The Reserve Bank of Australia (RBA) has noted the growing importance of the country’s super sector to the stability of the financial system due to its size and its links to banks.

As of June 2024 the sector manages assets worth nearly $4 trillion, which equates to about 150 percent of GDP and 25 percent of the total assets of the financial system.

The central bank noted that the closed nature of the pension sector, with its long-term investment horizon and limited leverage, helps mitigate systemic risks.

But with the sector now accounting for a quarter of Australia's financial assets, the central bank warned that its significant growth, increasing connectivity with banks and a growing footprint in financial markets created new risks, including the ability to amplify shocks.

“The value of assets managed by pension funds has doubled in the decade to 2024. and is expected to continue to grow faster than the entire financial system,” the RBA said.

As the pension sector grew, the central bank said its financial ties to the banking system had strengthened, with funds holding almost a third of banks' short-term debt securities and more than a quarter of bank capital, which could amplify financial shocks if their investment actions become correlated during market stress.

"A recent illustration occurred during the onset of the pandemic in Australia, when pension funds increased their sales of bank debt securities back to issuing banks, adding pressure on bank funding - which in turn increased funding costs in the financial system," said RBA.

Thomas Dutka, director of manager research at Morningstar, told InvestorDaily that mandatory contributions boost fund flows, allowing them to outpace the broader economy.

Australia's biggest super fund, AustralianSuper, has already hit an ambitious target of $1 trillion in assets over the next decade.

"[Super funds’] the impact on the economy is growing, so obviously there will be more and more risks," Dutka said, declining to specify the severity of that risk.

However, he noted that larger funds selling shares can have a significant impact on the price, while multiple funds selling the same shares at the same time can cause "a lot of problems".

This was also raised by the RBA, which said: “Unexpected demands for liquidity – including capital calls for private asset exposures, sudden policy changes or margin calls on foreign currency hedges – could lead to synchronized asset sales by some domestic markets as funds try to raise money quickly.”

However, Dutka also stressed that the large scale of most funds means they tend to be less active in managing their equity investments.

"It's not like driving a speedboat, it's more like a super tanker," Dutka said.

“They don't try to do very active high turnover trades or take positions like that because it's just not that easy to do.

"So it's a risk, but there are also limitations that can potentially mitigate it."

Mitigating this impact, according to the RBA, starts with continued efforts by funds to strengthen their liquidity risk management practices.

As super funds invest more in foreign assets, managing demand for liquidity from currency fluctuations will also become critical, the central bank said. Additionally, as more members retire and begin withdrawals, the sector may face cash flow challenges.

"Liquidity risk management will require constant vigilance, including with respect to currency hedging margin calls," it said.

However, the RBA noted that any changes are expected to happen gradually, adding that the Australian Prudential Regulation Authority has already tightened standards to improve liquidity management in funds.

"APRA is now requiring a higher level of sophistication in liquidity risk management practices across the sector," he concludes.