portfolios.
Rotman International Journal
of Pension Management
Wilson Sy
Volume 1 •Issue 1
Fall 2008
Wilson Sy is Principal
Researcher at the
Australian Prudential
Regulation Authority.

there were statistically significant differences between retail
and the other sectors.
Before discussing the survey findings, this article1explains how
different fund types originated and developed historically. It
identifies two distinct models of pension fund governance with
one based on non-profit trustees taking more direct responsibility
in portfolio construction for pension beneficiaries in their funds,
and the other based on for-profit retail trustees passing the
portfolio construction task to related service providers in
conglomerate structures. We then show how this interpretation
provides an explanation for the observed differences in pension
governance between retail and the other sectors.
Next, we discuss the existence of multiple conflicts of interest
faced by retail funds. Unlike non-retail trustees who should
negotiate the optimal fees for investment management services
for their funds, retail trustees who have investment managers
as executive directors on their Boards have impaired incentive
to similarly negotiate the fees paid for investment management.
We close by summarizing our interpretation of the main findings
from the survey data on Australian pension governance, indicating
what can be done to improve the Australian pension system.
From Employer Funds to Market Funds
Superannuation began in 1862 with the establishment of a
defined benefit pension fund for the employees of the Bank of
New South Wales (Dunnin, 2008). For the next 100 years, the
pension industry remained structurally unchanged, consisting
of defined benefit pension funds for some employees in parts
of the corporate sector and a few decades later, for civil servants
in the public sector (ComSuper, 2008). This period coincided
with strong trade unions and a strong belief in governments
providing social welfare in many parts of the world. The
institutional model, where trustees have the fiduciary duty
to act in the interest of beneficiaries in providing defined
benefit pensions was in harmony with the prevailing social
ideals. The situation was similar in other parts of the world
such as in the United Kingdom. (Myners, 2001).
Major shifts in public policy during the Cold War had far-reaching
significance for the global financial markets (Greenspan, 2007).
Big governments and large budget deficits ceased to be acceptable
from the mid 1970s and governments began to curb the power
of organized labour unions, starting with Margaret Thatcher in
Great Britain. She was joined by Ronald Reagan in the United
States in the 1980s in a major political shift to free-market
capitalism. This period also saw the rise of professional fund
managers armed with new theories of investment and financial
markets (Mees et al., 2005) and a transition from an employer-
dominated defined benefit institutional model to a defined
contribution market model for the pension industry. The Wallis
(1997) inquiry into the Australian financial system recognized
the changed financial landscape, with increased competition,
globalization, conglomeration and a shift from institutional
intermediation to one based on markets.
Over the transition period, pension assets were progressively
shifting from all-in-house management by corporate and
public sector trustees to management by new professional
fund managers on a wholesale and commercial basis through
Pooled Superannuation Trusts (PST), which hold the assets
on behalf of pension funds as beneficiaries. This trust structure
was also used in the 1980s by the same fund managers to offer
managed investments for individuals as retail unit trusts in
competition with the investment services offered traditionally
by stockbrokers. Australian retail unit trusts are the equivalents
of UK unit trusts or US mutual funds invented in earlier
decades (Mees et al., 2005).
Income from distributions and capital gains of retail unit trusts
(collective investments) are passed through and taxed in the
hands of individuals at marginal tax rates. When the retail unit
trust structure was used to set up retail superannuation trusts
starting in late 1980s, tax was then paid at concessional rates
by the trusts themselves. When universal superannuation
arrived in Australia in 1992, this structure provided a vehicle
for contract workers, temporary employees, small businesses
and the self-employed to save for their own retirement.
These public-offer pension funds, though nominally mutual,
have offered their pension products to the public at large on a
commercial basis. Their products were mainly used for wealth
accumulation and their trusts were mainly vehicles for holding
assets in trust. This was the origin of defined contribution
(accumulation) pension funds in the retail sector. The Wallis
Inquiry (1997) into the Australian financial system provided
explicit recognition of this connection in promoting efficiency
with recommendation 89: “Regulation of collective investments
and public offer superannuation should be harmonized”. These
retail pension funds as collective investments are similar to
US mutual funds for investors in the 401(k) plans, with the
main difference being tax treatments.
