Trump’s bombastic and provocative approach to the trade war has culminated in a tumultuous two years for capital markets. Sudden increases in tariffs have been followed by back downs, bravado has given way to overtures, and severe selloffs have been succeeded by relief rallies. However, it has been this ongoing uncertainty which Trump’s political success hinges on as his negotiating style has leveraged the following maxim: escalate and then negotiate.

While the negotiation of a ‘phase one’ deal represents a considerable win for Trump, the unavoidable reality is that the trade war has been costly, and the economic toll continues to mount. It’s unclear whether the proposals outlined in the phase one agreement will cover this cost, particularly given the difficulty involved in calculating the indirect effects of US tariffs and China’s retaliatory measures, which have contributed to waning business investment and consumption.

The remaining tariffs and commitments to purchase additional agricultural products should appease the China hawks, but the currency pledges are similar to those already agreed to under the G20 pact. Further, the commitments pertaining to intellectual property theft and forced technology transfers appear similar to China’s obligations under their foreign investment regime implemented last year.

As always, the devil is in the detail. Trump will be under mounting pressure to deliver more meaningful results in the subsequent phase two negotiations, due to take place after the presidential election in November 2020. For the last two years, global markets have delicately traversed thorny trade issues, and with markets now topping record highs, any negative news is likely to significantly depress global share indices.

Looking at recent drawdowns, which can be used as a barometer for the aggression demonstrated by each side, it’s clear that the pullback in early 2018 represents the initial flare-up between the two powers as the tariff regimes commence and the Twittersphere works itself into a frenzy.

S&P 500 TR Index drawdowns, January 2018 to December 2019


Source: Financial Express, iRate

Trump has frequently cited the S&P 500 as a proxy for the success of his presidency, and notwithstanding the turbulence experienced in 2018, this has proved to be one of his defining accolades. Since the end of 2016, the market’s cumulative return has edged close to 60%, providing a boon to passive investment strategies.

“If the Dems (Crooked Hillary) got elected, your stocks would be down 50%” – @RealDonaldTrump

The cynics will argue that Trump opportunistically deployed tariffs to stymie economic growth and force the ‘Powell-Put’ in early 2019 in order to reignite a languishing stock market. Consequently, this about face from Powell to a more accommodative monetary policy stance precipitated a significant reversal for risk assets, powered global stock indices to new highs, and set Trump’s twitter feed ablaze.

S&P 500 TR Index cumulative returns, January 2017 to December 2019


Source: Financial Express, iRate

“My only question is, who is our bigger enemy, Jay Powel or Chairman Xi?” – @RealDonaldTrump

Trump’s detractors assert that his tariff regime was part of a cunning ploy to pressure the US Federal Reserve to aggressively ease monetary policy to counter flagging economic growth. Unfortunately for the bystanders, the trade war spurred a synchronised global slowdown and left the global economy on the precipice of a recession. Auspiciously for Trump, the Fed eventually embarked on an easing cycle, which aside from producing the ‘Trump bump’ in the stock market, sparked an insatiable thirst for fixed income securities.

S&P 500 TR Index cumulative returns, January 2017 to December 2019


Source: Financial Express, iRate

“The Fake News Media barely mention the fact that the stock market just hit another new record” – @RealDonaldTrump

Trade is still the market’s biggest unknown

The genesis of the sino-yankee trade dispute lies with America’s historical trade deficit with China, the alleged theft of intellectual property, and manipulation of the Chinese Yuan. Despite how polarised American politics is, across the political divide there is widespread support for tariffs to reduce the domestic trade deficit and protect domestic industries. China’s admission into the World Trade Organisation (WTO) and ascent to a global trading powerhouse is seen to come at the cost of American manufacturing jobs and resulted in the hollowing out of the middle-class in the rustbelt of America, which is where much of Trump’s support comes from.

Moreover, the US ban on technology produced by the Chinese technology behemoth, Huawei, played into the theme of suppressing Chinese ingenuity. Importantly, a concerted effort has been made to insulate the American consumer from the brunt of the tariff regime as best as possible through primarily targeting industrial goods rather than consumer items. However, conflicting evidence suggests that US businesses and consumers have equally borne the financial brunt of the tariff regime through inflated end-prices.

“China has been ripping this country off for 25 years” – @RealDonaldTrump

China’s retaliatory measures have been predictable and were designed to inflict as much carnage as possible on the US agricultural, chemical and automobile sectors at the heart of Trump’s support base. These targeted measures intentionally weaken the economic interests of Trump’s forgotten class of export-dependent workers, whose grievances he leveraged in the 2016 election following decades of automation and globalisation.

