Lonsec Retirement Perspectives Archives

Why do we have Fixed Income as part of your broader portfolios?

Fixed Income is added to a broad portfolio of assets for several reasons. They include:

Return: Frequent income from the cash flows of the coupon or interest payments to stabilise the risk and return of your client’s portfolio.
Defensive: Capital Preservation. The relatively steady return of capital of fixed-income products (unless there is a credit event default with particular debt security) can partly offset losses from a decline in share prices.
Risk Diversification: Broadening the opportunity set in a multi-asset portfolio to diversify risk.

Although there are many benefits to fixed income products, as with all investments, there are several risks investors should be aware of.

Credit and Default Risk: Federal, State, and Semi-Government bonds and securities have the backing of the relevant Government. Whereas, corporate bonds, are backed by the financial viability of the underlying company. Should a company declare bankruptcy, bondholders have a higher claim on company assets than do common shareholders. Bonds with credit ratings below BBB are of lower quality and considered below investment grade or junk bonds
Interest Rate Risk: This risk happens in an environment like now whereby market interest rates are rising, and the price paid by the bond falls behind. In this case, the bond would lose value in the secondary bond market if sold or market to market on a daily basis like share prices.
Market Risk: The prices of bonds (like shares) can increase and decrease over the life of the bond. If the investor holds the bond until its maturity, the price movements are immaterial since the investor will be paid the par face value (usually the 100 cents in the dollar) of the bond upon maturity. However, if the bondholder sells the bond before its maturity through a broker or financial institution in the secondary market, the investor will receive the current market price at the time of the sale. The selling price could result in a gain or loss on the bond investment depending on the underlying corporation, the coupon interest rate, and the current market interest rate.
Inflation Risk: Inflationary risk is also a danger to fixed-income investors. The pace at which prices rise in the economy is called inflation. If inflation increases, it eats into the gains of fixed income securities. For example, if fixed-rate debt security pays a 3% return and inflation rises by 5%, the investor loses out, earning only a -2% return in real terms.

What’s Better for Fixed Income Investors when Interest Rates are Rising?

During a period of rising interest rates (yields) fixed-income investments that pay a fixed rate of interest, such as bonds are not helpful, for two reasons:

Firstly, there is an inverse relationship between a bond’s price and its yield – as interest rates increase, bonds fall in value, so bondholders can face capital losses if the bonds are sold prior to maturity. If not sold prior to maturity and they do not default, you get the original par value back plus interest.

Secondly, the income stream from fixed-rate bonds remains the same until maturity. However, as inflation rises, the purchasing power of the interest payments declines.

Investments that pay a floating rate of return are likely to be better off in an inflationary environment, as the interest rate they pay is adjusted periodically such as every 90 days to reflect market rates. If interest rates rise, the interest paid by the investment should also increase at the next reset date. Investors in these types of securities and products do like interest rate hikes as they have very little interest rate duration (or term) risk.

Inflation is generally regarded as damaging to holders of cash and cash equivalents securities or products since the value of cash usually does not keep pace with the increased price of goods and services.

Strategies Employed by Lonsec’s Managers For Diversifying Fixed Income Portfolios During a Climate of Rising inflation and Interest rates

Typically, you take into consideration the client’s return, risk, time horizon, and liquidity expectations.

Usually, such a portfolio is expected to have a minimum time horizon of three years and provide monthly or quarterly income with a level of liquidity to pay their monthly retirement benefits with minimal impact on their capital.

The anchor for the fixed income portfolio is an active fund manager with a core portfolio of investment-grade coupon-paying bonds that continually mature at par into the next series of bonds. In the current investment climate, these active managers have already taken defensive positions by reducing interest rate risk in the portfolio to below benchmark levels of duration and rotating into higher quality rated bonds. Yes, the daily mark to market price will fluctuate and I have seen portfolios of fixed-rate bonds in some cases now down 8% over one year to the end of April 2022. However, the fixed income portfolio manager is unlikely to sell them before maturity (assuming fund flows are unchanged), and if the bonds don’t default you will get your par value principle back. As the current bond market correction continues in a typical once-a-decade event now is not the time to crystalize your mark to market paper losses. Continue to focus on your three-year strategy and the fund manager will wait for the opportune time to add interest rate risk to core bond holdings when the economic growth fundamentals start to slow and suggest inflationary pressures have peaked. By then the yields and the carry will be much higher in the portfolio.

