for all those who love industry funds read this warning from Alan Kohler, MTAA comes to mind.... Business Spectator - Breaking Business News, Commentary & All Day Analysis Super fund whiplash Super fund returns have been bad lately, right? Wrong. They have been fabulous – so good, in fact, that they are actually an illusion. Australia’s super fund managers are the Wizards of Oz, quaking behind a curtain of unlisted asset valuations and waiting for Dorothy to pull the curtain aside and expose their pitiful reality. In fact super performances could be worse this year than the sharemarket, which is the reverse of what happened in 2008 when super funds on average outperformed the sharemarket by more than 50 per cent. If the sharemarket is steady this year or even goes up, and published super fund returns fall heavily – which is entirely possible, even likely – it will be an absolute disaster for the industry … and the government. After all, super is mandatory in this country. So far super funds have been a refuge from the horrors of the sharemarket for which politicians can take credit, but that will change in 2009 because their diversification into unlisted assets over the past decade will start to work against them. Those in the superannuation business talk about little else these days. It’s simply because investments in direct property, direct infrastructure, hedge funds, and private equity are valued only periodically, often just once a year. What’s more, market valuations are not used, but rather discounted cash flows and net present value of income flows using capitalisation rates. The future cash and income flows are little more than a guess these days, and capitalisation rates are moving sharply against the funds. So it is imperative that super fund members get out while they can. The risk of staying in a superannuation default fund is now incredibly high. If you can cash your fund in, do so; if it’s too early to retire, then switch to a 100 per cent listed option within the fund. You will be overpaid by at least 10 per cent for your default fund units and make an instant profit of that amount. The listed versions of the funds’ unlisted assets have all collapsed in value, but in many cases the unlisted valuations reflected in the value of the core fund have not moved or even in some cases gone up. This is about to catch up with the funds in a big way. The super funds’ median return in January was -1.85 per cent according to SuperRatings, and for the year to January 31 it was -17.68 per cent, even though Australian shares were down 5 per cent in the month and 37 per cent in year. The MSCI global index fell 40 per cent. This was generally reported as being dreadful and a cause for despondency and alarm, but in fact it was spectacularly good and normally there would be high fives around the super funds’ offices when such results were published. But there are no high fives, only fear, because every super fund CEO and chief investment officer knows what’s buried inside their funds and they know what’s coming at them this year. The allocations to unlisted assets varies widely of course, but a typical fund is roughly as follows: Australian direct property 7 per cent; international direct property, 5 per cent; international infrastructure 7 per cent; Australian infrastructure 5 per cent; absolute return hedge funds (growth) 3 per cent; absolute return hedge funds (defensive) 3 per cent; international private equity, 3 per cent; Australian private equity, 1 per cent. The usual practice is to value a quarter of these portfolios each quarter, which means each asset is valued once a year. However the two big industry fund vehicles – Industry Super Property Trust (ISPT) and Industry Funds Management (IFM) – revalue their entire portfolios every quarter. The valuations are usually done by the major accounting firms, and audited by another one of them once a year in July. In the December quarter, the $6.8 billion ISPT core fund suffered a fall of $370 million, or 5.4 per cent for the quarter, which seems to have been the first decline. IFM’s Australian book was reduced by 5 per cent in the December quarter and its offshore assets by 10 per cent. Listed property trusts have fallen at least 50 per cent. In many cases listed infrastructure funds have dropped by much more than 50 per cent. So are the listed funds undervalued or are the unlisted funds overvalued? And then there are the hedge funds and private equity funds, as well as the super funds’ own direct property and infrastructure (not via ISPT and IFM). In many cases, geared hedge and private equity funds are now worthless because underlying asset values have fallen 50 per cent behind a 60 per cent gearing ratio. Many of these will only hit the super funds’ core fund valuations on June 30 this year, when the unlisted portfolios are valued and audited. I repeat: get out while you can.