Wide moats can narrow
01 June, 2016
Over the last ten years the Australian share market has generated an average 4.4% annual return and the official interest rate has fallen from 5.5% to 1.75%. As a result, savers have found it difficult to generate meaningful returns from their savings.
Aussie company Challenger has sought to solve this problem. It offers annuity products, which provide a defined set of cash returns in the future in exchange for an upfront payment. As Australia's growing base of retirees seeks saving solutions in a low-return environment, Challenger has grown at a handsome clip, expanding its leading role in this small but growing market.
To date Challenger has had the market much to itself, as their annuity business has been too small to attract attention from potential competitors.
Changing regulation may see the annuity market become larger and more complex. Annuities may be made more tax efficient, mandatory in retirement portfolios and could pay out over longer periods than they currently do. Competition from well resourced financial institutions may well follow.
Challenger currently sells annuities to the members of super fund giant QSuper. In May QSuper obtained a life insurance licence, enabling it to offer annuity products of its own to its members. Challenger now relies on a potential competitor to sell its products. For all its technical smarts in producing annuities, and the first mover advantage in the space, Challenger lacks direct relationships with the ultimate buyers of its products.
While we don't own Challenger shares, it is an interesting case study. For many years, Challenger's competitive advantage, or moat, has been its leading role in a niche market. Ironically, growth in this market is likely to attract competitors, narrowing Challenger's moat. If these competitors have the advantage of directly owning customer relationships, then Challenger's moat probably narrows further. Challenger may soon itself be challenged.