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Towards a national default option for low-cost superannuation

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  • Wilson Sy
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    Abstract

    Purpose – The purpose of this paper is to propose an approach to design a national default option to maximize retirement savings in defined contribution superannuation, using a proportionate shareholding approach (PSA) which minimizes total cost of investing for all investors. Design/methodology/approach – Through analytic modelling, the author shows how transaction costs in combination with size effects and agency incentives have limited the ability of professional managers to use arbitrage and active investment to create a price-efficient market. Statistical models show how investors would experience difficulties in understanding fund performances due to inherent noise in the data. The models suggest financial intermediation has created an information asymmetry which reduces the effectiveness of market competition to lower costs in superannuation. Findings – The authors find that the PSA is a collective optimal strategy and it is also an individual optimal strategy, because of the presence of informational inefficiency. Passive investing does not need commercial indices. PSA is more passive and flexible than standard indexing, and is fully-scalable and available to all investors. Research limitations/implications – Professional investment managers have not beaten the market, not because the market is efficient, but because it is inefficient due to a market failure to recognise and resolve principal-agent conflicts of interest. Practical implications – The proposed national default option has the potential to substantially increase national savings through low-cost superannuation. Originality/value – The paper provides a new rationale for passive investing based on the hypothesis of market inefficiency. It also provides the first formal proof of the “Cost matters theorem.” The proposed idea of a national default option will create a simple, understandable and cost-effective alternative for all workers and will also provide a performance benchmark to encourage the development of a more competitive and efficient superannuation market.

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    Bibliographic Info

    Article provided by Emerald Group Publishing in its journal Accounting Research Journal.

    Volume (Year): 22 (2009)
    Issue (Month): 1 (July)
    Pages: .46-67

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    Handle: RePEc:eme:arjpps:v:22:y:2009:i:1:p:46-67

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    Related research

    Keywords: Indexing; Investments; Pensions; Savings;

    References

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    1. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, American Finance Association, vol. 46(5), pages 1575-617, December.
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    11. Basu, Anup & Drew, Michael, 2006. "Appropriateness of Default Investment Options in Defined Contribution Plans: The Australian Evidence," MPRA Paper 3314, University Library of Munich, Germany, revised 02 Nov 2006.
    12. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, American Finance Association, vol. 7(1), pages 77-91, 03.
    13. Ross M. Miller, 2005. "Measuring the True Cost of Active Management by Mutual Funds," Finance, EconWPA 0506010, EconWPA, revised 08 Jul 2005.
    14. Brown, Kerry & Gallery, Gerry & Gallery, Natalie, 2002. "Informed Superannuation Choice: Constraints and Policy Resolutions," Economic Analysis and Policy (EAP), Queensland University of Technology (QUT), School of Economics and Finance, Queensland University of Technology (QUT), School of Economics and Finance, vol. 32(1), pages 71-90, March.
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