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Survey Statistics Total
Number of funds 187
Total assets (AU$ billion) 513
Number of member accounts (millions) 20
Number of directors 1319
Number of service providers 2575
Source: Sy et al, 2008
Table 1: Survey Coverage

32 Volu me 1 •Iss ue 1 •Fal l 20 08
Pension in the retail sector represents a market model of pension
management, where pension investors can shop around for a
broad array of pension products (Dunnin, 2004) in an open
competitive market. The implicit assumption of the market model
is that market discipline from competition will lead to cheaper
products with better risk return characteristics that individuals
can choose to suit their own circumstances. The pension trustee
is, in many cases, a coordinator of administration, custody
and investment of pension assets, with substantially reduced
fiduciary duty in investment management.
The Advent of Industry Funds
The 1970s and early 1980s were periods of high inflation and
the power of labour unions was in decline. Starting in 1983,
the ACTU (Australian Council of Trade Unions) and the
former Labour Government (Keating, 2007) agreed on the
need to break the nexus between wage increases and inflation.
Instead of spending wage increases immediately, possibly
fuelling higher inflation, they were to be saved as universal,
fully-vested superannuation. The establishment of industry
funds was part of the negotiated remuneration compromise
accepted by weakening trade unions. The industry funds
were non-profit organizations set up to accept and manage
superannuation from wage awards of ordinary workers
belonging to defined industry sectors.
Initially, fund membership was restricted to select industries,
but over time, many (now about half) have become public-offer
funds accepting employees from all industries. The structure of
Trustee Boards of industry funds reflects their historical origin,
with substantial stakeholder representations. The concept of a
fiduciary duty to act in the best interest of beneficiaries under
the trust law of the Superannuation Industry (Supervision)
Act 1993 (SIS Act), in relation to investment management,
was particularly relevant for industry funds, with its mutuality
origin. The trustees typically sought professional advice from
asset consultants and outsourced most functions to service
providers, including professional investment managers.
By the 1980s, it was evident that lifetime employment was
becoming rarer in the new era of free-market capitalism,
where hiring, firing and job-hopping were more frequent.
Most people expected to be employed by several employers
in their working lives and this job mobility made defined
benefit plans administratively complex. The preference
was for pension portability where workers could take their
superannuation benefits with them from one employer to
the next. Industry funds were set up from the start as defined
contribution (accumulation) funds. The Superannuation
Choice legislation in 2005 generally requires employers to
allow employees to have freedom of choice in their pension
funds. Employees are able to shop for pension products from
any number of public-offer funds in a “market” that now has
suppliers from the industry sector as well as the retail sector.
The Australian Pension System Today
As compared with 1982, when 82 percent of memberships
were in Australian defined benefit funds (APRA, 2007) at the
time of the 2006 survey, Figure 1 indicates that 70 percent of
20 million member accounts were in purely defined contribution
funds. Only 2 percent were in purely defined benefit funds and
28 percent were in hybrid funds, which offered either defined
benefit or defined contribution schemes. The hybrid funds of
the 2006 survey are defined benefit public sector funds and
corporate funds, where many are being closed or converted to
defined contribution funds or transferred to public-offer funds.
Australia saw cases where employees lost some or all of their
superannuation entitlements when their companies became
insolvent (Ferris, 2005). There were also cases with corporate
funds invested in company projects or in-house assets where
employees did not achieve satisfactory rates of return on their
pension investments. As awareness of the risk of under-funding
defined benefit liabilities grew, more and more public sector
and corporate funds ceased to offer defined benefit plans,
which are generally recognized as carrying higher financial
burdens than defined contribution plans. As of October 2004,
even new members of Parliament were no longer eligible to
be defined benefit members of the Parliamentary Contributory
Superannuation Scheme.
Rotman International Journal
of Pension Management
Volume 1 •Issue 1
Fall 2008
Source: Sy et al, 2008
Fig u re 1: M e mb e rsh i p Di s tri b ut i on by
Fund Type (June 2006)
Defined Contribution 70%
Defined Benefit 2%
Hybrid 28%

The migration of many smaller corporate funds to the retail
sector and to a lesser extent to the industry sector, was
accelerated by the Superannuation Choice legislation in 2005
and the introduction of Registrable Superannuation Entity
(RSE) licensing for pension trustees in June 2006. The costs
and increased sophistication associated with new requirements
of reporting, investment flexibility and portability favoured
larger operations with economies of scale. Figure 2 indicates
that, as compared with the early years of superannuation when
nearly all assets belonged to the public and corporate sector
funds, these two sectors contained only 19 percent of the total
Australian pensions asset (a combined AU$95 billion) in 2006.