The next part of the portfolio is your non-core strategies to enhance your income yield with some additional sub-sector strategies including credit, emerging markets, securitised assets.

Within these sub-sectors, it is important to note the following strategies. During this rate hike period floating-rate (or variable investment) strategies will do better than fixed-rate strategies as short-term rates rise due to the regular monthly or quarterly rate reset higher. Remember Floating Rate Portfolio Managers want short-term interest rates to go higher so they can pass on the higher income to their investors. Since you have a diversified portfolio of strategies this component of your portfolio will do well.

In terms of credit strategies, your typical credit manager will also be already defensively positioned. it is important in terms of capital preservation and market volatility to be higher up the capital structure in senior or senior secured debt rather than unsecured debt or hybrids. If interest rates rise too quickly and too high for an extended period, economic growth slows then the level of defaults is at risk of rising. Better to have a bias towards secured debt whereby you are protected by mortgaged assets. Also, the further up the capital structure you are the equity market beta reduces. What that means is debt lower down the capital structure usually moves in about a 0.7 correlation with equity prices. So, if equity or equities go down say 10% in price, lower down the capital structure debt such as unsecured or hybrids may go down an estimated 7% in price terms (and the reverse happens when share prices are rising and the Fund manager rotates down the capital structure). So, the credit fund manager may have added some floating-rate private secured debt or bank loans (subject to the credit rating) strategies in order to reduce the market volatility and increase capital preservation within your portfolio.

Finally, all the active strategies would be keeping up a higher-than-normal level of liquidity to quickly rotate back into higher-yielding credit and interest rate risk strategies when they deem it to be safe to do so.

Lonsec as part of our portfolio construction investment process monitors and actively manages the exposure to fixed interest assets taking into account the prevailing market conditions and risks. The current environment has been challenging for fixed interest managers; however, the market volatility will present investment opportunities and at some point, the yields offered from fixed income will warrant further investigation.

IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research). LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services. LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of 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. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness. If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2022 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright. The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

May 10, 2022/by Ron Mehmet

Lonsec Retirement Perspectives, Managed Accounts, News & Insights

Lonsec Retirement Managed Portfolios Update

Quarterly Update – Q1 2022

It’s been a volatile quarter for equity and bond markets, with existing inflationary fears further exacerbated by the Russian invasion of the Ukraine. While Russia is small in terms of its impact on capital markets, it is a big exporter of commodities, including oil, gas and agriculture as well as fertilisers. It therefore has a meaningful impact on trade and the global economy itself which has impacted investor sentiment more broadly. The result has been further pressure on already stretched supply chains, skyrocketing commodity prices and further inflationary pressures which have added to existing market stresses.

IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research). LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services. LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of 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. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness. If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2022 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright. The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

April 22, 2022/by Lonsec

Industry Retirement Insights, Lonsec Retirement Perspectives, News & Insights, Video

Managers in Focus – Fixed Income

Lonsec Research chatted with leading Fixed Income Managers to learn more about the sector, how they are approaching the changing investment landscape and what drew them to this sometimes overlooked, but very important, sector.

In this video, Isrin Khor, Lonsec Sector Manager of Fixed Income is joined by Anthony Kirkham, Head of Melbourne Operations and Investment Management/Portfolio Manager at Western Asset Management, and Sachin Gupta, Managing Director and Head of the Global Desk at PIMCO. The discussion focuses on the key qualitative strengths of PIMCO and Western Asset, particularly on business, people, and the process followed by a market outlook discussion.

