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SUPERANNUATION FUNDS MANAGEMENT CORPORATION OF SOUTH AUSTRALIA

FUNCTIONAL RESPONSIBILITY AND STRUCTURE

Establishment

The Superannuation Funds Management Corporation of South Australia (operating under the business name Funds SA) is a statutory authority established pursuant to the Superannuation Funds Management Corporation of South Australia Act 1995 (the Act).

Functions

The functions of Funds SA, as detailed in section 5 of the Act are:

Restrictions on Operations

Although the Minister may not issue directives to the Corporation, section 21 of the Act requires the Corporation to have regard to Government policy, at the Minister’s request, when preparing a performance plan or performing its functions under this or any other Act.

Section 7 of the Act further provides that the objective of Funds SA in performing its functions is to achieve the highest return possible on investment of the public sector superannuation funds while having proper regard for:

Funds SA has, by virtue of the Act, broad powers in relation to the investment of public sector superannuation funds.  Funds SA, however, cannot borrow money or obtain any other form of financial accommodation unless authorised to do so by the Regulations or by the Minister.  In addition, the Regulations under the Act impose restrictions on the investment of public sector superannuation funds as follows:

Management of Superannuation Funds and Schemes

The various public sector superannuation funds, as defined under the Act, and managed and invested by Funds SA, are identified in Note 1 to the financial report.

Funds SA is not responsible for the administration of any of the public sector superannuation funds.  The South Australian Superannuation Board is responsible for all aspects of the administration (ie contributions and benefits) of the South Australian Superannuation Fund, Southern State Superannuation Fund and the associated Employer Contribution Accounts.

The Police Superannuation Board is responsible for all aspects of the administration of the Police Superannuation Fund and the associated Employer Contribution Account.

The Department of Treasury and Finance is responsible for the administration of the Governors’ Pension Scheme, the Judges’ Pension Scheme and the Parliamentary Superannuation Scheme.

Additional information relevant to the characteristics and the administration of the superannuation schemes may be obtained by reference to the financial reports of the various schemes which are included elsewhere in Part B of this Report.

Structure

The structure of Funds SA is illustrated in the following organisation chart.

Funds SA operates with a small staff comprising investment officers and accounting and administrative support staff.  This structure is complemented by extensive use of external funds management firms.  Fund managers are utilised in relation to all investment types, and there is a single custodian (who is responsible for the integrity and holding of the assets) for the majority of those fund managers.  Each fund manager is appointed pursuant to an agreement which dictates the scope for investment, fees and reporting requirements.  The custodian, JP Morgan Chase Bank, is also appointed pursuant to a similar agreement.

Funds SA also has a number of controlled entities (fully owned).  Refer Note 20 to the financial reports for details.

Audit Committee

The Act specifically requires Funds SA to establish an Audit Committee.  The Committee comprises four Board members operating within the framework of an Audit Committee Charter.  Pursuant to that charter, the Committee is responsible for assessing the quality of both internal and external financial reporting; assessing the effectiveness of Funds SA’s internal control structure; and maintaining an effective and efficient liaison with both internal and external audit.  Audit representatives attended Audit Committee meetings throughout the year.

AUDIT MANDATE AND COVERAGE

Audit Authority

Audit of Financial Statements

Subsection 31(1)(b) of the Public Finance and Audit Act 1987 and section 28 of the Superannuation Funds Management Act 1995provides for the Auditor-General to audit the accounts of the Superannuation Funds Management Corporation of South Australia for each financial year.

Assessment of Controls

Subsection 36(1)(a)(iii) of the Public Finance and Audit Act 1987 provides for the Auditor-General to assess the controls exercised by the Superannuation Funds Management Corporation of South Australia in relation to the receipt, expenditure and investment of money, the acquisition and disposal of property and the incurring of liabilities.