The political objective is to compromise Trump’s re-election prospects in 2020 and force his arm into offering more amicable concessions. Reinforcing this effort is the fact that US exports to China are largely undifferentiated commodities that can be substituted elsewhere. However, Trump’s adversarial negotiating style led Chinese President Xi into a war of attrition, leaving both sides unrelenting in their demands up until the recent phase one agreement.

Unfortunately, this is not the end of the trade issue. While the US has achieved a substantial narrowing of the trade deficit from US$419 billion in 2018 to US $320 billion in 2019, the efficacy of weaponising tariffs to enforce compliance from trading partners is murky. The uncertainty pervading the economy has largely dissipated for now, thereby strengthening Trump’s mantra on growth and prosperity for the ‘deplorables’, while the Democrats are distracted by likely meaningless impeachment proceedings.

The trade war remains a live issue even if Trump prefers to leave further negotiations until after the election. After that, a phase two negotiation will test the US administration and the markets unlike anything we saw in 2019, which spells further volatility for markets. Is Trump playing a dangerous game or does he have 2020 vision?

“Trade wars are good, and easy to win” – @RealDonaldTrump

For consumers, 2019 was a year best forgotten as negative economic news created an almost perpetual drag on sentiment and global uncertainty resulted in repeated bouts of volatility. But for investors, including Australia’s 15 million super fund members, it was a year that saw a sizeable accumulation of wealth, driven by share market gains as well as some savvy investment decisions by the top-ranking funds.

Even with the high expectations set during a year that saw share markets rally ever higher, several super funds were able to translate this favourable environment into exceptional gains for members.

Topping the leader board in 2019 was UniSuper, whose balanced option delivered a return of 18.4% over the year and is among the top performers over 10 years with a return of 8.9% per annum. Over one year, UniSuper was followed by AustralianSuper – Australia’s largest fund – which returned 17.0% in 2019 and 9.0% over 10 years. However, it’s Hostplus that remains in first place over 10 years with an annual return of 9.2%.

Top 10 balanced options (return over 1 year)


*Interim return
Source: SuperRatings

Top 25 balanced options (return over 10 years)


*Interim return
Source: SuperRatings

UniSuper came out on top in a crowded field, in which the top 10 funds delivered an average return of 16.3%. It was a tight race over longer time periods, and while markets have certainly provided a tailwind, there’s no doubt that skilful management plays a role in squeezing out additional returns.

While returns may appear narrowly spread at the top, this hides some significant differences in asset allocation and investment strategies pursued by different funds. What was interesting to see was the diversity of approaches that funds take, even at the top of the leader board. While most funds have benefited from strong equity markets, the nuances among the top performers are where there has been strong value added for members.

In the case of UniSuper, the fund continues to pursue an active management strategy with exposures predominantly to Australian and International Equities, as well as significant cash and fixed interest exposures. Allocations to illiquid assets such as infrastructure and private equity are not a key component of their strategy.

Meanwhile, Hostplus has significant allocations to illiquid assets, with these being a key driver of its performance outcomes for Property, Infrastructure and Private Equity assets. AustralianSuper has also benefited from material unlisted asset exposures, as well as fee savings generated from its in-house investment structure.

Top pension funds

One of the key challenges super funds face is the current low-yield environment, which is making it harder for funds to generate income for members. This challenge is likely to be felt more acutely by those in the post-retirement phase, who rely on the income generated by their pension product to fund living expenses.

In this environment, picking the right pension fund and option can be critical. The below chart shows how capital stable pension options (20–40% growth assets) stack up over 10 years, and while there is some dispersion in the results, every option in the top 25 by performance exceeded the typical CPI plus 3.0% target. AustralianSuper’s Stable option is the best performer, returning 7.6% p.a. over ten years, followed closely by TelstraSuper’s Conservative option and Hostplus’s Capital Stable option.

Top 25 capital stable pension options (return over 10 years)


Source: SuperRatings

Understanding risk is critical for consumers

Most consumers can’t define risk, but they know it when they experience it. For superannuation members, risk can mean the likelihood of running out of money in retirement, or not having enough cash to pay for holidays, car repairs, or an inheritance for their kids.

For young members starting out in the workforce, short-term market falls might not matter too much because their investment horizon is relatively long. But for members nearing retirement, the timing of market ups and downs can have a significant effect on the wealth they have available in the drawdown phase.

For a young worker with a relatively low super balance, being exposed to riskier assets is less of a problem – in fact, it can help them accumulate wealth over their working life. However, for members approaching retirement (aged 50 and over), an unexpected pullback in the market can mean the difference between living comfortably and having to cut back in order to get by.