IMPORTANT NOTICE: This video is published by Lonsec Research Pty Ltd ABN 11 151 658 561, AFSL No. 421445 (Lonsec). Please read the following before making any investment decision about any financial product mentioned in this video.
Disclosure as at the date of publication: Lonsec receives fees from fund managers or product issuers for researching their financial product(s) using comprehensive and objective criteria. Lonsec receives subscriptions for providing research content to subscribers including fund managers and product issuers. Lonsec receives fees for providing investment consulting advice to clients, which includes model portfolios, approved product lists and other advice. Lonsec’s fees are not linked to the product rating outcome or the inclusion of products in model portfolios, or in approved product lists. Lonsec and its representatives, Authorised Representatives and their respective associates may have positions in the financial product(s) mentioned in this video, which may change during the life of this video, but Lonsec considers such holdings not to be sufficiently material to compromise any recommendation or advice.
Warnings: Past performance is not a reliable indicator of future performance. The information contained in this video is obtained from various sources deemed to be reliable. It is not guaranteed as accurate or complete and should not be relied upon as such. Opinions expressed are subject to change. This video is but one tool to help make investment decisions. The changing character of markets requires constant analysis and may result in changes. Any express or implied rating or advice presented in this video is limited to “General Advice” (as defined in the Corporations Act 2001 (Cth)) and based solely on consideration of 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. It does not constitute a recommendation to purchase, redeem or sell the relevant financial product(s).
Before making an investment decision based on the rating(s) or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances, or should seek independent financial advice on its appropriateness. If our advice relates to the acquisition or possible acquisition of particular financial product(s), the reader should obtain and consider the Investment Statement or Product Disclosure Statement for each financial product before making any decision about whether to acquire a financial product. Where Lonsec’s research process relies upon the participation of the fund manager(s) or product issuer(s) and they are no longer an active participant in Lonsec’s research process, Lonsec reserves the right to withdraw the video at any time and discontinue future coverage of the financial product(s).
Disclaimer: This video is for the exclusive use of the person to whom it is provided by Lonsec and must not be used or relied upon by any other person. No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this video, which is drawn from third party information or opinion not verified by Lonsec. Financial conclusions, ratings and advice are reasonably held at the time of completion but subject to change without notice. Lonsec assumes no obligation to update this video following publication. Except for any liability which cannot be excluded, Lonsec, its directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this video or any loss or damage suffered by the viewer or any other person as a consequence of relying upon it.

Copyright © 2021 Lonsec Research Pty Ltd (ABN 11 151 658 561, AFSL No. 421445) (Lonsec). This video is subject to copyright of Lonsec. Except for the temporary copy held in a computer’s cache and a single permanent copy for your personal reference or other than as permitted under the Copyright Act 1968 (Cth), no part of this video may, in any form or by any means (electronic, mechanical, micro-copying, photocopying, recording or otherwise), be reproduced, stored or transmitted without the prior written permission of Lonsec.

This video may also contain third party supplied material that is subject to copyright. Any such material is the intellectual property of that third party or its content providers. The same restrictions applying above to Lonsec copyrighted material, applies to such third party content.

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.

April 12, 2022/by Lonsec

Lonsec Retirement Perspectives, Media releases, News & Insights

Accessing Advice Helps Drive Better Retirement Lifestyle

With half the country in what seems never ending rounds of lockdowns and pandemic fatigue setting in, one of the last things most Australians want to do is look at their Superannuation balances and investment options. That is, however, exactly what SuperRatings is wanting us to do, as neglecting your super or responding to short term market moves can have a detrimental effect on your super balance.

SuperRatings Executive Director Kirby Rappell says, ‘We looked at the impact of switching out of a balanced or growth option and into cash at the start of the pandemic and found that those with a balance of $100,000 in January 2020 and who switched to cash at the end of March would now be around $22-27,000 worse off than if they had not switched.’

This effect of switching into cash as a response to market turmoil is also seen when looking at returns over the past 15 years. In this period, a typical balanced Super option has risen substantially, with a balance of $100,000 in July 2006 accumulating to $247,557, more than doubling in size. Those members investing in a growth option have experienced an even stronger result, with a similar starting balance growing to $254,006. Share focused options have delivered the highest returns, with the median Australian shares option growing to $276,099 and the median international shares option growing to $271,051, though these types of options involve greater risks. Over the same period, a $100,000 balance invested in cash would only be worth $151,158 today.

When considering your Super options, you don’t need to go it alone as many Super funds provide advice and tools to their members. Says Mr Rappell, ‘Most funds will offer scaled advice for free or at a low cost, with members able to get advice on topics such as contributions, investment options, insurance in the fund and the transition to retirement.’ Scaled advice is general in nature so you will need to check if your situation and goals align with the advice.
Continues Mr Rappell, ‘For members who want more tailored advice, some funds will offer comprehensive advice that will also take into account your financial assets outside of superannuation.’ While there will be a cost associated with this comprehensive advice, most funds will allow the cost of the advice to be deducted from the superannuation account, just make sure you check any costs and how they can be paid before agreeing to get the advice.
Looking at more recent returns, balances continued to grow in July. The typical balanced option returned an estimated 1.3% over the month and 18.5% over the year. The typical growth option returned an estimated 1.3% for the month and the median capital stable option also increased 0.9% in the month.