Scope of Audit

The audit program covered major financial systems and was directed primarily to obtaining sufficient evidence to enable an audit opinion to be formed with respect to the financial report and internal controls.  Further, with respect to the assessment of controls, the audit considered whether they were consistent with the prescribed elements of the Financial Management Framework as required by Treasurer’s Instruction 2 ‘Financial Management Policies’.

During 2002-03, specific areas of audit attention included:

Audit Communications to Management

No significant issues were raised as a result of the audit.  A management letter conveying the scope and results of the audit will be forwarded to the Chairperson subsequent to the signing of the accounts.

AUDIT FINDINGS AND COMMENTS

Audit Opinions

Audit of Financial Statements

In my opinion, the financial report presents fairly in accordance with the Treasurer’s Instructions promulgated under the provisions of the Public Finance and Audit Act 1987, applicable Accounting Standards and other mandatory professional reporting requirements in Australia, the financial position of the Superannuation Funds Management Corporation as at 30 June 2003, the results of its operations and its cash flows for the year then ended.

Assessment of Controls

Audit formed the opinion that the controls exercised by the Superannuation Funds Management Corporation of South Australia in relation to the receipt, expenditure and investment of money, the acquisition and disposal of property and the incurring of liabilities is sufficient to provide reasonable assurance that the financial transactions of the Superannuation Funds Management Corporation of South Australia have been conducted properly and in accordance with law.

Significant Matters Raised with Agencies

The audit of Funds SA indicated that the internal controls over its operations, including its accounting and investment functions were sound.  The audit took into account the role of the Audit Committee in assessing the effectiveness of Funds SA’s internal control structure.  No significant issues of concern were raised as a result of the audit.

INTERPRETATION AND ANALYSIS OF FINANCIAL STATEMENTS

Highlights of Financial Statements

2003

2002

Percentage

$’million

$’million

Change

NET FUNDS MADE AVAILABLE FOR

INVESTMENT

216.2

145.1

49.0

INCOME EARNED FROM INVESTMENT

ACTIVITIES

Inflation linked funds

75.3

50.4

49.4

Property

50.8

53.4

(4.9)

International equities

(175.8)

(372.3)

52.8

Other

63.8

12.2

423.0

Total Income Earned From Investment

Activities

14.1

(256.3)

105.5

ADMINISTRATION EXPENSES

2.8

2.6

7.7

Change in Net Assets

227.5

(113.8)

300.0

Net Cash Flows from Operations

83.3

78.9

5.6

Net Cash Flows from Investing

Activities

(369.7)

(54.2)

(582)

Net Cash Flows from Financing

Activities

216.2

145.1

49

2003

2002

Percentage

$’million

$’million

Change

ASSETS

Investments

5 409.9

5 181.7

4.4

Other assets

0.8

2.2

(63.6)

Total Assets

5 410.7

5 183.9

4.4

LIABILITIES

Current liabilities

11.1

6.8

63.2

Non-current liabilities

27.3

32.4

(15.7)

Total Liabilities

38.4

39.2

(2.0)

EQUITY

5 372.3

5 144.7

4.4

Statement of Changes in Net Assets

Net Funds made available for Investment

Net funds made available for investment consists of the net of receipts and payments, from and to the pubic sector superannuation funds.  Net funds made available for investment increased by $71 million to $216 million.  Details of receipts and payments related to the various funds are provided in Note 4 to the financial report.

An amount of $183 million ($211.7 million) was made available by the Treasurer in respect of accruing employers superannuation liabilities in relation to the South Australian Superannuation Scheme, Parliamentary Superannuation Scheme and Judges’ Pension Scheme.

Income from Investments

Net income from investment activities resulted in a return of $11 million compared to a negative return of $259 million in the previous year.  This result predominately reflects the recording of assets at net market values where unrealised gains or losses are brought to account.

