Unlisted assets in super: Is your fund handling the risks?

Funds need good governance to ensure there is equity between fund members.

Some Australian funds have significant percentages of their retirement savings invested in unlisted assets. 

Unlisted assets are investments which aren’t listed on a traditional exchange (e.g. the Australian Securities Exchange). 

The main types of unlisted assets super funds invest in are:

• infrastructure (e.g. toll roads, airports)
• property (commercial, residential)
• private equity (investments in private companies)
• private credit (also known as direct or private lending).

Super funds say they invest in these assets for a number of reasons, including:

• a view that they’re less volatile than shares
• portfolio diversity
• the possibility of achieving better risk-adjusted returns than other asset types
• a view that the trend towards long-term ownership of these assets ties in with the long-term goals of super.

Accessible version

What are unlisted assets in super?

This is an asset class which includes any investments that are not listed on a traditional exchange such as the Australian Stock Exchange (ASX).

It can include:

– Infrastructure
– Property
– Private credit
– Private equity

Notes: Infrastructure can include toll roads, airports, bridges, etc. Property is both residential and commercial (e.g. shopping centre, office block). Example of private equity = shares in a start-up company.

Potential for ‘liquidity mismatch’

In an actively traded market, like a stock exchange, people are buying and selling stocks every second. This allows you to put a value on a company at any given time. 

A super fund can use this information to update the value of your superannuation balance. By contrast, unlisted assets might be bought and held for years or even decades. This means a super fund needs to place a value on the company, so the fund can keep track of how much you own. 

Funds often undertake quarterly valuations of the unlisted assets they hold. However, fund members can often buy or sell on a daily basis. This can create a mismatch between the price paid and the value of the asset – this is known as a ‘liquidity mismatch’.

“Nobody is saying funds shouldn’t invest in unlisted assets, it’s about getting the governance right to ensure there is equity between all fund members”Super Consumers Australia director, Xavier O’Halloran

A good example is the value of an unlisted asset like an airport during the global pandemic. The closure of borders would have seen the value of airports plummet overnight, while the super fund might take months to revalue the asset. 

When a fund pays out some members at what turns out to be an inflated price for their share of the unlisted assets, do the losses fall with the members who stayed put? 

“Nobody is saying funds shouldn’t invest in unlisted assets,” says Super Consumers Australia director Xavier O’Halloran.

“It’s about getting the governance right to ensure there is equity between all fund members.”

How funds can address these mismatches

Given the potential problem stems from the difference between how often the unlisted assets are valued and how often they can be traded (by super fund members), it follows that the problem could be addressed by either:

• changing how often they’re valued, or
• changing how often members can switch options.

In theory, funds could value these assets much more frequently but this would increase investment costs and would run up against the problem that these assets are infrequently traded.

Super Consumers Australia contacted the biggest super funds (by membership number) who have significant (direct) investment in this asset class. 

Sunsuper failed to respond.

The remaining funds provided various levels of detail on how they deal with these issues.

Australian Super said it has a “prudent process” in place to ensure equity between members and that “the cornerstone of the process is using independent valuations”, but didn’t directly address liquidity mismatches.

What are funds doing with valuations?

Some funds increased the frequency of revaluations of their unlisted assets in light of the market disruption caused by COVID-19.

HESTA, for instance, revalued its unlisted assets on a weekly basis from March to June to try to achieve equity across its membership base.

Aware Super noted that while its unlisted assets are usually done quarterly, they can also be revalued on an ad-hoc basis when circumstances change. These circumstances can range from global crises to changes to the business surrounding the assets or changes in values of similar assets.

What are funds doing on frequency of option switching? 

Funds could also review how often members can switch options.

They’ve generally been reluctant to move away from offering daily switches. A Hostplus spokesperson told Super Consumers Australia that daily switching “has a significant positive impact” and that it “allows for increased transparency and immediacy when it comes to account values and investment switching”. 

The fund also said it “monitors investment markets closely to ensure that the pricing of our unlisted assets remains appropriate … and to ensure that all assets’ values reflect ‘fair value’ across all member balances.”

Experts say that offering daily liquidity access to options invested in more illiquid assets has its risks.

“By providing greater liquidity access to your membership, really what you’re doing is cross-subsidising one cohort of members, the more active trading cohort (against) the long-term investing cohort,” says David Bell, executive director of The Conexus Institute.

Super Consumers Australia director Xavier O’Halloran says funds need to be vigilant on the issue.

“That kind of practice has all of the damaging impacts of insider trading”

Super Consumers Australia director Xavier O’Halloran 

“What we don’t want is for the bulk of members who are investing their super for the long-term to be acting as a bank, cross-subsidising a small group of people who are taking advantage of delays in pricing information.”

“That kind of practice has all of the damaging impacts of insider trading.” 

University of Queensland honorary senior fellow Dr Rand Low says that super funds “should already be analysing redemption frequency and investor behaviour in their attempt to address the asset-liability conundrum.”

He says this is more imperative when the economy contracts and more people switch their super out of these single sector options invested in unlisted assets. 

This is analogous to a bank run, Low continues, so super funds could stress-test their portfolios in much the same way that US banks are required to do to show they are equipped to deal with different scenarios. 

“As part of their internal governance and risk management structures, one would hope that super funds consider adopting a similar approach,” says Low.    

Unlisted assets and quality of portfolio

In addition to the unit pricing equity, funds may have to spend money to rebalance their portfolio after members switch out of an option.

For instance, a fund may have to quickly sell an unlisted asset at a ‘fire sale’ price to pay the members who are switching out. It may also need to be reworked to conform to the asset allocation the fund wants for its portfolio.

“These are really complex challenges,” says Bell. 

“All those costs are borne by your remaining members in the fund and if you’ve made that decision to exit, you’re getting that benefit.”

Single sector options

As David Bell explains, the potential for unit pricing inequity is more pronounced when funds offer single-sector unlisted asset options. 

Some funds have diversified their property options in an attempt to counter these issues.

HESTA, for example, has combined its property and infrastructure options. HESTA CIO Sonya Sawtell-Rickson told us this option also has a 10% allocation into cash, “so it’s not solely comprised of illiquid assets”.

Similarly, Aware Super’s property option is mostly invested in liquid securities. All the fund’s options have a maximum allowable allocation to unlisted assets to manage liquidity demands and potential cross-subsidisation.

Bell believes it’s very difficult to formulate useful industry-wide rules on unlisted assets; the better approach, he continues, may be to ensure funds have a sound framework to tackle these issues.

Insider trading type activity

Another potential problem with unlisted assets is that staff inside funds with knowledge of these revaluations could use this information to their own financial gain.

“Funds have now identified activity and some can outline integrity measures,” says MP Tim Wilson, the chair of the house of representatives’ Standing Committee on Economics.

“It is clear that there is a role for the regulators to investigate, particularly because of the potential of executives and trustees to take advantage of arbitrage of the delay in revaluing unlisted assets.”

Staff with knowledge of these revaluations could use this information to their own financial gain

Bell says it would be a “terrible breach of governance” for such activity to occur at super funds.

“Good practice would be to ensure there is a ‘trading zone’ when staff are allowed to trade in these illiquid assets and when they’re not.”

Of the funds that spoke to Super Consumers Australia, Aware Super provided the most detail on their policy in this area. Staff at that fund who have access to ‘material non-public information’ need to gain approval for personal trades and investment switches.

Low says funds need structures in place to restrict or monitor sales for a set period after material internal corporate events that are likely to impact the market prices or valuations of assets occur.