Australian fund managers with a value focused investment strategy are struggling to keep up with the index as the market continues its shift in favour of growth stocks.

While value shares have outperformed growth over the past ten years, growth shares have been in front for the past five, despite a value comeback in 2016 and the early part of 2017. Recent performance shows that growth has extended its lead even further, while the average return for value managers is in negative territory so far in 2018 (see chart below).

Calendar year returns for Australian growth and value equity fund managers (% p.a.)

Source: Lonsec

Includes value and growth style Australian equity fund managers rated by Lonsec Research

Value investors look for well-run businesses with solid company fundamentals that may be undervalued due to industry headwinds or temporary negative events. In contrast, growth investors look for businesses with high growth potential or earnings momentum, which can include smaller, scalable businesses or established market leaders.

The behaviour of value and growth shares over different periods, and the tendency for one or the other to outperform, underlines the importance of diversification, not just across markets and sectors, but across investment styles as well. For example, despite the five-year trend, value has outperformed growth significantly over a twenty-year period.

Value versus growth shares (growth of $10,000 to May 2018)

Source: Lonsec, Bloomberg

Despite the relatively lacklustre performance of Australian shares in 2018, growth companies have remained in favour and are currently the main drivers of market returns, among them consumer staples shares like A2 Milk Co (A2M) and Treasury Wine Estates (TWE), as well as some big names like CSL (CSL), Australia’s leading biotechnology business.

Growth shares have dominated through the end of 2017 and the first half of 2018

Source: Lonsec, Bloomberg

Meanwhile, value shares (represented by the MSCI Australia Value Index) have been weighed down by recent poor performance from financials and telecommunication shares, including the major banks which have come under pressure from the Royal Commission into Financial Services. The banks may become attractive propositions from a value perspective, but the question is how long it will take before they regain favour from the broader market.

Release ends

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Warnings: Lonsec reserves the right to withdraw this document at any time and assumes no obligation to update this document after the date of publication. Past performance is not a reliable indicator of future performance. Any express or implied recommendation, rating, or advice presented in this document is a “class service” (as defined in the Financial Advisers Act 2008 (NZ)) or limited to “general advice” (as defined in the Corporations Act (C’th)) and based solely on consideration of data or the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person.

Warnings and Disclosure in relation to particular products: If our general advice relates to the acquisition or possible acquisition or disposal or possible disposal of particular classes of assets or financial product(s), before making any decision the reader should obtain and consider more information, including the Investment Statement or Product Disclosure Statement and, where relevant, refer to Lonsec’s full research report for each financial product, including the disclosure notice. The reader must also consider whether it is personally appropriate in light of his or her financial circumstances or should seek further advice on its appropriateness. It is not a “personalised service” (as defined in the Financial Advisers Act 2008 (NZ)) and does not constitute a recommendation to purchase, hold, redeem or sell any financial product(s), and the reader should seek independent financial advice before investing in any financial product. Lonsec may receive a fee from Fund Manager or Product Issuer (s) for reviewing and rating individual financial product(s), using comprehensive and objective criteria. Lonsec may also receive fees from the Fund Manager or Financial Product Issuer (s) for subscribing to investment research content and services provided by Lonsec.

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The federal government has taken a step toward providing better retirement outcomes for Australians with the appointment of an industry panel to advise on the development of Comprehensive Income Products for Retirement (CIPRs).

Its brief is to help frame the government’s plans to require superannuation trustees to design and offer appropriate income products for their members in retirement.

The panel’s expertise suggests that the eventual framework will reflect a deep understanding of the legal and technical aspects of retirement as well as the social and financial-planning needs of retirees, and perhaps also their behavioural biases.

Regarding the design of income products, it will be interesting to see whether the framework will point super funds in the direction of annuity-like products or drawdown solutions or a combination of the two―or a more expansive and flexible range of choices.

More interesting still will be to see how effectively the framework synthesises these various elements because, as experience in other markets shows, retirees’ financial behaviour can have a direct impact on the success or otherwise of attempts to develop new retirement income products.

The UK is a case in point.

UK Retirees Sit on Cash

Up until 2015 the purchase of an annuity was effectively the only choice open to UK investors when they retired, but low interest rates and other limitations had made annuities unpopular. From that year, the government allowed retirees to choose between annuities and drawdown products.

Predictably, sales of annuities in the UK have plummeted, forcing a restructuring of the retirement income market. Progress to date has been slow, however, and of limited benefit to retirees.

For example, the drawdown alternatives to annuities are mainly high-cost, being accessed through financial advisers and invested in the markets. Perhaps not surprisingly, regulation of such post-retirement products has increased, making them potentially more expensive and harder to access.

At the same time, new product development has been slow. Inflows into those products which have been launched have been small, providing little incentive for competition.

It’s in relation to this last point that the financial behaviour of retirees appears to be most relevant.

Since the pension freedoms came into effect, many retirees have taken large volumes of cash out of their savings early, despite the higher tax charges this incurs.

They have put that cash mainly into (in order of magnitude) bank accounts earning little to no interest and, anecdotally, into cars, conservatories and cruises.

But that’s not all: large amounts of money have been left invested in plan default solutions. Consequently, the amount of money remaining invested beyond retirement, which is neither being drawn down nor added to but kept for a rainy day, has grown massively.

Little wonder, then, that inflows to new retirement income products in the UK have been small.

What lessons, if any, should the panel―and, indeed, the rest of the Australian retirement industry―draw from this?

Three Angles on Retirement Income

There are three, in our view. One is to integrate into the government’s framework some understanding of retirees’ behaviour with respect to savings and investment, its potential impact on demand for retirement products, and how retirement products might be designed with retirees’ behaviour in mind.

Another lesson is that some thought might usefully be given to the way retirees step from work to retirement. It’s at this point that retirees’ financial behaviour becomes an issue as they make, or fail to make, important decisions for their future.

Their decisions could conceivably improve if they had more time to make them. They could, for example, continue to enjoy some capital growth as well as income for many years before investing at a more advanced age in an income-only product.

The third lesson, which is linked to the second, is to view CIPRs as part of a broader retirement solution which includes equity products that can provide growth while managing downside risk, and fixed-income products that can provide reliable income with better-than-average stability.

As the UK experience shows, the key to creating a successful retirement-income solution might lie in understanding, and allowing for, a range of factors beyond that of simple product design.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

In recognition of the growing challenges facing retirees, Lonsec has published a paper on the role annuities can play in retirement portfolios. The paper explores some of the common issues facing retirees such as sequencing risk, longevity risk and market risk.

The main benefits and risks of annuities are considered as well as how annuities can mitigate these risks. The paper examines how annuities can work with the age pension and other investment products to help retirees meet essential spending objectives as well as provide for discretionary spending.

Lonsec believes that annuities are an attractive proposition for retirees looking to secure part of their retirement income stream, including in conjunction with the age pension, to boost the amount of guaranteed income during retirement. Additionally, Lonsec notes that there is a mass market of retirees for whom annuities may be appropriate, typically those with retirement savings of between $250,000 to $1,500,000.

Lonsec does not have a preferred means to best make an allocation to annuities within a diversified investment portfolio but notes there are two commonly held schools of thought. The first is to allocate from the defensive assets within a portfolio and the second is to ‘carve-out’ a separate allocation for the annuity and retain the existing asset class weightings over a smaller asset base.

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.