Accumulation returns to July 2021

	FYTD	1 yr	3 yrs (p.a.)	5 yrs (p.a.)	7 yrs (p.a.)	10 yrs (p.a.)
SR50 Balanced (60-76) Index	1.3%	18.5%	7.9%	8.4%	8.0%	8.6%
SR50 Capital Stable (20-40) Index	0.9%	7.8%	4.5%	4.5%	4.8%	5.3%
SR50 Growth (77-90) Index	1.3%	22.7%	9.2%	9.5%	8.9%	9.6%

Source: SuperRatings estimates

Pension returns were also positive in July. The median balanced pension option returned an estimated 1.3% over the month and 20.0% over the year. The median pension growth option returned an estimated 1.5% and the median capital stable option also rose an estimated 0.9% in the month.

Pension returns to July 2021

	FYTD	1 yr	3 yrs (p.a.)	5 yrs (p.a.)	7 yrs (p.a.)	10 yrs (p.a.)
SRP50 Balanced (60-76) Index	1.3%	20.0%	8.4%	9.1%	8.5%	9.5%
SRP50 Capital Stable (20-40) Index	0.9%	8.6%	5.2%	5.2%	5.2%	5.9%
SRP50 Growth (77-90) Index	1.5%	24.4%	9.7%	10.3%	9.8%	10.6%

Source: SuperRatings estimates

Release ends

Warnings: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to “General Advice” (as defined in the Corporations Act 2001(Cth)) and based solely on consideration of the merits of the superannuation or pension financial product(s) alone, without taking into account the objectives, financial situation or particular needs (‘financial circumstances’) of any particular person. Before making an investment decision based on the rating(s) or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances, or should seek independent financial advice on its appropriateness. If SuperRatings advice relates to the acquisition or possible acquisition of particular financial product(s), the reader should obtain and consider the Product Disclosure Statement for each superannuation or pension financial product before making any decision about whether to acquire a financial product. SuperRatings research process relies upon the participation of the superannuation fund or product issuer(s). Should the superannuation fund or product issuer(s) no longer be an active participant in SuperRatings research process, SuperRatings reserves the right to withdraw the rating and document at any time and discontinue future coverage of the superannuation and pension financial product(s).

Copyright © 2021 SuperRatings Pty Ltd (ABN 95 100 192 283 AFSL No. 311880 (SuperRatings)). This media release is subject to the copyright of SuperRatings. Except for the temporary copy held in a computer’s cache and a single permanent copy for your personal reference or other than as permitted under the Copyright Act 1968 (Cth.), no part of this media release may, in any form or by any means (electronic, mechanical, micro-copying, photocopying, recording or otherwise), be reproduced, stored or transmitted without the prior written permission of SuperRatings. This media release may also contain third party supplied material that is subject to copyright. Any such material is the intellectual property of that third party or its content providers. The same restrictions applying above to SuperRatings copyrighted material, applies to such third party content.

August 20, 2021/by Nicci Chaplin

Lonsec Retirement Perspectives, News & Insights

Why having a sound investment philosophy and framework is important during uncertain times

The biggest challenge for investors in an environment such as the one we are experiencing now is that there is a lot of information, the environment is changing rapidly and there are many unknowns. In the past several weeks we have witnessed one of the fastest drops in markets in history, bond market liquidity has dried up, unemployment is rising, robust business models have unraveled with businesses such as Virgin Australia forced into administration and we have seen unprecedented levels of government stimulus. This follows an extended period where equity market returns were strong and volatility was at historically low levels.

