Downturn tests fund managers

Not all super funds performed badly when global sharemarkets went backwards. Annette Sampson looks at what they did differently to produce positive returns.

Not all super funds performed badly when global sharemarkets went backwards. Annette Sampson looks at what they did differently to produce positive returns.

Feel like your super fund is gambling your retirement savings on the sharemarket with little concern about the impact on your future income? You're not alone.

Most fund members will get little joy from their rosy annual super fund statement, knowing full well the healthy returns reported on June 30 have received yet another walloping from volatile investment markets.

While markets bounced back in October, the September quarter was a shocker for the average super fund.

The median balanced fund lost almost 5 per cent in the quarter, according to research company SuperRatings. That loss was big enough to wipe out the gains made during the past 12 months, with the average 12-month return now a loss of 0.3 per cent. How quickly times can change. At June 30, the average fund was up 8.7 per cent, after fees and taxes.

Fortunately, markets rebounded strongly last month, which should put your fund's annual return back into the black. But just how much more of this wild see-sawing are you expected to take?


The fact super fund returns have been going backwards comes at an inconvenient time for the government, which introduced legislation to lift compulsory super contributions to 12 per cent. While surveys by the Association of Superannuation Funds of Australia (AFSA) and the Australian Institute of Superannuation Trustees (AIST) have shown widespread support for the rise (67 per cent in the ASFA research, 70 per cent in the AIST survey), it does raise the question of whether those enforced savings are being well-employed.

The bad news is that if you're looking at short-term returns, wild swings have become commonplace. The graph shows the quarterly median returns of super funds since September 2003, with a clear distinction evident between the steady growth of the pre-GFC era (just one negative quarterly return and that a mere 0.5 per cent fall) and the extreme peaks and troughs since 2008.

Sure, we've had good periods, the best of which was a 9.3 per cent lift in 2009. But simple mathematics dictates that the bad periods have a disproportionate effect on our savings.

If your fund loses 20 per cent, you can't assume a 20 per cent gain will have you back on track. Because you're left with a smaller amount of savings, you'll need to earn more to get back to where you started - in this case, 25 per cent.

The outcome is that it is not just the short-term results of super funds that are looking sick.

The average balanced fund (which has 60 per cent to 76 per cent of its money in so-called "growth" investments such as shares and property) has virtually stood still for the past five years, with an annual return of just 0.9 per cent.

During the past seven and 10 years, it has also fallen short of its target of about 3 percentage points above the inflation rate. Over the past seven years it has averaged 4.56 per cent a year and over the past decade, 5.16 per cent.

It's all a far cry from the heady days of 2007, when the average fund earned almost 13 per cent over the previous five years and the best balanced funds had reported annual returns of more than 18 per cent.

"It's almost like having a home loan account with a redraw when you're getting those sorts of returns," a Super Ratings analyst, Kirby Rappell, says. "Balanced funds are not designed to give you 15 per cent. Over the long term, they're designed to give you inflation plus about 3.5 per cent. If you're getting 15 per cent or more, the chances are some of it will have to be 'redrawn' in the bad years."

SuperRatings says falling sharemarkets have been the big driver of fund losses during the past quarter, though to give them their due, balanced funds fell less than the sharemarket. Rappell says the wildly fluctuating Australian dollar has also been a big influence, depending on whether funds were hedged against currency movements or not.

"In October, for example, the Australian dollar ranged between US96? and $1.06," he says. "That has had a huge impact on returns and made it very difficult for fund managers. If you think the Australian dollar will be fairly constant over time, there's no point wasting money to keep your short-term returns looking good. Most funds are usually about half hedged and have advisers helping them to remove some of that protection when the Australian dollar is higher."

The head of investment strategy in Australia at Towers Watson, Tim Unger, says it is hard to see an end to the volatility, given the high level of uncertainty in global markets and economies. But he says most investment options in super funds would still be constructed to provide the returns they promise over the longer term.

"Prices have already adjusted to reflect what we already know," he says. "So a lot of the doom and gloom out there should already be factored into asset prices. What fund members need to do is to ensure their investment choice marries with the time horizon that they have."


Part of the problem is that Australians are notoriously disengaged with their super.

Balanced funds achieved the level of importance they have because most fund members don't bother choosing an investment option. They simply remain in the default option, which is usually a balanced or growth fund chosen because it should provide better long-term returns for most members.

