Challenges Faced by Australian Superannuation Funds Shifting to an Insourced Investment Team Model

By Nick Hurley, CFA, MBA

Challenges Faced by Australian Superannuation Funds Shifting to an Insourced Investment Team Model

Introduction

The Australian superannuation landscape has witnessed a significant shift in recent years, with a growing number of funds considering or adopting an insourced investment team model. While this approach offers potential benefits, such as increased control and potentially lower costs, it is not without its challenges. This article explores the problems Australian superannuation funds face when transitioning to an insourced investment team model.

Reluctance to terminate underperforming internal managers

Terminating underperforming managers poses a significant challenge for superannuation funds, especially considering the prevalent influence of unions in the management of industry super funds. These unions actively promote job security, which can create a cultural barrier to making difficult decisions regarding underperforming team members. The emphasis on job stability can lead to a reluctance to take necessary steps to address performance issues within an internal investment team. Insourcing may demand a significant cultural shift at the highest echelons of the organisation, including the board, particularly as it may require a shift in mindset towards a more performance-driven approach, prioritising the fund’s overall financial health and the interests of its members above all else. Balancing job security with the imperative to deliver strong investment returns is a delicate and critical aspect of successfully implementing an insourced investment team model within the Australian superannuation landscape.

Infrastructure Requirements and Oversight

One of the key challenges faced by superannuation funds when shifting to an insourced investment team model is the need for a robust supporting infrastructure. Internal teams require access to the same trading, compliance, technology, and back-office support systems that external managers have refined over years. This infrastructure is expensive to set up and can become costly for investors if not executed well. Trustees must carefully oversee this process, ensuring that the necessary resources and expertise are in place to effectively manage the fund’s investments.

Lack of Contractual Protections

When funds rely on external managers, they benefit from contractual protections that safeguard against potential losses resulting from large trading errors. However, with an insourced model, these contractual safeguards no longer exist. In the event of a significant trading error, the fund will be reliant on its own insurances or reserves to compensate for any losses incurred. This heightened risk requires vigilant risk management and a thorough understanding of potential vulnerabilities within the internal investment team.

Reduced Economies of Scale

Shifting to an insourced investment team model may lead to fewer economies of scale for certain fixed costs, including general management, compliance, risk management, and corporate actions. External managers often manage multiple funds, allowing them to spread these costs across a larger asset base. In contrast, internal teams may face higher per-unit costs, potentially impacting the overall cost efficiency of the fund.

Confirmation Bias and Sunk Cost Bias

Boards of super funds may be susceptible to confirmation bias and sunk cost bias when evaluating the performance of internal investment teams. Confirmation bias can lead to a tendency to seek out information that supports pre-existing beliefs, potentially overlooking signs of underperformance. Sunk cost bias may make it difficult for boards to acknowledge and act on poor investment management performance, as the investment in establishing and maintaining the internal team may create a reluctance to consider alternative approaches.

Conclusion

While transitioning to an insourced investment team model can offer benefits in terms of increased control and potential cost savings, it is essential to acknowledge and address the challenges that come with this shift. From infrastructure requirements and oversight to cultural transformation and potential biases, superannuation funds must carefully navigate these complexities to ensure the success of their insourced investment approach. By proactively addressing these challenges, funds can position themselves to effectively manage their investments and ultimately deliver better outcomes for their members.

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