The relative decline of the public and corporate sectors has
also been accompanied by a relative increase in public-offer
funds compared with non public-offer funds, due to greater
employment turnover and shifts between the sectors. In the
last couple of years, a few public sector funds have also
become public-offer funds. Between 2001 and 2007, public-
offer funds increased from 12 percent of APRA regulated
funds to 43 percent by number and increased from 58 percent
to 78 percent by asset value.
In contrast with some countries such as Finland, France, Korea
and Norway, where defined benefit pension still dominates
(OECD, 2007), the current trend in Australia is for regulated
funds to be increasingly dominated by public-offer defined
contribution funds in the industry and retail sectors in a
competitive market model of pension management. Industry
funds have non-profit trustees whereas retail funds have for-
profit trustees, which are often parts of financial conglomerates.
These differences and the history behind them are important
to understanding Australian pension fund governance policies
and practices. We now turn to the main findings from the
2006 APRA survey on these issues.
Ho w Ke y F u n d De ci si on s Are M ad e
Table 2 suggests that retail pension trustees see themselves mainly
as coordinators of activities such as administration, custody and
investment of the fund assets by various related companies in
their groups, rather than standalone providers of pension products.
Many of the directors are likely to be professional fund managers
providing investment and other financial services to the funds.
Since retail trustees see themselves as coordinators or organizers
of the creation of pension investment products, they tend to
leave most inputs to key decisions associated with investment
management to executives.
Tabl e 2 : Mai n S ou r c es o f I npu t t o Ke y
Decisions by Sector
Public
Key Decision Corporate Sector Industry Retail
Objectives and Trustee Consultant Trustee Executive
risk tolerance
Strategic asset Consultant Consultant Consultant Executive
allocation
Benchmark Consultant Consultant Consultant Executive
design
Investment Consultant Consultant Consultant Executive
manager selection
Performance Consultant Consultant Consultant Executive
monitoring
Introducing a Trustee Executive Trustee Executive
new fund option
Default option Trustee Consultant Consultant Executive
asset allocation
Asset consultant Trustee Trustee Trustee Executive
selection
Administrator Trustee Trustee Trustee Trustee
selection
Foreign exchange Consultant Consultant Consultant Executive
hedging policy
Source: Sy et al, 2008
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Source: Sy et al, 2008
Figure 2: Asset (AU$ billion) Distribution
by Sector (June 2006)
Public Sector 52
Corporate 43
Retail 268
Industry 150

Retail executives provide the main input to all key decisions of
retail funds, except for administrator selection, where trustees
provide the main input. Trustees in other sectors see investment
managers as service providers to be hired or fired based on advice
from asset consultants. As seen in Table 2, asset consultants
often have the main input to more than half of the key decisions
of corporate, public sector and industry funds including the
input to investment manager selection. The different approaches
to decision making can be understood from different historical
origins of the funds and they appear appropriate to the different
backgrounds of the trustee directors.
Service Provider Selection Practices
Most service providers (55 percent) in the survey are investment
managers. On average, industry funds and public sector funds use
23 and 21 service providers per fund, well ahead of corporate
funds that use an average of 12 service providers. Corporate
funds being typically smaller, often take an approach based
on combinations of two or more diversified portfolios, which
reduces the number of service providers used. Larger industry
and public sector funds typically use multiple investment
managers in separate asset classes, which increases the number
of service providers used. Retail funds are typically operated by
investment managers themselves, so they mainly employ only
non-investment service providers such as administrators and
custodians. With the exception of 26 retail funds that operate
as investment platforms and potentially use very large numbers
of investment managers, the remaining retail funds use an
average of seven service providers per fund.
Retail funds are much more likely to use service providers that
are related parties, as up to 66 percent of the funds by number
and 81 percent by asset value operate within broader financial
conglomerate structures. Typically, the provider is the parent
company of the trustee, or the provider and trustee have a
common parent company. Such relationships are found in the
survey in 39 percent of retail funds, 10 percent of corporate
funds and not in any of the other funds. The existence of such
relationships also increases the likelihood of associations of
service providers with Board directors.
Figure 3 shows that over 60 percent of retail directors have one
or more associations with service providers. This is more than
twice that of directors of corporate funds and about three times
that of public sector or industry funds. Many retail directors are
primarily employed by either their current funds or by service
providers to their funds and the proportions are substantially
higher than those in other sectors. This suggests that retail
directors are placed in situations of conflict of interest more
often directors in other sectors.
