Super funds are off to a positive start in the December quarter, regaining momentum following a rocky September and paving the way for double-digit returns for the 2019 calendar year.

While markets have come under pressure in recent months, super funds have once again proved they are up to the task of navigating the significant uncertainty in markets, geopolitics, and the global economy.

Super fund returns held up well in October, despite weakness from Australian shares and signs of softer economic growth globally. The major financials sector has come under pressure due to constrained lending, lower net interest margins, and continued fallout from the Royal Commission. IT shares also suffered a dip as investors questioned the lofty valuations of Australia’s local tech darlings.

According to SuperRatings’ estimates, the median balanced option returned a modest 0.3% in October, but the year-to-date return for 2019 is sitting at a very healthy 12.5%. The median growth option has fared even better, returning 14.4%, while the median capital stable option has delivered a respectable 7.1% to the end of October.

Over the past five years, the median balanced option has returned an estimated 7.6% p.a., compared to 8.3% p.a. from growth and 4.7% p.a. from capital stable (see table below).

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

  YTD 1 yr 3 yrs 5 yrs 7 yrs 10 yrs
SR50 Growth (77-90) Index 14.4% 11.9% 10.1% 8.3% 10.1% 8.5%
SR50 Balanced (60-76) Index 12.5% 10.5% 8.9% 7.6% 9.1% 7.9%
SR50 Capital Stable (20-40) Index 7.1% 6.8% 5.0% 4.7% 5.3% 5.6%

Source: SuperRatings

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

  YTD 1 yr 3 yrs 5 yrs 7 yrs 10 yrs
SRP50 Growth (77-90) Index 16.4% 13.3% 11.2% 9.4% 11.4% 9.5%
SRP50 Balanced (60-76) Index 13.8% 11.7% 9.8% 8.3% 9.9% 8.7%
SRP50 Capital Stable (20-40) Index 8.3% 7.7% 5.9% 5.5% 6.0% 6.4%

Source: SuperRatings

“This year has provided further solid evidence of the ability of super funds to deliver for their members through a challenging market environment,” said SuperRatings Executive Director Kirby Rappell.

“Whether it’s the US-China trade conflict, the weaker economic outlook, falling interest rates, or the rolling Brexit saga, there’s been a lot for funds to take in. This has been a real test of their discipline and ability to manage risks on the downside. Growing wealth in this environment while protecting members’ capital is a tall order, but they have managed it well.”

Shifting asset allocation key to managing risk

One of the most important trends in the superannuation industry is the broadening of members’ investments across different asset classes. Over the past five years, super funds have shifted away from Australian shares and fixed income and moved a higher proportion of funds into international shares and alternatives (see chart below).

Change in asset allocation (2009 to 2019)

Super fund asset allocations have shifted towards alternatives

Source: SuperRatings

The shift to alternatives is significant and has been the subject of debate within the industry. Alternatives include private market assets and hedge funds, which despite the negative connotations can provide an important source of diversification and downside protection when markets take a turn for the worse.

These assets tend to be less liquid, but they can play an important role for funds looking to generate income while managing risks for their members in a world characterised by low yields and growing uncertainty. However, funds should be clear about their alternatives strategy and the risks they could potentially add to members’ portfolios.

“This shift in asset allocation is in part being driven by the low interest rate environment, which has prompted super funds to reach for yield by allocating to alternatives and other less liquid assets,” said Mr Rappell.

“This isn’t necessarily a bad thing, and it may in fact result in a more robust asset allocation, but it’s something members should be aware of. Alternatives can help protect capital under certain market conditions, but they can also be used to boost returns by taking on some additional risk. We generally think the shift to a broader asset allocation is positive, but funds should not be complacent in ensuring risk is appropriately managed.”

Lonsec has again been voted Research House of the Year according to an annual survey of financial advisers and fund managers conducted by and reported in Money Management magazine.

Lonsec this year was considered highly regarded among advisers for the quality of its staff, its model portfolio capabilities, value for money, the quality of its consulting services, the depth of its investment product research, and the sophistication of its asset allocation research.

“We’re absolutely delighted to be named Research House of the Year for 2019, and to be voted number one by advisers for the fourth year in a row,” said Lonsec Research Executive Director Libby Newman.

“This is testament to our people, whose commitment to the continual improvement of our research capabilities and the value of our offering has kept us on top.”