The major reason for a return to a positive result in 2003 were improved returns from International equities and Australian equities.  In 2002, equities across the globe experienced depressed valuations, reflecting poor conditions in world share markets.  This trend continued in 2003, particularly in International Equities (albeit to a lesser extent).  However, offsetting the negative result on International Equities were comparatively strong results in each of the other sector funds, hence producing a positive result for the fund overall in 2003.  Note5 to the financial statements reports full details of income earned from investment activities for each of the investment classes comprising the Fund.

It is relevant to observe the later comments, particularly on stock market risks, included under ‘Asset Allocation and Risk’.

A structural analysis of net income earned by the Corporation for the four years to 2003 is presented in the following table.

Net Income Earned From Investment Activities

2003

2002

2001

2000

$’million

$’million

$’million

$’million

Inflation Linked Funds

75.3

50.4

43.9

53.7

Property

50.8

53.4

45.2

32.3

Australian Equities

5.8

(28.3)

177.6

232.7

International Equities

(175.8)

(372.3)

(131.7)

328.8

Australian Fixed Interest

22.0

15.7

34.6

27.6

International Fixed Interest

30.0

20.0

(0.9)

0.0

Cash and other

6.0

4.9

9.4

106.1

14.1

(256.2)

178.1

781.2

The above table reflects that the Corporation’s investment strategy is weighted towards equity holdings.  Refer chart and discussions under Statement of Net Assets.  The volatile nature of equities will cause returns from these investments to fluctuate due to the effect of prevailing economic conditions.

Investment Expenses

Investment expenses are deducted from income to determine Net Income Earned from Investments in the Statement of Changes in Net Assets.  In 2003 these expenses amounted to $27.6 million of which $21.9 million (79.3 percent) related to fund management fees.  These fees equate to 0.4 percent of funds under management.

Fund Manager fees over the last four years were:

Year

$’million

2000

14.6

2001

17.3

2002

16.3

2003

21.9

Although fund manager fees have generally increased over the past four years, when compared to average funds under management, they remain under 0.5 percent.

Statement of Net Assets

As the Corporation’s main function is to invest and manage the public sector superannuation funds, assets predominantly consist of investments.  Total liabilities as a percentage of total assets are 0.7 per cent.

As a result of the decision by the Government to move to full funding of the public sector superannuation liability, the introduction of new superannuation products and as a result of investment earnings, Funds SA continues to experience growth in total funds under management (net assets) as illustrated in the following chart.

Investment Classes

Funds SA is an investment organisation with broad powers and as indicated $5.4 billion of funds under management.  These funds are represented by seven investment classes and the level of holdings for each of these investments (excluding cash) at 30 June for the last three financial years is illustrated in the following chart.

As previously noted the above chart reflects the Corporation’s investment strategy’s weighting towards equity holdings.  There was an increase in International Equities holdings during the current financial year due mainly to the majority of past service liability funding received late in the previous financial year being invested in the current year in International Equities.  Most other investment classes have remained constant over the past three years.

Statement of Cash Flows

The following table summarises the net cash flows for the four years to 2003.

2003

2002

2001

2000

$’million

$’million

$’million

$’million

Net Cash Flows

Operations

83.3

78.9

(74.7)

(2.8)

Investing

(369.7)

(54.2)

(61.7)

(374.0)

Financing

216.2

145.1

85.6

316.1

Change in Cash

(70.2)

169.8

(50.8)

(60.7)

Cash at 30 June

128.5

198.7

28.9

79.7

Net cash flows from Investing Activities reflects the level of redemptions and purchases of investments.  For 2003, the purchases and sales of Australian Equity of $670 million and $683 million respectively mainly reflect a change in fund manager.  International Equity purchases and sales of $787 million and $285 million respectively are due mainly to bringing International Equity back into line with the Strategic Asset Allocation and also includes some movement due to fund manager transitions.

For details relating to Financing Activities which reflect receipts and payments from and to the various superannuation schemes refer to Note 4 in the financial statements.