Whether you are running an investment committee or speaking to clients in such an environment, going back to basics is warranted. Referring to your investment philosophy and the investment framework that underpins it is fundamental in periods such as this. Importantly, it will assist in avoiding making reactive investment decisions that can have an adverse impact on the long-term outcomes of your portfolios. This is particularly important in the current environment where there is a proliferation of news flow. On a client level, dusting off the investment philosophy and refocusing your client’s attention on your fundamental investment beliefs will help you deal with nervous clients and aid in preventing them from making kneejerk decisions relating to their investments. If we cast our minds back to the GFC, we know that clients that were reactive and cashed out from a typical balanced portfolio locked in a loss of about 8.5% on average, whereas those that remained invested, benefitted from the subsequent rebound in markets.

At the core of Lonsec’s investment philosophy is our belief in a diversified portfolio approach across asset classes and investment strategies with a strong focus on risk management. We aim to do this through a combination of active asset allocation decisions focused on managing risk and active bottom-up investment selection focused on ensuring portfolio are diversified not only by asset class but also investment strategies. As a practical example, in the current environment our focus within asset allocation remains on valuation, cyclical and liquidity factors and market sentiment. This provides us a starting point for assessing the current environment.

From a bottom-up fund selection perspective, we remain focused on understanding the role that every fund plays in the portfolio recognising that during periods of severe market dislocation, our ‘risk control’ funds should provide some dampening against this volatility, whereas our ‘growth’ funds will more than likely suffer the full extent of any market moves.

The strength of having an investment framework will assist navigating through uncertain times as it helps understand performance drivers and ‘where to from here” scenarios. Additionally, it ensures that conversations we have with clients on expectations of portfolio performance are clear and easily understood.

For more information about how Lonsec can help you with your investment philosophy and process, please contact us on 1300 826 395 or info@lonsec.com.au.

April 27, 2020/by Veronica Klaus

Lonsec Retirement Perspectives

Retirement Income Review – what you should know

What is it?

In September 2019, Treasurer Josh Frydenberg announced a long-awaited independent review of Australia’s retirement income system.

The review, recommended by the Productivity Commission, will examine the retirement income system’s ‘three pillars’ –

the age pension,
superannuation, and
voluntary savings, including home ownership.

The Commission urged the government to carry out the review before increasing the superannuation guarantee (SG) rate. The SG is scheduled to rise in stages to 12% by 2025.

The review provides an important opportunity to evaluate how Australia’s retirement income system is tracking and what reforms may be needed to ensure the system is both equitable and sustainable over the long term. The system needs to accommodate the challenges of Australia’s ageing population and more people entering retirement with debt or without the security of a home.

Who is undertaking the review?

The review will be chaired by former senior treasury official Mike Callaghan, a former executive director of the IMF, and will include Carolyn Kay, a director of the Future Fund, and Deborah Ralston, professorial fellow in banking and finance at Monash University and a member of the central bank’s payments system board. She is also chair of the SMSF Association but will step down while working on the review.

The final report will be provided to the government by June 2020.

What will the review consider?

The terms of reference are quite high-level and broad and could cover:

home ownership – the review will examine the growing number of non-home owner retirees and how people survive the private rental market.
the interaction between super and the age pension – whether the means test acts as a disincentive to saving given the more super you have, the less pension you get. Also, whether an income test as well as an assets test is needed (Australia has two tests, unlike most other countries).
superannuation tax concessions.
income and intergenerational equity, and
the cost to the federal budget.

What it won’t cover

Industry experts have pushed for sensitive issues to be probed, such as including the value of a retiree’s home in the means test for the age pension and aged care, lifting the qualifying age for the government pension and overhauling superannuation tax breaks for the wealthy. However, the government appears to have ruled out touching some sensitive parts of the system, such as including the principal place of residence in the age pension asset test and cutting generous super tax concessions.

Concerns

In general, the review has been welcomed by industry participants, however, most have warned against ‘changing the goalposts’ on legislative arrangements for Australians who have already retired and are already partly or fully self-funding their retirement.

The government has sought to ease concerns with Senator Cormann stating the inquiry will not lead to a ‘major wave of significant reforms’ and will present a fact base which will inform the public about where the system is at and how it operates.

There is also nervousness about whether the government will seek to use the inquiry to abandon its timetable for increasing the superannuation guarantee (SG) to 12% by 2025 and reduce the beneficial tax treatment of superannuation, particularly for large balance holders.

Lonsec’s view

Lonsec believes that whatever the government is seeking to achieve from the review should be revealed to the industry as soon as possible. This will help provide clarity to those product providers operating in the Australian financial services industry looking to deliver new retirement products and services but are reluctant to do so until they fully understand the changing regulatory landscape.