Figure 3: Percentages of Board Directors
with Primary Employer Being a Fund Service
Provider or the Current Fund (June 2006)
Trustee Board Practices as seen in Figures 3 and 4 indicate that,
consistent with a more limited investment role played by trustee
directors in the retail sector, the effort expended by retail directors
in running their funds is generally less than that of other sectors.
Not including subcommittee meetings, the total time spent
ranges from 559 director hours per fund per year for the average
retail fund to 1,364 director hours for the average Industry
fund. Retail directors with fewer investment duties also hold on
average seven other simultaneous directorships, well above the
average number simultaneous directorships held by directors of
other funds. The less time spent by retail trustees is consistent
with a greater reliance on executives (often the same directors)
doing their work outside the funds as related service providers.
In contrast, non-retail trustees generally spend time either
performing similar tasks themselves or reviewing work done
by external consultants.
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Public
Board Practice Corporate Sector Industry Retail
Average number of 7.8 7.1 8.8 5.0
directors per fund
Average number of Board 6.7 9.1 7.5 9.1
meetings per annum
Average hours per 3.9 4.4 4.8 2.4
Board meeting
Average number of 13.1 15.1 14.7 10.7
subcommittee meetings
per annum per fund
Average hours spent 69.0 123.0 119.0 90.0
per annum per director
outside Board meetings
Source: Sy et al, 2008
Tabl e 3 : Boa r d Pra c ti c e Dis t ri b uti o n by S e cto r
Source: Sy et al, 2008
Corporate
Public Sector
Industry
Retail
0 5 10 15 20 25 30 35 40 45 50 55 60 65
A Fund Service Provider Current Fund

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Fig u re 4: Av e rag e To ta l N u mb e r of D i rec t o r
Hours Spent Per Fund Per Year
From the way trustee structures were historically set up,
directors of corporate, public sector and industry funds are
largely (59 percent to 75 percent) drawn from stakeholders
such as employer sponsors and fund members, and to a lesser
extent (3 percent to 33 percent) from industrial unions and
government. In contrast, only 20 percent of retail directors
are drawn from particular stakeholders or official bodies, a
majority (66 percent) representing none of those parties.
Public sector funds have 97 percent of their directors appointed
from outside the Board by employer sponsors, fund members,
industrial unions, the government, or through executive search
firms. Industry and corporate funds follow at 88 percent and
76 percent, respectively. Only 19 percent of directors of retail
funds are appointed from outside the Board, with 4 percent
being elected by employer sponsors and 15 percent through
executive search firms. The remaining appointments are made
internally by the Board or through personal contacts.
Board remuneration of retail directors is typically double that
of directors in other sectors. Directors of corporate and retail
funds can receive substantial, regular payments (greater than
AU$ 200,000 on average) from service providers, who are
often primary employers of those directors. These payments
from service providers, being their primary employers, are
well in excess of similar payments to directors in other sectors,
whose Board positions are not their primary employment.
Directors of corporate, public sector and industry funds are
more likely (62 percent to 73 percent) to invest their personal
superannuation in their own funds than directors of retail funds
(21 percent). When these directors have personal stakes in
their funds, their investments as a percentage of their total
superannuation, are more substantial (71 percent to 92 percent)
than those of directors in retail funds (57 percent). Personal
stakes appear to matter in mutual funds governance in the
United States (Cremers et al., 2006).
Clearly, retail fund directors have more alternatives than others
to invest their personal superannuation, such as to invest in their
own corporate funds or to self-manage their own investments
(Sy, 2008), as they are typically fund managers. Among public-
offer funds, directors of industry funds are six times more
likely than directors of retail funds to have family members
in their funds.
The Mutual Fund Mutation
Many of the observed differences between retail and other
sectors can be explained by the differences in approach to
investment management. Non-retail pension funds are governed
by non-profit trustees who take a broad interpretation of
investment fiduciary duties as outlined in the SIS Act. Retail
pension funds are governed by for-profit trustees who oversee
fund managers and financial advisors selling pension fund
products in an open competitive commercial market. In
a similar discussion on mutual funds in America, Bogle
(2005) called this difference a mutation from stewardship
to salesmanship. What could be the cause of this mutation?
From a traditional corporate governance view, governance of
retail pension funds requires the management of multiple conflicts
of interest. The traditional corporate governance problem requires
the Board under the Corporations Act to mediate the conflict of
interests between the shareholders as principals and the executives
as agents, represented by the left side of the triangle in Figure
5. The traditional pension trustee governance context requires
the Board under the SIS Act to act in the best interest of the
members as principal in the oversight of executives as agent,
represented by the right side of the triangle in Figure 5.