But, as Unger points out, someone nearing retirement may not want to take the risk that their retirement savings will take a further hit.

Unlike younger fund members, older members don't have 20 or 30 years left to rebuild their savings.

"My best advice is to ensure the risk profile of your super matches the time you have," he says. "It's one of the things you can control. There's no point worrying about the things you can't."

Rappell says fund members also need to ensure their fund stacks up well on fees and longer-term investment returns. He says these have been the two main drivers separating the better performing funds during the past five to 10 years from the laggards.

"What it comes back to is taking the time to benchmark the performance of your fund," he says.

While fees can make a big difference to long-term returns, Rappell says it is not just a matter of picking the cheapest fund. "It should be about what you get in your pocket after fees and charges."

The good news is that, while past performance cannot be guaranteed to continue, there are funds that have outperformed the herd through both the pre-GFC boom and the tough times since.

Rappell ran some numbers for the Herald that compared the top 20 balanced funds before the GFC with the top 20 now.

Looking at their five-year returns, he found 12 of the funds that made the honour roll in September 2006 also made the top 20 in September 2011.

These included many of the large non-profits funds: Australian Super, Care Super, Catholic Super, Cbus, Equipsuper, HostPlus, NGS Super, Q Super, REST, Sunsuper and Telstra Super.

The number of funds doubling up for the one-year top 20 was lower - nine of the original 20 were still there in September 2011 - but Rappell says it is the ability to deliver longer-term consistency that matters.


He says non-profit funds dominate the list for two reasons. First, their administration fees tend to be lower than for commercial funds, which means less of the annual return is eaten up by expenses. And second, the consistent performers all tend to have similar levels of investment in alternative assets such as infrastructure, hedge funds and private equity.

He says alternative investments helped smooth returns through the GFC, at least in part because these assets are only valued on an annual or quarterly basis - unlike listed assets, where the values change by the minute.

Unger says some alternatives can also help cushion falls in sharemarkets if they genuinely behave differently from shares - though not all alternatives fit this bill.

He believes Australian super funds can't do much about the volatility we're seeing on investment markets but they could do more to try to reduce their reliance on shares for long-term returns.

"They're probably still over-reliant on what has worked in the past, which is equities," he says.

"To be fair, Australian funds are probably better diversified than those offshore but they could introduce more genuine diversification into the funds."

The market leader of investment consulting at Mercer, Graeme Mather, says the GFC and its fallout have made super funds focus more on risk management - and not just the risk that markets will fall.

He says the problems experienced by funds such as MTAA have prompted a greater focus on liquidity risk (whether the fund is able to get out of its investments if it needs cash) and there is also a greater emphasis on "getting under the bonnet" of more complex investments and finding out how they work. "Funds are looking at risk in different ways to get better investment strategies that are truly diversified."

He says one approach being used more often is dynamic asset allocation. This isn't shifting completely out of one investment class (such as shares) if you think it's going to tank like it or not, funds offering a balanced portfolio have to offer just that. But Mather says funds are looking more to take advantage of medium-term anomalies in valuations.

One example was in 2008 when, thanks to the GFC, good-quality corporate bonds were offering high yields compared with the risk involved. Funds using dynamic asset allocation were able to make good profits over the next couple of years to offset some of their equity losses. Of course, not everyone gets these calls right but Unger says super funds are looking for fund managers with proven skills in this area, rather than just paying fund managers to provide market returns.

"There's a strong focus on fees," he says. "One way for funds to keep fees down is to index part of their portfolio and use more active managers to add value.

"Rather than paying high fees for index returns, they can access those index returns cheaply and use their fees in other areas. In other words, if your fee budget is 80 basis points [0.8 per cent], they're wanting to get the most bang for their buck."

Mather says Mercer has also been working with funds to try to hedge against GFC-like events through managers using lower-risk equity strategies that try to get sharemarket returns with reduced volatility. Like dynamic asset allocation, not all managers can do this, though he says some of the early signs are promising.

Unger says funds are also questioning whether their portfolios are genuinely diverse, in that they include assets and strategies not closely linked to sharemarket movements.

"What they should be trying to do is to reduce their reliance on equities because you don't want to be overly dependent on one asset class," he says. "Frequent extreme events seem to be increasing and funds are starting to plan for that."

Twitter: @sampsonsmh

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