For this reason, it’s important to consider not only the return that a fund delivers but also the level of risk it takes on to achieve that return. In this context, risk means the degree of variability in returns over time. Growth assets like shares may return more on average than traditionally defensive assets like fixed income, but the range of return outcomes in a given period is greater.

The table below shows the top 25 funds ranked according to their risk-adjusted return, which measures how much members are being rewarded for taking on the ups and downs.

Top 25 balanced options based on risk and return

Fund option name 7 year return (% p.a.) Rank
QSuper – Balanced 9.1 1
CareSuper – Balanced 9.8 2
Cbus – Growth (Cbus MySuper) 10.3 3
Hostplus – Balanced 10.5 4
BUSSQ Premium Choice – Balanced Growth 9.6 5
Sunsuper for Life – Balanced 10.0 6
Catholic Super – Balanced (MySuper) 9.4 7
HESTA – Core Pool 9.6 8
CSC PSSap – MySuper Balanced 9.0 9
MTAA Super – My AutoSuper 9.5 10
Media Super – Balanced 9.4 11
Intrust Core Super – MySuper 9.8 12
AustralianSuper – Balanced 10.5 13
Mercy Super – MySuper Balanced 10.0 14
Rest – Core Strategy 9.0 15
First State Super – Growth 9.7 16
QANTAS Super Gateway – Growth 8.3 17
TWUSUPER – Balanced 8.8 18
Energy Super – Balanced 9.3 19
Local Government Super Accum – Balanced Growth 9.0 20
AMIST Super – Balanced 8.9 21
VicSuper FutureSaver – Growth (MySuper) Option 9.8 22
Club Plus Super – MySuper 8.9 23
NGS Super – Diversified (MySuper) 8.9 24
LGIAsuper Accum – Diversified Growth* 8.9 25

Risk/return ranking determined by Sharpe Ratio
*Interim return
Source: SuperRatings

QSuper’s return of 9.1% p.a. over the past seven years is slightly below the average of 9.7% across the top 10 ranking funds, but it has the best return to risk ratio of its peers, meaning it delivered the best return given the level of risk involved. Funds such as CareSuper, Cbus and Hostplus were able to deliver higher returns, but for a slightly higher level of risk.

Super funds are on track to finish 2019 with the strongest returns in years, defying fears of a market fade in the final quarter. While market conditions have been challenging, investors have not yet succumbed to the negative economic headlines, which has been good news for super funds.

If momentum holds up through the rest of the year, members in the median balanced option will be looking at an annual return of around 15.0% for 2019 – a result not seen since 2013.

According to leading research house SuperRatings, funds have done a good job of managing uncertainty, which has only been exacerbated by global risks and challenging economic conditions at home. But while consumers are feeling the pinch, their super is holding up well.

A rebounding share market saw the ASX 200 Index return 3.3% in November, putting Australian shares on track to deliver a return of around 26.0% for 2019, which would be the highest investors have seen since 2009. This is despite weakness from the major Financials sector, which slipped 2.0% over the month as the major banks were marked down due to the lower interest rate outlook, while Westpac (-13.1%) was the latest to be hit with negative headlines.

Looking at November’s results, the median balanced option returned an estimated 2.0% over the month, with Australian shares contributing 0.6% and international shares 1.0%, bringing the year-to-date return to 14.8%. The median growth option delivered an estimated 2.3% over the month, bringing the year-to-date return to 17.2%.

Over the past five years, the median balanced option has returned an estimated 7.9% p.a., compared to 8.7% p.a. for growth and 4.9% p.a. for capital stable (see table below).

Estimated accumulation returns (% p.a. to end of November 2019)

YTD 1 yr 3 yrs 5 yrs 7 yrs 10 yrs
SR50 Growth (77-90) Index 17.2% 15.2% 10.5% 8.7% 10.4% 8.6%
SR50 Balanced (60-76) Index 14.8% 13.4% 9.3% 7.9% 9.3% 8.0%
SR50 Capital Stable (20-40) Index 8.3% 8.5% 5.5% 4.9% 5.4% 5.6%

Source: SuperRatings

Pensions products have similarly performed well over the course of 2019, with the median balanced pension option returning an estimated 16.3% year-to-date to the end of November, compared to 19.6% for growth and 9.6% for capital stable.