FURTHER COMMENTARY ON OPERATIONS

Asset Allocation and Risk

The decision as to how the funds will be invested is established through an investment policy.  Underpinning the investment policy and decision making process is an understanding of the risks facing Funds SA.  It should be noted that in the investment market at large there exists a range of financial risks which impact on Funds SA’s operations.  These include:

In managing some of these risks Funds SA utilises derivative instruments.  Refer to Note 23(b) of the financial report for further details.

Investment Products

Members of the Triple S Scheme are provided with investment choice to enable them to tailor the investment strategy more directly towards their individual risk/return preferences and financial circumstances.

Four investment products (ie strategies) have been designed for Triple S Scheme member investment choice (balanced, growth, conservative and cash) and also one for the defined benefit schemes. (Refer to Note 3 to the Financial Statements.)  The objectives of these products is shown hereunder with respect to:

Defined

Benefit

Balanced

Growth

Conservative

Product Objectives:

Real return objective greater than

4.5 percent

4.0 percent

5.0 percent

3.0 percent

Investment time horizon

8 years

7 years

10 years

4 years

Expectation of negative return

2 years in 8

2 years in 7

3 years in 10

1 year in 4

$million

$million

$million

$million

Total Funds at 30 June 2003

3 295.9

1 918.4

116.4

25.4

The cash product ($16.1 million at 30 June 2003) has a target of maintaining the real value of capital invested.

Strategic Asset Allocation and the Actual Position

Reference should be made to Funds SA’s annual report for the strategic asset allocations applying to each of the investment products.  A comparison of the target asset allocation for each of the five products compared to the actual position at 30 June 2003 revealed that all variances were within the rebalancing ranges around the strategic target.  That is, a rebalancing policy has been adopted by Funds SA to ensure the efficient maintenance of the asset allocation within an acceptable tolerance around the strategic asset allocation target.

Investment Returns

As mentioned earlier, Funds SA values its investments at net market value, in accordance with the requirements of Australian Accounting Standard AAS 25 ‘Financial Reporting by Superannuation Plans’.  Any increases or decreases in the market value are brought to account through the Statement of Changes in Net Assets.  As such the value of the investments under management has a direct impact upon the level of income earned by Funds SA in any one year.  Funds SA has established performance benchmarks for each asset class as follows:

Asset Class

Performance Benchmark

Australian equities

Standard and Poors/ASX 300 Accumulation Index

International equities

Tailored benchmark incorporating specific sub sectors and hedge

Property

Mercer Australian Unlisted Property Index Standard and Poors/ASX

Property 300 Accumulation Index

Inflation linked

UBS Warburg Australian Inflation Linked Bond Index

Fixed Interest

(Australia) UBS Warburg Australian Composite Bond Index

(International) Lehman Global Aggregate 300 AUD Index. Hedged

Cash

UBS Warburg Australian Bank Bill Index

Funds SA’s objective is to exceed the relevant benchmark in each asset class.

Return Performance by Asset Class

The return performance of each of the six distinct asset classes (after fees), against their relevant benchmark, for the 2002-03 financial year, is depicted in the following chart:

The chart above shows that the return performance for all asset classes were above the benchmark return other than Property which was slightly under.

Return Performance by Product

The return performance of each of the distinct products (excluding ‘cash’), against their relevant benchmark, for the 2002-03 financial year, the last three years and the last five years (where relevant) is depicted in the following charts.

These charts show that Balanced and Conservative Products produced positive returns for the year whereas Defined Benefit and Growth produced negative returns.  This reflects the asset classes in which these schemes are invested.  However all products returns were above the benchmark for the year.

This is also consistent for the three years ending 30 June 2003 whereas for the five years ending 30 June 2003 both the Defined Benefit and Balanced Products provided positive returns of approximately five per cent which also were over the benchmark.

Growth and conservative products were first offered in 1999.

2002-03 Financial Year (Returns Percent)

Three Years ending 30 June 2003 (Returns Percent per annum)

Five Years ending 30 June 2003 (Returns Percent per annum)

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