The timeframe for the review recommendations is mid-year, however as any changes to the retirement income system become likely, Lonsec will provide a summary of these and help make sense of the implications for advisers.

February 5, 2020/by Michael Elsworth

Lonsec Retirement Perspectives, News & Insights

Combining retirement and behavioural biases can be a dangerous mix

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

October 17, 2019/by Michael Elsworth

Lonsec Retirement Perspectives, News & Insights

Risk measurements in retirement solutions

When accumulating savings for retirement, the investment objective is clear – to grow and maximise savings. Risk in the accumulation phase is also well-defined and focused on the loss of capital, as measured by the volatility of investment returns or related downside risk measures. Risk tolerance is then typically used to determine appropriate investment profiles, with the aim of achieving greater wealth to fund retirements.

However, the risk-return landscape becomes significantly more complex once retirement comes into the picture. The primary objective in the decumulation phase ceases to be pure growth and more about using accumulated wealth to sustain a target level of income throughout retirement. Therefore, volatility of investment returns is no longer a suitable risk measure as it does not describe the risk of failing to meet this objective.

Retirement income risk measure

Traditional measures of variance (standard deviation) focus on both upside and downside variation. However, behavioural economists commonly point out that individuals are more averse to downside variation than upside variation. A more relevant risk measure in the context of decumulation is the probability of running out of money, or a measure of income variation. This captures important dynamics such as the sequence of returns, which can be particularly damaging in decumulation.

The risk can be depicted as:

The importance of risk measurement in retirement products is highlighted in a Treasury consultation paper which proposes a range of standard metrics to help consumers make decisions about the most appropriate retirement income product for their own circumstances.

The discussion paper proposes that a measure of income variation be provided in respect of all retirement income products and this measure is presented on a seven-point scale.

The finance industry uses terms like longevity risk, market risk, sequencing risk and inflation risk, which are all relevant to the outcome experienced by investors in a retirement income product. However, these terms are not well understood by a lay person, so an income variation measure could help fill in some gaps.

Retirement objectives

Lonsec’s Retirement Lifestyle Portfolios are objectives-based portfolios focused on delivering a sustainable level of income in retirement, as well as generating capital growth. Specifically, the portfolios are designed to assist advisers in constructing portfolios to meet retiree essential and discretionary income needs, while generating some capital growth to meet lifestyle goals.

Differences to Lonsec’s core accumulation model portfolios are:

Income objective of 4% p.a. for all portfolios
Greater bias to AUD denominated assets – historically higher dividends, franking credits
Greater focus on absolute rather than relative performance
Constructed to manage capital drawdown risk
Fixed income allocations have less duration and greater credit exposure
Key building blocks are Yield, Capital Growth & Risk Control

In reality, risk in retirement is multi-dimensional. An individual retiree may have multiple goals, such as leaving a bequest, with a different level of importance attached to each. An individual’s risk aversion in retirement will therefore be defined by a holistic view of their retirement goals, and the risks to those goals across all scenarios that could play out during retirement. Typically, more than one risk measure is necessary, with multiple scenarios required to truly appreciate the risks inherent with each solution.

September 17, 2019/by Michael Elsworth

Lonsec Retirement Perspectives

Superannuation Guarantee – time to pause & reflect or full steam ahead?

After almost 30 years since the introduction of compulsory superannuation in Australia, many practitioners have called for a review of the superannuation guarantee (SG) system before the legislated increase in employers’ compulsory contributions from 9.5% to 12% by 2025. These increases are:

Period	Super Guarantee (%)
1 July 2002 – 30 June 2013	9.00
1 July 2013 – 30 June 2014	9.25
1 July 2014 – 30 June 2021	9.50
1 July 2021 – 30 June 2022	10.00
1 July 2022 – 30 June 2023	10.50
1 July 2023 – 30 June 2024	11.00
1 July 2024 – 30 June 2025	11.50
1 July 2025 – 30 June 2026 onwards	12.00

Source: Australian Tax Office

The case against

The Grattan Institute recently published research showing that higher SG contributions would not be in the interests of many working Australians as many middle-income workers would give up wages of up to 2.5 per cent while working, in exchange for less than a 1 per cent boost to their retirement incomes. Grattan argues almost all the extra income from a higher super balance at retirement would be offset by lower age pension payments, due to the pension assets test. Pension payments themselves would also be lower under a 12 per cent super regime, because they are benchmarked to wages, which would be lower if employers contributed more to super. Grattan calculates that lifting compulsory super from 9.5% of wages to 12% would make the typical worker up to $30,000 poorer over their lifetimes.