The results come as Lonsec launches new enhancements to its iRate platform, which allow users to incorporate ASX shares in their portfolio analysis and comparisons, with individual superannuation investment options to be added in December. This will enable advisers to get the best possible picture of their client’s portfolio, from shares and other listed products to traditional managed funds and superannuation.

“Our ability to provide in-depth investment product research is the most important factor our advisers look for, and we’re happy that they continue to regard us highly in this area,” said Ms Newman.

“We’re also working on delivering the most powerful tools in the market, so you have the best possible view of how your advice delivers value across your client’s portfolio. This is a very exciting time for Lonsec, and we’re grateful to our adviser community for putting their faith in us once again.”

Check out the full results of the Money Management survey.

 

 

 

 

Congratulations to all of the award winners and finalists for this year’s SuperRatings and Lonsec Fund of the Year Awards Dinner. A full list of the awards is available below.

Lonsec Disruptor Award

Drawn from the Lonsec rated universe, products or issuers who have challenged the status quo.

Winner
Vanguard

Finalists
Allianz Retire+
VanEck Vectors MSCI International Sustainable Equity ETF
Vanguard

Lonsec Investment Option Award

Drawn from the Lonsec rated superannuation investment options and based on a qualitative assessment of the investment team and portfolio design to meet member needs.

Winner
Sunsuper for Life (Balanced Fund)

Finalists
AustralianSuper Balanced (MySuper) Investment Option
Cbus Industry Growth
Sunsuper for Life (Balanced Fund)

 

Lonsec Sustainable Investment Award

Seeks to recognise and highlight the work of asset managers and key players incorporating ESG.

Winner
Ausbil Active Sustainable Equity Fund

Finalists
Alphinity Sustainable Share Fund
Ausbil Active Sustainable Equity Fund
BetaShares Australian Sustainability Leaders ETF

Congratulations to all of the award winners and finalists for this year’s SuperRatings and Lonsec Fund of the Year Awards Dinner. A full list of the awards is available below.

SuperRatings Fund of the Year Award

 

Winner
Sunsuper

SuperRatings MySuper of the Year Award

Awarded to the fund that has provided the Best Value for Money Default Offering.

Winner
UniSuper

Finalists
AustralianSuper
CareSuper
Cbus Super
First State Super
HESTA
Hostplus
QSuper
Statewide Super
Sunsuper
UniSuper

 

SuperRatings MyChoice Super of the Year Award

Awarded to the fund with the Best Value for Money Offering for Engaged Members.

Winner
Sunsuper

Finalists
CareSuper
Cbus Super
Hostplus
Mercer Super Trust
QSuper
Statewide Super
Sunsuper
TelstraSuper
UniSuper
VicSuper

 

 

SuperRatings Pension of the Year Award

Awarded to the fund with the Best Value for Money Pension Offering.

Winner
QSuper

Finalists
AustralianSuper
BUSSQ
Equip
HESTA
QSuper
Sunsuper
Tasplan
TelstraSuper
UniSuper
VicSuper

 

 

SuperRatings Career Fund of the Year Award

Awarded to the fund with the offering that is best tailored to its industry sector.

Winner
HESTA

Finalists
Cbus Super
HESTA
Hostplus
Intrust Super
Mercy Super
TelstraSuper

 

SuperRatings Best New Innovation Award

Awarded to the fund that has developed and launched the most innovative product or service during the year.

Winner
Hostplus Self Managed Invest

Finalists
First State Super Explorer
Hostplus Self Managed Invest
Intrust Super SuperCents
Kogan Super
Raiz Invest Super
Sunsuper Adviser Online Transact

 

Infinity Award

Awarded to the fund most committed to addressing its environmental and ethical responsibilities.

Winner
Australian Ethical Super

Finalists
Australian Ethical Super
AMP
CareSuper
Christian Super
HESTA
Local Government Super

 

SuperRatings Momentum Award

Awarded to the fund that has demonstrated significant progress in executing key projects that will enhance its strategic positioning in coming years.

Winner
Cbus Super

Finalists
Cbus Super
HESTA
Mercer Super Trust
Rest
Sunsuper
Tasplan

 

SuperRatings Net Benefit Award

Awarded to the fund with the best Net Benefit outcomes delivered to members over the short and long term.

Winner
AustralianSuper

Finalists
AustralianSuper
CareSuper
Cbus Super
Hostplus
QSuper
UniSuper

 

SuperRatings Smooth Ride Award

Awarded to the fund that has best weathered the ups and downs of the market, while also delivering strong outcomes.