Estimated pension returns (% p.a. to end of November 2019)

YTD 1 yr 3 yrs 5 yrs 7 yrs 10 yrs
SRP50 Growth (77-90) Index 19.6% 17.1% 11.5% 9.9% 11.7% 9.6%
SRP50 Balanced (60-76) Index 16.3% 14.9% 10.0% 8.5% 10.2% 8.8%
SRP50 Capital Stable (20-40) Index 9.6% 9.4% 6.3% 5.7% 6.2% 6.4%

Source: SuperRatings

“We may not have seen the ramp up in shares before Christmas that some were hoping for, but it’s still safe to say that 2019 has been a highly successful year for super funds and their members,” said SuperRatings Executive Director Kirby Rappell.

“It’s been a nervous year for investors, so it’s great to see that super can deliver some much-needed stability and solid returns during this period. There might not be a lot of positive economic news at the moment, but at least super is one story we can all draw some hope from.”

“Since the Royal Commission’s final report at the start of the year, super funds have fought hard to restore members’ trust in the system. We’ve seen good funds responding proactively to the changing regulatory landscape, which has been pleasing. We expect to see an increase in fund mergers in 2020, but it’s important that regulatory responses don’t move us towards a one-size-fits-all approach, which could be detrimental to member outcomes.”

Members must look beyond raw returns

Everyone agrees that funds that aren’t delivering for members have no place in the super system. However, focusing purely on returns as a measure of a fund’s success ignores a range of factors, not least of which is the level of risk involved in generating that return.

As the chart below shows, there is a significant dispersion of risk and return outcomes among different funds. Looking at how balanced options compare over the past five years, there are some producing higher returns than the median option, but many are producing these higher returns by taking on a higher level of risk (measured as the standard deviation of returns).

Risk and return comparison – Balanced (5 years to 30 November 2019)

Risk and return quadrant - Balanced

Source: SuperRatings

When assessing investment performance over time, the top-left quadrant (higher return for lower risk) is what members should generally aim for. Similarly, the bottom-right quadrant (lower return for higher risk) represents the laggard funds. Over any given time period, there will always be funds that outperform and those that underperform.

Looking at past performance can be useful when picking the right fund, but it shouldn’t be the sole criteria. For one thing, past performance is no guarantee of future performance, but there are many factors members should take into account when assessing a super fund, including insurance, governance, member services, and of course fees.

Markets continued their upward trajectory in November. When you look at the returns across key asset classes over the last 12 months most asset classes have generated double digit returns. Growth assets such as equities and listed real assets generated over 20% for the year ending 30 November, while bonds generated high single digit to double digit returns. This has been a great outcome for investors and certainly well above Lonsec’s long-term expected returns for asset classes.

Part of what has fuelled these high returns, post markets getting the wobbles after the US yield curve inverted in August, can be attributed to markets pricing in the avoidance of a recession and the expectations of a potential recovery in growth. We have witnessed such ‘mini-cycles’ in the past, in 2013 and 2016, however what is different this time is that EPS growth is more muted and other factors which contributed to previous mini-cycles, such as the US or Chinese fiscal stimulus, are less likely to have an impact.

So what does this mean for markets? We think markets may experience a short-term upswing as the ‘mini-cycle’ plays out. We have therefore slightly adjusted our dynamic asset allocation tilts deploying some of the excess cash in our portfolios towards Australian equities. Our overall asset allocation continues to have a defensive skew with the objective of diversifying the portfolios by asset type and investment strategy. This positioning reflects our broader view that asset prices are stretched and that while some economic indicators have stabilised, we believe we are closer to the end of the cycle.

In recent years it seems that market sentiment is shifting more rapidly than ever. We saw this earlier this year when the US Federal Reserve flipped on its monetary stance from a tightening stance to a “let’s take pause and see how things pan out” position.  In August we saw the yield curve invert meaning that long-term bond yields were lower than short-term bond yields. The most common measure of this is the difference between 2 and 10 year government bond yields. Markets reacted negatively to this as an inverted bond yield is typically an indication that investors are concerned about the economy. It has also been a good predictor of a looming recession with an inverted yield curve preceding every US recession since the 1970s. Interestingly, the time between the yield curve inverting and a recession is highly variable and equity markets have historically performed strongly until a recession has hit. For example, in 1988 the S&P 500 rose by over 30% prior the recession and in 2006 it rose approximately 16%. The yield curve has since steepened and is no longer inverted. So does this mean we are out of the woods?

From our perspective the economic news is mixed. Indicators such as manufacturing data have been trending down, however housing has been strong in the US and has improved in Australia. Consumers are also holding up in the US. Geopolitics continue to be an X-factor with news regarding US – China trade talks continually shifting, whilst the prospect of further quantitative easing is certainly plausible. From a bottom-up perspective, many of the professional investors Lonsec speaks to are indicating that they don’t expect a recession within the next 12 months but over a 2 year timeframe the risk of recession rises.