Not surprisingly, these findings have sparked fierce debate amongst industry practitioners, with some questioning the assumptions made by the Grattan Institute, contending their calculations are based on people working until age 67 when in fact many retire before this for numerous reasons. The adequacy of the ASFA retirement standards is also a point of difference between protagonists. Grattan contends the ASFA retirement standards would mean many retirees would be significantly better off in retirement and this was not the purpose of super. Grattan’s research showed that most people reaching retirement would achieve 70 per cent of the income they had while they worked, a reasonable outcome given that in retirement most people have lower costs with children having left home and many without mortgages.

The case for

According to the Committee for Sustainable Retirement Incomes analysis, for those not eligible for an age pension (likely to be at least 40% of retirees into the future), maintaining pre-retirement living standards will require contributions of 15-20% (18% is the OECD average); for those eligible for some age pension, the contribution rate required will be lower but, even at typical earnings, would most likely be more than 12%.

Mercer contends Australia’s retirement system is not up to the standard of better systems overseas and still required the SG to move to 12% to provide comfortable retirements. Despite being compulsory, Australia’s super system covers only 75.7% of the population while comparable systems covered 80 to 90% of the population. Mercer also believes Australia’s SG contributions need to rise to 12% to ensure retirement income levels reach OECD averages. International comparisons showed Australia’s pension and retirement system in a positive light, with the Melbourne Mercer Global Pension Index in 2018 listing Australia at No.4 out of 34 countries examined. However, once the net replacement rate of pre-retirement income is factored in Australia does not compare so favourably. The OECD said Australia’s average net replacement rate was 40.7%, while for the OECD it was 65%.

No discussion could be complete without the views of former Prime Minister Paul Keating, the architect of the current SG system whose frustration at the current discourse was evident recently. He heavily criticised Liberal MPs proposing to scrap a plan to raise the SG, saying the suggestion that an increase would stifle wage growth was a ‘great lie’ and likening those against the SG increase to climate change deniers and anti-vaxxers.

What’s next?

There are many critics that suggest a redesigned assets test could help ensure increased savings boost retirement incomes. Grattan’s findings that an increase in savings through the SG would lead to a reduction in lifetime incomes is true of a voluntary increase in savings in any form other than increased investment in the family home. A better designed assets test, perhaps even a merging of the income and assets tests, could help ensure savings are not unduly penalised.

What would be beneficial is if industry practitioners articulated what they consider to be the objective of the retirement incomes system, and focused analysis on whether increasing the SG would or would not help to achieve that objective, and at what cost. A good starting point would be that Australians have secure and adequate incomes at and through retirement. ‘Adequacy’ would seemingly have two components, though there appears to be debate around the send point:

sufficient to ensure no aged person lives in poverty (the role of the age pension); and
sufficient to maintain pre-retirement living standards (the role of superannuation and other savings)

Only when there is broad agreement on these points can the problem of how to best achieve them can be solved.

August 26, 2019/by Michael Elsworth

Lonsec Retirement Perspectives

Record low interest rates – implications for retirees

With the Reserve Bank of Australia (RBA) cutting the official cash rate to just 1.00% on 2 July, retirees and investors face increased challenges in deriving enough income from their investments to meet their needs. This is an ongoing issue with more interest rate cuts forecast by financial markets. The following chart puts this challenge in perspective.

Key rates are on the way down in the world’s largest economies

Source: Reserve Bank of Australia, June 2019

Lonsec’s Retirement Lifestyle Portfolios are objectives-based portfolios focused on delivering a sustainable level of income in retirement, as well as generating capital growth. Specifically, the portfolios are designed to assist advisers in constructing portfolios to meet retiree essential and discretionary income needs, while generating some capital growth to meet lifestyle goals.