Winner
QSuper

Finalists
CareSuper
Cbus Super
CSC PSSap
HESTA
Media Super
QSuper

 

 

James Syme, Portfolio Manager, Pendal Global Emerging Markets Opportunities Fund

After five tough years, we think the combination of a more benign US monetary outlook and some extremely compelling valuations makes for some powerful opportunities in the emerging market (EM) domestic demand space.
We see domestic demand — the sum of household, government and business spending in an economy including imports but not exports — as the primary area of opportunity in EM, particularly after the 2018 sell-off.
We emphasise an exciting combination of supportive top-down conditions, good quality companies and attractive valuations.

India in favour
India is currently our most favoured market, despite economic growth recently falling to a six-year low.
We like a number of domestic names there including mortgage lenders. Now that the global liquidity outlook has eased, there is the prospect of the Reserve Bank of India continuing to cut rates even as Indian credit growth recovers.
India, unusually in EM, has not had a credit cycle in the last ten years, so the current pick-up in credit could be enduring.
Alongside that, India has ongoing demand for 5-10m residential units per year that need financing.

Mexico and UAE good value
Elsewhere, Mexican equities look markedly cheap relative to history, despite growth being decent, implying some excessively negative market expectations for the political environment.
We also like property stocks in the United Arab Emirates (UAE), particularly in Dubai.
Through its currency peg, the UAE effectively imports US monetary policy. Higher US rates coincided with oversupply of development properties to push real estate prices and related stocks down significantly.
As the Fed’s more accommodative stance improves financial conditions in Dubai, and helped by rising tourist numbers, the prospects for attractively valued Dubai property stocks look good.

South Korea and China
Turning to South Korea, the ongoing corporate governance revolution there is one of the main reasons for our overweight position.
China is a slightly separate story and continues to disappoint.
It has tightened monetary policy significantly in the last two years as the strength of the US dollar has put pressure on the Chinese renminbi, which has been a constraint on the People’s Bank of China’s ability to act.
Activity indicators remain soft, and we think that more stimulus through faster credit creation remains key to a recovery in China.

We’re bullish about:
• The EM domestic demand space offers an exciting combination of supportive top-down conditions, good quality companies and attractive valuations
• A more benign US monetary policy outlook

We’re bearish about:
• Potential for escalation in the US / China trade conflict
• Chinese growth continues to disappoint

Why allocate to Emerging Markets?
As cash rates head below 1%p.a. in Australia, the need for returns from growth assets to offset lower returns from income assets becomes very important for retirees. However in terms of portfolio construction, trying to improve returns without increasing risk becomes very important, due to the increased concerns of retirees around drawdowns. ‘

We believe that a discrete allocation to Emerging Market equities can assist retiree portfolios to achieve these goals because:
• Emerging markets tend to higher GDP growth than developed markets (DM) – and higher equity market returns (+2.46% pa over 20 years^)
• Despite this, emerging market countries are under-represented in most global equity portfolios
• The different growth profiles between DM and EM bring the benefits of diversification to a global equity allocation, without the need to try and time shifts between them.

Figure 1 demonstrates that a simple 50/50 split between MSCI World and MSCI Emerging Markets would have delivered a significantly higher return, at a very small increase in risk, than a purely developed market portfolio over the last fifteen years.

  • Figure 1: Risk-return profile since 1 Jan 2001

^ Calendar year performance of MSCI World and MSCI EM indices in AUD over 20 years to 31 December 2018.

Hear more about emerging markets as London-based portfolio manager Paul Wimborne of J O Hambro Capital Management presents an update in Sydney and Melbourne in November
Sydney (Nov 14)
Melbourne (Nov 12) 

DISCLAIMER
This communication has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 for the exclusive use of advisers and the information contained within is current as at 21 October 2019. It is not to be published, or otherwise made available to any person other than the party to whom it is provided.
PFSL is the responsible entity and issuer of units in the Pendal Global Emerging Markets Opportunities Fund (Fund) ARSN: 159 605 811 (formerly BT Emerging Markets Opportunities Fund). A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1800 813 886 or visiting www.pendalgroup.com. You should obtain and consider the PDS before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund referred to in this presentation is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested.
This communication is for general information purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their or their clients’ objectives, financial situation and needs. This information is not to be regarded as a securities recommendation.
The information in this communication may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information in this communication is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information.
Where performance returns are quoted “After fees” then this assumes reinvestment of distributions and is calculated using exit prices which take into account management costs but not tax you may pay as an investor.

