Industry super funds have outperformed retail funds for eight of the past 10 years but, contrary to popular belief, it's not due to lower fees. The superior performance of industry funds boils down to their asset allocation mix. In other words, the proof is in the pudding, not the price tag.

A study by superannuation ratings group Chant West has found that total investment fees charged by industry funds and the underlying funds they invest in are actually slightly higher than those for retail funds.

Average investment fees for a representative sample of industry funds were 0.93 per cent, compared with 0.83 per cent for retail funds. The difference, albeit slender, can be explained by industry funds' greater reliance on unlisted alternative assets.

Management fees for direct property, hedge funds, private equity, infrastructure and other alternative assets tend to be higher than fees for traditional investments such as shares and listed property.

Adviser fees and commissions add 1.2 per cent on average to the total fees charged by retail funds, which makes retail funds more expensive in the hands of investors. However, Warren Chant of Chant West says it's up to investors to determine whether the advice they receive is value for money.

While some super industry observers put the difference in performance down to fees, Chant says others cite good governance as the deciding factor. They argue that industry funds draw their board members from outside and tend to outsource their investment decisions to independent consultants. Chant says there may be some truth in that argument but it's not sufficient.

"We believe [the difference in performance] comes down to investment beliefs," says Chant. Retail fund managers are reluctant to invest too heavily in unlisted assets in the belief that their members want the liquidity offered by listed investments so they can get their money back at a moment's notice if they choose.

Industry fund asset consultants JANA and Frontier have backed their belief that super funds should be prepared to make short-term tactical changes to their asset allocation strategies when sectors of the market become significantly over or undervalued.

The average balanced industry fund had 28 per cent of members' money allocated to alternative assets as at December last year, almost three times as much as the average retail fund at 10 per cent.

With the exception of hedge funds, valuations for unlisted alternative investments have held up relatively well in recent years, which has cushioned the impact of the global financial crisis on industry funds.

For example, listed property fell by 58 per cent in the year to March, while unlisted property fell by just 4.9 per cent. This is partly because listed property is more highly geared, has more overseas investments and greater property development exposure but that's only part of the explanation.

Unlisted assets are valued less frequently so their valuations do not yet reflect substantial falls in asset values over the past 12 months. The spectre of major asset devaluations worries many investors and their advisers. Chant says he has received queries from some of the group's 5000 adviser clients asking why he wasn't downgrading his ratings of industry funds.

So Chant West modelled projected returns for the June quarter, assuming a worst-case scenario where the value of a typical mix of direct property, infrastructure and private equity investments falls 15 per cent, cash rises by 1 per cent and all other assets remain flat (see table below).

Under this scenario, industry fund returns would fall by 3 per cent, after investment fees and tax, compared with a 1 per cent fall for retail funds. However, industry funds would still beat their retail rivals over the full year to June, with a negative return of 17 per cent compared with negative 21 per cent for retail funds.

Given that the sharemarket has bounced back over the past three months, Chant West ran the numbers a second time with a 15 per cent devaluation of unlisted assets accompanied by a 15 per cent rise in listed investments.

This scenario favours retail funds, which have a higher exposure to shares and listed property (66 per cent versus 56 per cent for industry funds). Indeed, retail funds would return 9.3 per cent for the June quarter compared with 5.2 per cent for industry funds.

But even in this second scenario, industry funds would come out tops over the full year to June with a negative return of 10 per cent compared with a fall of 12.8 per cent for retail funds.

While asset revaluations will undoubtedly be a drag on industry funds' performance over the next six months or so and narrow the performance gap with retail funds, Chant says that's not a valid reason for dumping a fund that has performed well for a long time.

SUPER RETURNS ??? SHUFFLING THE ASSET DECK
                July 08- Mar09 (%)      June quarter (projected %)      2008/09 (projected %)   
SCENARIO 1*                     
Industry fund   -14.4           -3                      -17
Retail funds    -20.2           -1                      -21
Difference              5.8             -2                      4
SCENARIO 2*                     
Industry funds  -14.4           5.2                     -10
Retail funds    -20.2           9.3                     -12.8
Difference              5.8             -4.1                    2.8
*Scenario 1: Unlisted asset valuations -15% for June quarter ; cash +1% ; shares/other 0%
*Scenario 2: Unlisted asset valuations -15% for June quarter ; cash +1% ; shares/other +15%
All returns for balanced funds (61-80% growth assets) net of investment fees and tax
SOURCE: CHANT WEST