Should super funds lend directly to businesses?

When you get Anthony Pratt, Gina Rinehart, Lindsay Fox and Paul Keating backing an idea, the star power alone is enough to make people sit up and listen.

Last week a who's who of business and power attended a roundtable hosted by Pratt's company Visy and Fairfax Media to push the idea that super funds should lend directly to business, bypassing the banks.

In theory this has a lot going for it. In practice, there are significant hurdles to overcome.

In fact, companies already can issue corporate bonds for debt financing, and super funds can already buy them, if they can document why it meets their investment strategy. But the corporate bond market is under-developed in Australia compared with the United States.

The Murray inquiry noted in 2014 a deeper and more liquid corporate bond market would provide diversification benefits to both issuers and investors alike.

The report noted a steady increase of Australian companies issuing bonds in recent years, but 80 per cent of it was overseas. About 30 bonds are issued in the domestic market each year, mostly by the big banks.

It's a well-known problem in Australia that lack of access to capital is a major brake on business growth. Businesses below the very top tier struggle to raise money except through equity.

Banks are reluctant to lend to businesses and Keating, whose government established Australia's superannuation system, noted the problem would get even worse as the next wave of the Basel rules on capital adequacy made lending more expensive for banks.

Most entrepreneurs seeking a business loan from a bank will be told, "sure, but you'll have to put your home up as security". When you hear of entrepreneurs betting the house on their business, it's not just a quaint turn of phrase. And for all that failure is meant to be revered in the start-up community, it sometimes has serious consequences.

Of course, we don't want super fund members to bear the cost of that business failure either, but there'd be a net positive for society if good businesses could more easily access capital. They'd find it easier to grow and this would have flow-on benefits for the economy and the share market.

But what's in it for super funds and their members? First, it would help them diversify their investments, particularly as the ageing population means more Australians move from accumulation to pension phase.

As Keating said at the round table: "The super scheme that I set up was focused on accumulation. Now that Australians are living longer and moving into retirement we need superannuation phase two. That means funding retirement, guaranteed income. It means tapping into long-term income streams."

The focus on accumulation means most super accounts are oriented to growth assets such as shares or, particularly in the self-managed super fund sector, property.

Ben Marshan, the head of policy and government relations at the Financial Planning Association, says many super portfolios are too weighted to growth assets and it would be helpful for super funds to have a greater choice of fixed-income investments.

While super funds do have defensive assets such as cash, government bonds, infrastructure assets and gold, Marshan says adding corporate bonds to the mix would help diversify the risk and investing horizon.

Nothing much would have to change from a regulatory point of view. Super funds can already invest in corporate bonds if it ticks their investment boxes.

So why doesn't it happen all that much?

Martin Fahy, the chief executive of the Association of Superannuation Funds of Australia, says the main impediment is that the regulator, APRA, is increasingly focused on liquidity.

"Unless and until there is a relatively large and regularly traded market in Australian corporate bonds, there will be limitations on the extent to which super funds will be able to take up bonds issued in Australia by large corporations," Fahy says.

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It's a bit chicken and egg, then. If all the super funds acted together they could create that liquidity, but it's hard to see how individual decisions would create the same push.

Assuming large businesses such as ASX200 companies could issue corporate bonds that hit the sweet spot for super funds, how does that help smaller companies?

Lending to small and medium businesses would be a much riskier proposition because of the higher risk of default. Higher returns might make that worthwhile depending on the investment strategy - but the loan would be more expensive.

One way to manage the risk would be to bundle all small and medium business loans into another investment vehicle, perhaps a collateralised debt obligation (CDO) where you spread the risk by investing in a small fraction of multiple loans.

Of course, this carries its own risk. You'd have to safeguard against "free rider syndrome", a well-known phenomenon in economics, whereby people are less conscientious about doing their part because the fact that the consequences are shared makes it less personally risky.

One of the causes of the global financial crisis was that demand for CDOs backed by residential mortgages became so high that lending standards for home loans were dropped in order to fill the pipeline with mortgages to create new CDOs..

All this is still some way off, considering the corporate bond market is under-developed even for large businesses.

Caitlin Fitzsimmons is the Money editor and a regular columnist on money, work and life. Find her on Facebook: @caitlinfitzsimmons or Twitter: @niltiac,

This story Should super funds lend directly to businesses? first appeared on The Sydney Morning Herald.