The average return for Industry Super Funds was -3.1% decline for the year. Given what has occurred in the past six months for listed equity and bond markets, it’s actually a good result, almost too good to be true. In fact, it may well be too good to be true.
The MSCI global index, which measures the performance of stocks in 47 countries, plunged 20.6 per cent in the June half. That’s the worst performance since the measure was established in 1990. Small to mid-sized companies fell even more.
Technology stocks have been among the hardest hit, with many of the big American names down by more than 30% and some fell double that. Netflix had fallen by a massive 72% at its low point in mid-June and cryptocurrencies were down a whopping 61 per cent.
Bonds were not immune either. The most heavily traded global bond (which also happens to be the global interest rate benchmark) is the US government 10-year bond. It’s just notched up its worst performance since 1788.
So why have Industry Super Funds held up so well?
That’s where the magic of valuations enters the equation. Assets that are actively traded on open markets like listed property, stocks and bonds are easy to value. The prices change daily as buyers and sellers battle it out and it is easy to put a number on their worth.
But Industry Super Funds have large investments in assets and companies that aren’t listed or traded out in the open. And so, valuing them becomes an arbitrary process – a matter of opinion.
These behemoths, after vacuuming up a large chunk of the world’s available infrastructure, also began to look at a whole range of other assets such as direct property, unlisted companies, new ventures and a range of alternative assets managed by what’s known as hedge funds and venture capital firms.
Many of Australia’s largest Industry super funds have tipped around a quarter of member’s cash into these unlisted and alternative investments. This is not typical for the average “Balanced” fund managed by a financial adviser.
As most of these investments are not listed on public markets, their values are deemed to be stable. And that’s where the logic begins to blur. For if the unit prices of listed property trusts and listed companies collapse, shouldn’t it make sense that there be a corresponding downturn in the value of unlisted property and unlisted companies?
Let’s see how this magic works
For the past few years, Melanie Perkins, Cliff Obrecht and Cameron Adams have been feted as the young lions of Australian business.
In a little over a decade, the online graphic design outfit they created, Canva, has become a global phenomenon with claims it had built a customer base of more than 75 million in 190 countries — a feat that catapulted them into the rich lists.
The company isn’t listed on public stock exchanges. It instead has funded its growth by raising money from private investors, including our large Industry Super Funds.
In September last year, some Canva investors said its value had doubled in just a few months to a whopping $58 billion, making it worth more than Telstra. In the wake of Wall Street’s tech wreck this year, however, that has plunged. The problem is that no one can agree on just how far its value has fallen. Some say it’s now worth $25 billion, others say it’s worth more. Another investment firm, Franklin Templeton, publicly slashed the value of its stake in the company. Others haven’t or, if they have, are keeping quiet.
Two of the largest Industry Super funds, Hostplus and Aware, will not reveal their valuations. But it appears Hostplus has outsiders running the ruler over its unlisted investments – of which there are several thousand – while Aware values them internally. This places an opaque veil over a large slab of Industry Super fund performance.
Now you might ask – wouldn’t there be a conflict of interest to value the assets you manage on behalf of others internally? Imagine the back-lash if financial advisers were able to value client’s assets internally.
It is that lack of transparency that should have regulators concerned.
How to inflate your performance – and your ego
That begs the question. How much of the gains and losses in Industry Super funds are plucked from thin air?
One of the easiest ways for venture capital firms to talk up their book is to tip in, say, $10 million for a 10 per cent stake in a start-up. A few months later, if everything is going well, it may opt to inject more money. This time, however, it might invest $10 million for just a 5 per cent stake.
Why would you do that? It sounds like you’re short-changing yourself.
Well, no. Not if you look at it in reverse. Rather than say it has received only half the shares for the same amount of cash, the venture capital group instead says that its original investment has doubled. It’s earned itself a 100% return on that first tranche.
The investors in its funds, including our Industry Super funds, are ecstatic! A couple of months later, it does the same. And so on. Ever greater profits, all miraculously achieved through a multi-billion dollar thimble and pea trick.
What happens, however, when things turn sour?
The answer is, we don’t know. But perhaps it’s time we did.