Amidst this uncertain backdrop, from an asset allocation perspective we have retained our slight defensive bias holding a greater exposure to real assets and focusing on diversification via uncorrelated assets such as alternatives.

Financial advisers are operating within a paradox. On the one hand, the industry is still reeling from the blow of the Royal Commission and the high levels of mistrust within the community towards the financial services sector. On the other hand, there’s every sign that demand for quality financial advice is growing – to the extent that some advisers may find themselves on the back foot when it comes to putting in place the necessary capabilities to deliver tailored advice solutions.

It seems that, if anything, the media coverage of the Royal Commission has only raised in people’s minds the inadequacy of their own financial knowledge when it comes to managing and growing their wealth. According to the most recent survey conducted by ASIC in August this year, 79% of participants agreed that financial advisers had expertise in financial matters that the participant did not have. Even after being exposed to the negative headlines, 75% agreed that financial advisers could recommend products that they normally could not find on their own, and 73% agreed that advisers could introduce them to good ideas they might not have thought of on their own.

So the need and desire for financial advice remains in place, but consumers still face a knowledge problem when it comes to finding an experienced adviser who they believe can genuinely help them achieve their objectives. It’s clear that the main reason people seek financial advice is to benefit from the expertise of the adviser, who they believe can provide recommendations that will improve their financial wellbeing and help them prepare for major life events. What it comes down to is not the overall perception consumers have of financial advice, which remains positive, but the way in which they discern the quality of individual advisers.

When it comes to demonstrating quality, advisers need to be able to show clearly how their advice adds tangible value to the client. Once a positive first impression is made, advisers must then follow through on their value proposition with a roadmap for success that the client can understand and that makes intuitive sense. Breaking down what are inherently complex topics can be a challenge, but it’s critical to ensuring clients are fully engaged in the process and can see for themselves how your advice is helping them build their wealth and meet their objectives. High-quality investment research can play a key role in supporting this process by giving advisers the information, visual data, and easy-to-use reporting tools they need to have deeper conversations that speak directly to their clients’ needs.

The Royal Commission has not spelled the death of financial advice, but it has made it harder for advice that can’t draw a direct link between the client’s individual needs and the investment decisions of the adviser or portfolio manager. We are entering a new age of financial advice that is seeing the role of the adviser shift from that of administrator and stock picker to someone who can deliver a holistic advice experience by showing that they have a deep understanding of their client’s position and can recommend high-quality investment products that support the client’s needs. This means having a thorough understanding of the qualitative aspects of different products, how they compare, and they can be used as part of a tailored investment solution.

The results of the ASIC survey support this, and while some of the survey findings may come as a surprise, many advisers will see this as old news. When it comes to choosing an advice provider, communication is one of the most important factors customers look for and anticipate in their interactions with advisers. Experience and reputation are obviously important, but a key differentiating factor is the way advisers talk to and engage with their clients. The ability to talk to clients in a way they can understand is just as important as an advisers reputation (38% versus 36%), while taking the time to understand their client and their goals is also one of the top attributes (32%).


Source: ASIC

What’s also interesting is that, for those respondents who had received financial advice (Group A), low cost became far less of a determining factor. For advisers who are successfully able to demonstrate the value of their advice, clients are more willing to pay because they can see how the advice they receive results in superior outcomes. That’s why it’s important to have not only high-quality investment research, but the right platform and tools that can deliver this research in a way that allows you to present complex information, including in-depth product comparisons and portfolio reports, clearly and concisely.

It’s also why we’ve continually evolved Lonsec’s iRate platform to ensure it’s more than just a place to access research, ratings and data. We give you the tools you need to get a more complete picture of your client’s portfolio, analyse and compare products across a range of qualitative factors, and demonstrate how your advice is contributing directly to their investment outcomes. For advisers looking to win the conversation game, a high-quality research provider can give them the edge they need.

Private markets have long been the domain of institutional investors. With benefits such as higher return potential, lower volatility, lower correlation to traditional listed assets, and enhanced diversification, it’s not hard to see why they are so attractive. Institutional investors such as super funds have been steadily increasing their exposure across the private market spectrum, which includes equity, real estate, infrastructure and debt.

Private markets by their nature require significant long-term commitments (in some cases capital can be locked up for ten or more years) and have significant barriers to entry given the large amounts of capital required. Both factors have traditionally made it difficult for retail investors to access the benefits of private markets, but this is quickly starting to change.