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.

Super funds have managed to push through a challenging quarter for markets, posting gains in September and recovering from August’s falls. Despite the recent volatility and geopolitical risks that have shaken global markets in recent months, Australia’s super funds have proved up to the task of navigating the current uncertainty.

The median balanced option returned 1.2% in September, according to leading superannuation research house SuperRatings. The median growth option fared slightly better, returning 1.5% in September, while the capital stable option returned 0.4%.

It has been a successful year for super funds, which has seen the median balanced option return hit 11.5% over the calendar year to date. Over the past five years, the median balanced option has returned 7.8% p.a., compared to 8.6% p.a. from growth and 4.9% p.a. from capital stable.

Accumulation returns (% p.a. to end of September 2019)

  1 mth 1 yr 3 yrs 5 yrs 7 yrs 10 yrs
SR50 Growth (77-90) Index 1.4% 7.0% 9.1% 9.5% 10.3% 8.3%
SR50 Balanced (60-76) Index 1.2% 6.9% 8.5% 7.8% 9.1% 7.7%
SR50 Capital Stable (20-40) Index 0.4% 5.8% 4.9% 4.9% 5.4% 5.6%

Source: SuperRatings

Pension returns also saw promising growth in September, with the balanced option returning 1.2% over the month, compared to 1.5% from the median growth option and 0.5% from the median capital stable option.

Pension returns (% p.a. to end of September 2019)

  1 mth 1 yr 3 yrs 5 yrs 7 yrs 10 yrs
SRP50 Growth (77-90) Index 1.5% 7.9% 10.6% 9.7% 11.5% 9.3%
SRP50 Balanced (60-76) Index 1.2% 7.8% 9.3% 8.5% 10.0% 8.6%
SRP50 Capital Stable (20-40) Index 0.5% 6.7% 5.6% 5.5% 6.1% 6.3%

Source: SuperRatings

However, while pension returns have held up well, the low rate environment is making it challenging for super funds to deliver income to those in the retirement phase. The RBA’s interest rate cut last week brings the cash rate to a new record low of 0.75% and has pulled longer-term rates down with it. Falling rates have resulted in capital gains in bond markets since the start of 2019, but the downside is the challenge the low rate environment presents to retirees in need of income.

“With interest rates so low, the hunt for yield is intensifying and is likely to become more of a challenge for super funds going forward,” said SuperRatings Executive Director Kirby Rappell.

“Pension returns are holding up well, but the split between capital gains and income is critical for retirees, because they rely on income streams to fund activities in retirement. Over the past few years we’ve seen super funds steadily reduce their allocation to bonds in favour of other income-generating assets like alternatives and property in order to generate their required yield. We expect this theme to continue to play out as rates remain low and possibly move lower over the next year or two.”

The income challenge

The key theme throughout 2019 has been the steady fall in yields as uncertainty surrounding the economic outlook has seen investors move into bonds and other safe assets. In Australia, the yield on 10-year government bonds ended September at 1.0%, down from 2.3% at the start of 2019. As the chart below shows, yields have been on the decline since the Global Financial Crisis, with the 10-year yield falling from a high of 6.5% just prior to the market meltdown. Meanwhile, the cash rate is now 225 basis points below the “emergency lows” of 2009.

Falling yields have supported capital growth but at the expense of income

10-year bond yields are at an all-time low

Source: Bloomberg, SuperRatings

Over the past 15 years to September 2019, an estimated growth rate of 6.9% was observed for the SR50 (60-76%) Balanced Index, which is well ahead of the return objective of inflation plus 3.0%. Over this period, a starting balance of $100,000 in the median balanced option would have accumulated to over $271,000, which exceeds the return objective by around $43,000.

Growth in $100,000 invested over 15 years to 30 September 2019

Super funds have exceeded their return objective

Source: SuperRatings

“Long-term super returns are healthy, even when you include the GFC period,” said Mr Rappell. “However, there’s no doubt that super funds are finding it harder to identify opportunities in the current environment. With valuations stretched, funds are paying more for growth, while lower interest rates mean they need to look beyond traditional assets to generate income.”