Source: Sy et al, 2008
Corporate
Industry
Public Sector
Retail
0 200 400 600 800 1,000 1,200 1,400
Average hours spent per fund per year
COMPANY
& TRUSTEE
BOARDS
Executives
MembersShareholders
Figure 5: Triangular Conflicts of Interest for
Retail Pension Funds

In addition to principal-agent conflicts of interests, there is
a new principal-principal conflict for retail pension funds
represented by the bottom side of the triangle in Figure 5.
Retail trustee directors may be in a situation where they have
to decide whether company shareholder profits or whether
pension fund member benefits should have priority in the
direction of executive action. As Bogle (1999) pointed out
for directors of American mutual funds, in trying to serve
two masters, have tilted the balance of interest in favour of
company shareholders.
While company Boards and Trustee Boards of retail pension
funds are distinct entities, their historical origins and typical
compositions consisting of significant numbers of overlapping
executive directors make the distinction more theoretical than
real, particularly in many cases where the shareholders are
related entities or a parent company. In practice, conflicts are
resolved by retail trustees treating fund members like clients
or consumers in a pension product market, and could possibly
dilute the notion of trusteeship in favour of the notion of
product manager.
Unlike non-retail trustees who negotiate the best possible
terms for investment management services for their funds,
retail trustees with investment managers as executive directors
on their Boards have impaired incentive to negotiate best terms
for investment management services. Retail pension firms are
expected to maximize profit for company shareholders by
setting or accepting prices for pension products (including
managers’ fees) within a competitive market. This resolution
of multiple conflicts of interest does not imply that there is
any beach of regulation.
The retail approach to public offer superannuation based on
market products is consistent with the recommendations of
the Wallis Inquiry (1997) that envisions a close relationship
with collective investments. Wallis suggested a resolution of
the ambiguities between the roles of trustee and fund manager
by introducing the concept of a single responsible entity, which
was adopted in subsequent regulation.A number of overlapping
legislations in this area, such as the SIS Act 1993, the Financial
Services Reform Act 2001 and Superannuation Legislation
Amendment (Choice of Superannuation Funds) Act 2004,
has allowed ambiguities to remain in the interpretation (APRA,
2006) of the role of trustee, which needs further clarification
(Parliament of Australia, 2007). The legal issues for Australia
and similarities with legal issues for other countries such as
the United States and the United Kingdom have been recently
discussed by Donald (2008). We view these issues as originating
from a shift of the global financial system to one largely based
on market solutions that are not always fully consistent with
earlier systems based largely on institutional solutions.
The differences in governance structure in the Australian pension
system may also have parallels with observed differences in
manager behaviour between for-profit mutual funds and non-
profit pension funds in the United States (Del Guercio and
Tkac, 2002). The empirical relationships between fund flow
and investment performance suggest mutual fund managers
operate in fundamentally different environments from those
of the pension fund managers.
A Lo w- C os t De fa ul t Op ti on f or A l l
We have shown that the historical origins of various pension
arrangements are important when interpreting the main findings
of the 2006 survey of Australian pension governance structures
and practices. We have identified and highlighted an important
aspect of trustee practice that may explain the cost differences
between retail funds and non-retail funds. Most non-profit
trustees perform investment fiduciary duties including portfolio
construction, whereas for-profit trustees within conglomerate
structures in the retail sector mostly pass the portfolio construction
task to either related executive fund managers or related financial
advisors, or to individual pension investors themselves, which
introduces additional costs to members.
Regardless of the laws defining consumer expectations and
protection, portfolio construction is a worthwhile task for
trustees to perform in many cases, as it saves individual
fund members from the costs associated with making complex
investment decisions. Every defined contribution fund should
have a few low-cost diversified portfolios for most members
to choose as their default options, without having to make
complex investment decisions. Such decisions should only
be made by those members who have more complicated
financial needs and have matching financial sophistication,
resources and advice.
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Fall 2008

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Endnotes
1. The author thanks Keith Ambachtsheer, Charles Littrell, Keith Chapman,
Ramani Venkatramani, Antonios Alysandratos, Katrina Ellis, Belinda
Tracey, and Kevin Liu for helpful comments. However, the views and
analysis expressed in this paper are those of the author, and do not
necessarily reflect those of APRA or other staff.
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