Private asset managers are exploring ways to make investing in private markets more accessible to retail investors by introducing greater liquidity and reducing minimum investment sizes. Along with slowing economic growth and the continued hunt for yield, this is making private markets an increasingly viable and attractive opportunity for retail investors and SMSFs seeking greater portfolio diversification.

Lonsec has seen an uptick in private market vehicles targeting retail investors coming to market over the last 12–18 months. Of particular note is the increased interest in private market funds (both equity and debt) being offered under ASX listed structures such as Listed Investment Trusts (LITs).  Such structures have been common in the UK and the US for some time but are a relatively new development in the Australian market.

Offering private assets through a LIT structure provides several benefits to retail investors, including:

  • The ability to create a diversified portfolio of unlisted assets with no minimum investment size;
  • Access to private markets in a more liquid investment structure, with investors able to buy and sell units via the ASX;
  • A greater focus on the long-term investment strategy. Because LITs are closed-end vehicles, managers are less concerned about funding applications and redemptions, which has the potential to boost returns compared to an open-end pooled vehicle;
  • No requirement to manage commitments to fund future investments. Capital is paid upfront and invested in the LIT from day one, so there are no additional capital calls for the investor.

However, as we all know, rarely do investors come across a free lunch, especially in the retail world. Trade-offs must be expected and managed in order to get the most value out of any asset class, and private markets are no different. When including private market assets in a portfolio, it’s important to think about the following:

Private market assets are illiquid

Private assets are by their nature highly illiquid, and investors wishing to redeem may have to do so at a discount to Net Asset Value (NAV). It’s important to treat an investment in private markets as a long-term investment, irrespective of the structure in which it’s offered. Investors wanting (or worse, needing!) to sell LIT units in periods of market stress, when many investors are heading for the door, may face significant discount to NAV. It’s important to ensure the private asset manager has policies in place for managing these discounts should they arise.

Expect some volatility along the way

Private assets offered in LITs will have a higher correlation to the broader equity market and are more volatile than traditional private asset investments. By offering private assets in a listed structure, market beta is introduced, exposing investors to swings in sentiment in a similar manner to any other security listed on the ASX. Volatility risk may also arise when units in the LIT are thinly or heavily traded, which could make the unit prices very volatile regardless of changes in the underlying value of the investments held by the LIT.

It takes time to become fully invested

Unlike traditional private assets, where commitments are drawdown over time, investors in private market LITs pay their capital upfront in exchange for units. Private asset managers don’t invest 100% of that capital immediately, but instead wait for investment opportunities to arise. Consequently, it may take between 12 months to four years to reach the target portfolio allocations. During this ‘ramp-up’ period, private asset managers will invest in other liquid assets ranging from cash through to credit or even equities. This ensures investors are generating a reasonable return or income from an early stage while the portfolio is getting set.

However, it does of course introduce other risks and exposures. It’s important to understand what assets you will be exposed to during the ramp-up phase, as this will impact your returns (and risk). You may not be getting the exposures you expected for some time.

Lonsec believes retail investors can benefit from investing in private markets, but they need to be mindful of the trade-offs when investing via listed vehicles. Retail investors’ needs are inherently different from those of institutional investors—they typically have shorter time frames, a greater need for liquidity, and smaller amounts of capital to invest. While private asset managers have sought to meet a number of these needs in recent years, there’s no panacea for investing in what are inherently illiquid, long-term assets. Retail investors need to ensure that investing in private markets via LITs aligns to their long-term objectives and risk appetite.

For those inclined to question the value of financial advice, there are two important trends taking place right now that need to be reckoned with. Firstly, the federal government is committed to the scheduled rise in the superannuation guarantee, which will see the rate rise to 10% by 2021 and, if the government sticks to the schedule, to 12% by 2025. Workers are gearing up to have more of their retirement wealth exposed to financial markets in coming years, raising the stakes for the wealth management industry and making financial advice less a luxury and more a practical necessity.

Secondly, there have been some troubling signals coming from financial markets over the past six months. While the bull market trend in equities has held up since the start of 2019, the ‘recession dashboard’ is starting to light up, with leading indicators suggesting things might not be as rosy as the stock market suggests. Market turning points pose a real challenge for fund managers and have a way of pushing their process and discipline to their absolute limit. In times like these, product recommendations and manager selection really count, and advisers can quickly find their own processes exposed when things go wrong.

However, even as the value of advice is growing, the perception of advice has suffered through the trauma of the Royal Commission and the uncovering of illegal and unscrupulous practices. Regulatory changes and the shifting nature of advice will inevitably lead to some attrition in the industry, but for the rest there is an acute awareness that things won’t improve on their own. Clients need to be presented with a highly compelling value proposition that demonstrates how the advice process helps them. It also needs to address both the perception issues and the very real regulatory issues around conflicted advice and best interest duty. This is where having the right investment research becomes critical.

