Merger talk at QSuper-Sunsuper could mean a chill for managers

News that two of Australia's largest superannuation funds could combine to forge a new industry leader points to a pickup in industry consolidation and the prospect of evermore challenging conditions Down Under for money managers.

Market veterans said Brisbane-based heavyweights QSuper, with A$113 billion ($77.1 billion) in assets under management, and Sunsuper, with more than A$70 billion, have been discussing a tie-up now for more than three months.

In a Nov. 4 news release, the two funds confirmed "preliminary, non-binding discussions about a possible partnership," driven by their "absolute responsibility" to act in the best interests of members.

David Fagan, a spokesman for QSuper, declined further comment. Sunsuper spokeswoman Catherine Hughes didn't respond to repeated calls.

The QSuper-Sunsuper news comes as Australian regulators have been pushing for industry consolidation, leaving super funds facing "a lot of heat" to merge, noted Alex Dunnin, executive director, research and compliance, with Rainmaker Group, a Sydney-based financial research and publishing firm.

For example, a Productivity Commission report in January on the efficiency and the competitiveness of Australia's superannuation system concluded that "evidence of economies of scale is compelling" and even with the ranks of institutional super funds dropping to 217 from 650 in just over a decade, "significant unrealized economies of scale remain." Institutional superannuation funds hold more than A$1.8 trillion in assets.

In recent years, mergers have more often than not involved smaller funds.

The current year has seen funds in the A$10 billion range combining or considering doing so. In May, A$16 billion Equip Super merged with A$9.7 billion Catholic Super. In July, A$13 billion MTAA Super and A$9.5 billion Tasplan Super signed a memorandum of understanding to explore a merger. And in September, Hostplus Super, a A$42 billion fund, absorbed Club Super, a smaller fund with A$600 million in assets.

In July, meanwhile, two big players — First State Super, a A$96 billion fund, and VicSuper, a fund of A$23 billion — agreed to merge by mid-2020 to form a A$120 billion heavyweight, subject to due diligence. If consummated, the combined entity would cement its status as runner-up to Melbourne-based AustralianSuper's more than A$170 billion in assets.

A QSuper-Sunsuper partnership would have a more dramatic impact on Australia's super rankings.

Should the two funds combine, it would create a "colossus" with A$180 billion, topping the current industry leader, Mr. Dunnin noted.

One Asia-Pacific money management executive based in Hong Kong, who declined to be named, expressed "surprise" that funds as large as QSuper and Sunsuper would feel the need to merge, noting that "economies of scale" eventually have to be weighed against the challenges the combined entity would face in delivering alpha with close to A$200 billion in assets.

Kate Farrar, CEO of LGIAsuper, a A$13 billion, Brisbane-based super fund, in a telephone interview cited her team's strategy of remaining nimble enough to take advantage of midmarket investment opportunities as one reason her fund has dfecided not to jump on the merger bandwagon.

Still, a number of industry veterans said they see ample room for QSuper and Sunsuper to benefit from combining.

"Economies of scale are still available," even when both parties to a merger are big funds in their own right, said Melissa Birks, head of advocacy at the Australian Institute of Superannuation Trustees, a Melbourne-based organization representing the A$1.4 trillion non-profit segment of the country's superannuation industry.

Increased size would allow the merged entity to have more influence in accessing and negotiating investments; reduce fees and costs; and provide improved member services and product offerings, she said.

A QSuper-Sunsuper combination could prove to be a "great move," capable of delivering tremendous value for members, agreed Josef Pilger, Sydney-based partner and global pension and retirement leader with Ernst & Young.

Mr. Pilger predicted a fund as large as A$500 billion could be seen soon. "As 'super' commoditizes, scale is key," he said.

Rainmaker's Mr. Dunnin said the QSuper-Sunsuper news suggests momentum for consolidation is building fast.

In some respects, the two aren't obvious partners, he said. QSuper is a public-sector fund, with a chunk of defined benefit assets, while Sunsuper is a private-sector fund focused on defined contribution, he noted.

The fact that these funds "are even considering a merger shows that the race is on," Mr. Dunnin said. And increasingly, the thinking may be "if you want to merge you better get in before the cool dance partners are taken," he added.

A February report by KPMG's Australian office contended the pace of super consolidation is picking up sharply now and predicted the ranks of non-profit "industry" funds, such as Sunsuper, will drop to 12 over the coming decade from 38 at present, while the number of non-profit public-sector funds, such as QSuper, will decline to 15 from 37 over the same period. Corporate super funds, meanwhile, will plunge even more, to six from 24, while the number of for-profit retail super funds will tumble to 52 from 118, KPMG asserted.

A decade from now there could be between nine and 12 "mega" industry funds garnering 85% of what should continue to be sizable net system inflows, predicted David Bardsley, a Melbourne-based KPMG Australia partner who worked on the report.

Mandatory employer contributions of 9.5% of employee salaries and potential investment gains should leave super funds in Australia on track to double every four to six years. Mergers would accelerate that growth, and if a bigger-is-better mentality drove combinations in the past, the process of assessing partners has become a lot more sophisticated in recent years, Mr. Bardsley said. Partnering with funds that have strengths in growth sectors, such as aged care or education, is a focus now, he noted. Elsewhere, a fund with an exceptional investment track record could partner with another that has strengths in distribution or member services, he said.

Money management executives say that anticipated pickup in the pace of consolidation will result in considerable headwinds for their businesses.

Bigger superannuation funds will have more scope to bring management of their assets in-house and drive harder bargains on fees for whatever they continue to award as mandates to external managers, noted the head of institutional sales in the region for one global manager based in Singapore.

And with the continued move by asset owners to winnow the ranks of the asset managers they work with, success in building partnerships with those clients — forging broad relationships covering a range of services as opposed to relationships built around product sales — increasingly will be key to surfing those consolidation waves, he said.

Another money management executive, who likewise declined to be named, predicted careers like his focused on institutional sales in Australia will increasingly give way to broader remits, covering high-net-worth investors, private banks and retail products along with institutional.