The country’s two biggest super funds, AustralianSuper and the Australian Retirement Trust (ART), now control a quarter of the Australian Regulatory Authority (APRA)-regulated market, collectively managing more than $620 billion in assets, Morningstar research has revealed.

After a flurry of mergers, strong performance and high flows, the mega fund club has expanded to include Aware Super, UniSuper and Hostplus. Meanwhile, three additional funds – Cbus, Rest and HESTA – are on the verge of joining this elite group.

While this concentration of assets allows these massive funds to exploit economies of scale, Morningstar warned that this size is a “double-edged sword” bringing with it potential challenges in investment processes and management.

"Active listed equity strategies with greater outperformance potential often have capacity constraints," the research firm said, meaning they can only absorb a limited portion of a large fund's allocated capital.

Namely, of the $2.7 trillion market capitalization on the Australian Securities Exchange as of March 31, $646 billion, or 24 per cent, was held by APRA-regulated superannuation funds – half of them by the big eight with-profits funds.

Morningstar analysts explained that when a mega-fund tries to make an active shift in its holdings, it struggles to transact at scale without affecting share prices. This limitation can affect both asset allocation and investment style.

"A mega fund may have no choice but to focus on passive, enhanced index or systematic strategies within certain listed asset classes," Morningstar said. "It may also need to limit its allocation to these classes, even if capital market assumptions and the asset allocation process suggest otherwise."

In contrast, smaller funds, while less able to compete on fees, have the advantage of flexibility.

Morningstar highlighted that some smaller funds that perform "very well" can pursue active strategies with higher returns without the capacity issues faced by their larger peers.

To mitigate these challenges, many large funds are increasingly turning overseas, reducing the traditional "home bias" that defines the sector. Yet despite this change, Australia's largest funds still dominate key domestic asset classes, particularly Australian shares.

With AustralianSuper targeting $1 trillion in assets over the next decade, Morningstar has raised the prospect of a future resembling the banking sector - dominated by a few colossal funds alongside a smaller number of niche players.

However, the firm is cautious on its outlook, suggesting that further consolidation and regulation may not be the "panacea" that some may be hoping for.

"New potential high-fund concerns are emerging," it said. "Ultimately, there is unlikely to be a one-size-fits-all solution when it comes to super funds and it is imperative that members are astute when evaluating a fund in the future."

Maja Garatsa Djurdjevic

Maya's career in journalism spans more than a decade in finance, business and politics. Now an experienced editor and reporter in all elements of the financial services sector, before joining Momentum Media, Maya reported for several established news outlets in South East Europe, looking at key processes in post-conflict societies.