Quality investment research is essential to your value proposition

It’s tempting to see investment research as a cost of doing business. The reality is that research is not merely there to supply data, tick a compliance box, or support an established view on a particular product. Quality research is an essential part of the value proposition, because it enables advisers to deliver the things that clients expect from their financial advice: namely, to be able to take full advantage of the depth of Australia’s investment product market and be given recommendations that are most likely to satisfy their investment goals.

Achieving this requires advisers to conduct a full comparison of individual financial products covering a wide range of factors. For any recommendation to be meaningful, it must go beyond past performance to focus on the key qualitative factors that drive future performance and determine whether the product is in line with the client’s needs and preferences. To do this well, advisers must be able to draw on a full team of research specialists with experience across different asset classes, structures, and sectors. Having quality research means partnering with a team that can cover the breadth of products available in the market, and for each product perform the deep dive needed to truly understand how it works and how it can best be incorporated into the client’s portfolio. Having the right investment research means having the resources and capabilities to deliver on your value proposition.

This is why the regulatory challenge facing advisers should not be seen as something distinct from the value proposition. Meeting the highest regulatory and professional standards is something that clients expect, and it’s essential that advisers can demonstrate how they meet these standards. Advisers face a perfect storm of regulatory change, and the winners will be the ones able to adapt to the higher expectations set for them by the regulators and the community. Demonstrating a commitment to acting in the client’s best interest and an ability to avoid or effectively manage conflicts is key.

Tighter regulatory standards reflect the community’s desire for better investment outcomes

The Safe Harbour provisions of the Best Interest Duty state that, when recommending a financial product, an adviser must have conducted “a reasonable investigation into the financial products that might achieve those of the objectives and meet those of the needs of the client that would reasonably be considered as relevant to advice on that subject matter.” In practice, this means that the adviser has not simply looked at a product in isolation and determined if it’s likely to make their client better off but has actively compared it to other similar products and recommended the most suitable one.

In the case of super, there are specific requirements that relate to the due diligence advisers must undertake. Firstly, they must consider the client’s existing products and any products the client requests to be considered. Secondly, the adviser must show the benefits of a new fund, including qualitative factors such as the member servicing environment, the types of insurance the fund offers, the educational material it makes available, and the menu of investment options.

And the standards are getting tighter. The FASEA standards state that advisers “must not advise, refer or act in any other manner where you have a conflict of interest or duty.” This goes beyond the Corporations Act, which merely requires advisers to disclose a conflict and gain the client’s consent before acting for them. The FASEA standard is also broad in the sense that it isn’t limited to conflicts in relation to remuneration. The FPA’s view is that the primary ethical duty in this standard is: if you have a conflict of interest or duty, you must disclose the conflict to the client and you must not act. While these standards are tight, they reflect the community’s expectations that recommendations are free of conflict.

Partnering with a research provider gives you the resources and capabilities to conduct in-depth product comparisons and allows you to show the client how your expertise adds value. Having the right research means you’re better able to support product recommendations with in-depth analysis and detailed product comparisons. It puts you in a better position to meet the regulatory standards and it lets you have deeper conversations with your clients that directly address their needs.

Selecting the right manager involves looking at more than just past performance. It’s about delivering future outperformance based on an in-depth assessment of individual investment teams. This means understanding how people, strategies, and capabilities come together to position fund managers for success. When it comes to selecting for future success, qualitative research is not merely a filter or a heuristic, it’s the backbone of your entire research process.

While you might be able to get away with poor manager selection when the bull market is raging, the real test comes when the market reaches a turning point. Given the troubling signals from financial markets over the past six months, this is something many investors are starting to take very seriously. Market turning points pose a real challenge for fund managers and have a way of pushing their process and discipline to their absolute limit. In times like these, product recommendations and manager selection really count, and advisers can quickly find their own processes exposed when things go wrong.

Identifying future outperformance is an artform, not a science. Lonsec’s entire research process is built around understanding the range of qualitative factors that determine manager success and giving advisers the tools to select investment products based on individual client needs. Our analysis is based on an onsite assessment of investment teams, combined with a rigorous peer review process that safeguards the quality and integrity of our investment product ratings. Looking back over the past 10 years, our qualitative process has proven its worth. Lonsec’s Recommended and Highly Recommended managers have outperformed their respective benchmarks, even during a period where the long-running beta rally has pushed passive investment strategies ever higher, casting shade on many active managers who have struggled to offer value in this environment.