Many behavioural studies have shown there are several traits and biases that can impede us from making reasonable decisions about everything from what to eat to how to invest. Understanding these biases and considering whether they may be negatively impacting decisions can be beneficial when implementing long-term investment plans. These studies show, in general, people have asymmetric risk profiles and fear losses more than the expectation of gains by at least a 2:1 margin[1]. Interestingly, and perhaps not surprisingly, this ratio increases substantially as people approach retirement.

American psychologist and economist, Daniel Kahneman, who won a Nobel Prize for his work challenging the prevailing assumption of human rationality in modern economic theory has stated, ‘If you have an individual whose objective is to maximise wealth at a certain future point in time, then loss aversion is very bad because loss aversion will cause that individual to miss out on many opportunities.’

This loss avoidance trait stands in contrast to a basic investment principal, that investors need to accept higher risk (and higher potential for near-term losses) in order to achieve higher returns over the long term, particularly during market sell-offs. When faced with losses, rational decision-making can become impaired by the emotional desire to avoid more losses.

There are a wide range of cognitive biases that can impact retirement plans, some are listed below:

Confirmation bias

Confirmation bias is the natural human tendency to seek information that confirms an existing point of view or hypothesis. This can lead to overconfidence if investors keep seeing data that appears to confirm the decisions they have made. This overconfidence can result in a false sense that nothing is likely to go wrong, increasing the risk of being blindsided when something does go wrong.

Information bias

Information bias is the tendency to evaluate information even when it is useless in understanding a problem or issue. Investors are exposed to an array of information daily, and it is difficult to filter through this and focus on the relevant information. In general, investors would make superior investment decisions if they ignored daily share price movements and focused on prices compared to the medium-term prospects for the investments. By ignoring daily share price commentary, investors would overcome a dangerous source of information bias in the investment decision making process.

Loss aversion bias

Loss aversion is the tendency for people to strongly prefer avoiding losses than obtaining gains. The loss aversion effect can lead to poor and irrational investment decisions, where investors refuse to sell loss-making investments in the hope of making their money back. Investors fixated on loss aversion can miss investment opportunities by failing to properly consider the opportunity cost of their investments.

Anchoring bias

Anchoring bias is the tendency to rely too heavily on, or anchor to, a past reference or one piece of information when making an investment decision. For example, if you were asked to forecast a stock’s price in three months’ time, many would start by looking at the price today and then make certain assumptions to arrive at a future price. That’s a form of anchoring bias – starting with a price today and building a sense of value based on that anchor.

How do we try and overcome the biases when building retirement portfolios?

The objective based nature of Lonsec’s Retirement portfolios means there is a greater focus on absolute rather than relative performance. Additionally, the portfolios have been constructed to manage risks, including:

  • Market and sequencing risk
  • Inflation risk
  • Longevity risk

Some investment strategies that can assist in controlling for these risks include:

Variable beta strategies can vary equity market exposure by allocating to cash in periods where equity market opportunities are perceived to be limited due to expensive valuations, or where market downside risk is considered high.

Long / Short – Active Extension (also known as 130/30 funds) utilise a broad range of strategies including short selling and adjusting the net equity position for performance enhancement, risk management and hedging purposes.

Multi-asset real return funds invest in a wide range of asset classes, with the managers having considerable flexibility in the type and percentage of asset classes allocated to. Typically, these funds will seek to limit downside risk, while also targeting a real return i.e. a CPI + objective.

Real assets such as property and infrastructure, commodities and inflation linked bonds can assist in managing against inflation risk.

When constructing the Retirement portfolios, Lonsec takes a building block approach by assigning a role for each fund – yield generation, capital growth and risk control.

The yield component of the portfolios generate yield, or a certain level of income from investments that have differing risk return characteristics. The capital growth component is designed to generate long term capital growth, with limited focus on income, and is more suited to early retirees. The risk control component is critical for retirement portfolios and is designed to reduce some of the market risks in the yield and capital growth components. It is important to note that the risk control part of the portfolios will not eliminate these risks but aims to mitigate them. Asset allocation and diversification are also important ingredients in managing the overall volatility of the portfolios.

The Retirement portfolios can assist in managing the risks that impact retirees, however it is important to note that none of these strategies provide a guaranteed outcome. The range of products that offer certainty of income or capital protection such as annuities has increased in recent years, in recognition of Australia’s aging demographics and demand for greater certainty in retirement. Separate guidance on the use of annuities is available from Lonsec.

 

[1] Gachter, Johnson, Herrmann (2010). Individual – level loss aversion in riskless and risky choices. Columbia Business School

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