Differences to Lonsec’s core accumulation model portfolios are:

Income objective of 4% p.a. for all portfolios
Greater bias to AUD denominated assets – historically higher dividends, franking credits
Greater focus on absolute rather than relative performance
Constructed to manage capital drawdown risk
Fixed income allocations have less duration and greater credit exposure
Key building blocks are Yield, Capital Growth & Risk Control

With 10 year Australian government bond yields currently less than 1.50% p.a., Lonsec has opted for a diversified approach to meeting this income objective. Income in these portfolios is generated by the following funds:

Equity funds
Legg Mason Martin Currie Real Income Fund	A portfolio of listed companies that own ‘hard’ physical assets, like property, utilities and infrastructure (e.g. A-REITs, airports, toll roads, electricity and gas grids). Real Asset companies like these are an integral part of everyday life and are often monopolistic in nature. Their demand profile is, therefore, relatively inelastic and not pegged to the business cycle, hence these companies have more predictable free cash flow and dividends. The typically long-term nature of their cash flows (underpinned by long term contracts and favourable regulatory structures) also offers protection during market downturns, as well as upside growth potential from population growth. This means Real Asset companies typically have a low beta versus the broader equity market and can provide low-volatility, regular and dependable income streams.
Plato Australian Share Income Fund	A tax effective, income focused, ‘style neutral’ Australian equity portfolio that is broadly diversified (50-120 stocks) and seeks to generate income through investing in fully franked dividend yielding stocks in the run-up period to the ex-dividend dates. The Fund has been specifically designed to be tax effective in the hands of a 0% rate tax payer by capturing franking credits and exhibits a high portfolio turnover (circa 150% p.a.).
IML Equity Income Fund	An equity income strategy that seeks to generate income through investing in dividend yielding stocks and an options strategy. The options strategy generates income through buy-write and covered call option strategies and selling put options.
Grant Samuel Epoch Global Equity Shareholder Yield Fund	A long-only, benchmark unaware product that aims to invest in global companies assessed as generating free cash flow which supports both a sustainable ‘shareholder yield’ and some cash flow growth. Its objective is to generate a target return of 9% p.a. or greater over ‘a full market cycle’, expected to be derived from dividends (4.5%), share buy-backs and debt pay downs (1.5%) and cash flow growth (3%).
Talaria Global Equity Fund	An active long-only, ‘benchmark unaware’ investment product that invests in large cap securities within developed and emerging markets. The Fund is relatively concentrated, targeting 25-40 ‘quality’ companies that are purchased at ‘reasonable’ valuations. Approximately 50-70% of the Fund is committed to equities, with the residual reserved as option cover for put options sold. Stock positions are entered (and exited) via the sale of fully cash backed (covered call/put) stock options. The option premium earned provides an additional source of return beyond capital growth and dividends and creates a ‘buffer’ against losses by reducing the cost of stocks purchased.
Fixed Income Funds
Schroder Fixed Income Fund	A Diversified Fixed Interest product normally invested in Australian and global (hedged) government and non-government debt markets and may have material exposure to credit assets, including up to 20% sub-investment grade sectors.
PIMCO Global Bond Fund	A Global Fixed Interest fund normally invested in a mix of bonds paying fixed rate (predominantly) coupons such as those issued by sovereign governments, corporations and other structured securities like mortgage bonds. Lonsec notes that PIMCO’s total return approach implies a degree of indifference as to the source of returns either from income / distributions (e.g. coupons) or growth (e.g. asset price growth).
Janus Henderson Tactical Income Fund	The Fund will normally be invested in a mix of bonds or debt securities paying fixed and/or floating rate coupons issued by Australian governments and corporates, residential mortgage backed securities and hybrid securities. The Fund is designed to actively allocate between Australian cash, Australian fixed interest and Australian credit, providing greater scope than traditional bond funds to protect capital in a rising yield environment.
Macquarie Income Opportunities Fund	A relatively conservative credit fund with short duration fund which uses a core/satellite approach and distributes income monthly. The ‘core’ is a portfolio of predominantly ‘investment grade’ floating rate securities and ‘satellites’ exposures of Global High Yield and Emerging Markets Debt.

These funds provide a diverse source of income for retirees, though this does not come without risk. With equities generating a significant portion of the income it is imperative that equity market risk is managed through allocating to more traditional fixed income funds and funds able to play a Risk Control role in the portfolios.

July 5, 2019/by Michael Elsworth