Conveying the importance of insurance to members is one of the biggest challenges that super funds face. Insurance is often seen as a cost rather than a benefit, especially for younger members, meaning funds need to be in a position to clearly communicate the advantages for individuals and for the system as a whole.

The government’s Protecting Your Super (PYS) package came into effect from 1 July this year and aims to reduce the erosion of account balances through unnecessary fees and costs. Part of the legislation involves the cancellation of insurance for members whose account has been inactive for 16 months or more. Based on early analysis conducted by SuperRatings, it’s clear that the PYS changes will have a significant impact across the industry. For the median fund, around 17% of insured members are expected to lose cover. For the quartile of funds most affected by the changes, this figure rises to over 23% (see table below).

What percentage of insured members have lost cover?
Quartile least impacted 13.7%
Median 17.2%
Quartile most impacted 23.4%

Based on an early analysis of member behaviour, it’s clear that members are more engaged with their insurance than was widely anticipated by the industry. According to SuperRatings, the median expected opt-in rate is around 20%. For a quarter of the industry, almost a third of members are expected to opt in, which is significantly higher than funds’ initial expectations. This suggests that inactive members are perhaps not as disengaged as commonly thought (see table below).

Expected Opt-in Rates
Quartile least impacted 32.9%
Median 20.0%
Quartile most impacted 13.4%

These results highlight the importance of fund communication in helping to convey the benefits of insurance and other member services. A member-centric approach to reinstating cover for members that opt in late is beneficial, with funds typically offering a 60 to 90-day reinstatement period. The provision of advice and insurance calculators will assist members in deciding whether to opt in and whether their level of cover is appropriate.

A variety of strategies have been used by funds over the last year to engage with this cohort of members. While traditional forms of member communications such as direct mail have been used in the past, funds have experienced success with email, outbound calling, SMS and digital marketing campaigns. There has also been significant coverage of these changes in the media, which has led to increased awareness and activity of members wishing to ensure they have the appropriate level of insurance coverage. But what’s clear is that, when presented with a clearly communicated choice, members are likely to engage and take action.

This is the start of the process, and undoubtedly it will be an evolving area that will pose different challenges for funds. A limited number of funds have passed on insurance premium increases, with a number indicating that their insurer has decided to wait and see what the overall impact of PYS and other changes such as the Putting Members’ Interests First legislation will be, and these funds may implement changes in the future. SuperRatings will continue to monitor the impact, but it’s anticipated that there will be upward pressure on insurance premiums as funds and insurers digest the changes.

Funds are operating in a different environment where there are conflicts between regulatory settings and potential claims that will emanate where insurance has been ceased for members. How funds are going to strike an appropriate balance when they’re in a somewhat invidious position will be one of the key themes that SuperRatings tracks in coming months.

This article is based on information from the upcoming Benchmark Report released annually by SuperRatings. The Benchmark Report is based on the most in-depth survey of Australia’s superannuation market, covering investment performance, fees, governance, member servicing, and insurance.

One of the topics asset allocators are grappling with at the moment is whether asset class valuations are expensive or not.  Whether you are an active asset allocator, or an active bottom-up stock picker, valuation will most likely be at the core or at least form part of your analysis when making a decision to enter or exit an investment. Valuation historically has been a good long-term metric in assessing the potential future return of an asset. However, with interest rates at depressed levels, asset prices that are expensive based on historical levels, don’t appear to be that expensive given the low interest rate environment. Equity markets in general and growth companies, in particular those that are expected to grow their free cashflow in the future, have benefited from the low interest rate environment as they tend to be more sensitive to interest rates akin to a long duration bond. It could be argued that if interest rates remain at low levels (and possibly lower) risk assets will continue to benefit. Despite this we believe that at some point markets will focus on fundamentals and that the market will need to demonstrate earnings growth to sustain valuations. Furthermore, studies suggest that the relationship between interest rates and valuations is not linear, meaning that markets benefit from low interest rates to a point.

From an asset allocation perspective, valuation remains an important tool to help make active asset allocation decisions. We believe that in the current environment you also need to consider medium-term signals such as where we are in the cycle, liquidity and sentiment, as these factors can influence the extent to which asset prices can remain elevated or depressed for periods of time.

Important information: Any express or implied rating or advice is limited to general advice, it doesn’t consider any personal needs, goals or objectives.  Before making any decision about financial products, consider whether it is personally appropriate for you in light of your personal circumstances. Obtain and consider the Product Disclosure Statement for each financial product and seek professional personal advice before making any decisions regarding a financial product.