Fund labels meaningless

All super funds must set out their investment objectives, giving members some guide to what the fund is aiming to achieve.

The fund might be targeting high growth, a modest return above inflation or something in between. If you know your risk tolerance and have thought about your investment goals, these investment objectives are an important guide to choosing a fund.

The problem is that a number of people in the super industry believe funds do a poor job of setting out their objectives. They say most investment objectives put out by super funds are vague and ill-defined - unhelpful at best and misleading at worst.

Making the problem worse, there are no standard definitions for terms such as "growth", "balanced", "conservative" or "capital stable". There is even disagreement about whether assets such as property should be classified as growth or defensive assets. The labelling of funds and the statement of investment objectives, important consumer information, is a mess.

The most vocal critic of this aspect of super fund member communication is Jeff Bresnahan, the managing director of industry research group SuperRatings. Bresnahan has issued a paper calling on the industry to set better standards for communication of fund descriptions and investment goals.

SuperRatings looked at the investment objectives of more than 400 super fund investment options and found that only one in four had objectives that could be measured and were useful to members.

Bresnahan has recommended all investment objectives include three things: reference to a target real return above inflation (measured by the consumer price index) an annualised time frame (that is, the target return can be produced over a given number of years) and a statement of the risk of a negative return every three or five (or however many) years.

Bresnahan says: "A fund might state that its objective is to provide higher returns over the medium- to long-term through a portfolio diversified across all asset types but with an emphasis on shares and property.

"In such a case, the fund member is dealing with a series of nondescript words that provide no way of measuring outcomes in terms of actual returns or time-frames."

The chief executive of the Association of Superannuation Funds of Australia, Pauline Vamos, is another who does not mince words over the issue. "It's a dog's breakfast," she says. "The industry should get its act together."

Vamos says there are some fundamental questions that need to be answered, such as whether certain assets should be described as defensive or growth. "Some argue that property is a defensive asset because it provides a stable income from long-term tenants. Others argue it is a growth asset because it produces a capital gain.

"We had an industry roundtable on this issue and what we learnt was that no one agrees.

"I think the answer is that you have to look at the portfolio as a whole and set some measurable risk and return parameters around a set of time frames."

Bresnahan says fund descriptions don't mean much. "A balanced fund, which is what most people opt for, could have a 40 per cent allocation to growth assets or an 80 per cent allocation to growth assets.

"There is no standard definition of what a balanced or growth or capital stable fund means. The way labelling works in the industry is ridiculous.

"At the level of asset classes, in the past all portfolio managers classified their property holdings as growth assets because the ultimate purpose of the investment was to profit from any growth in capital value. But then fund managers started saying their properties were defensive assets because they had government tenants on 25-year leases providing very stable income."

The communications manager at the funds research group Morningstar, Phillip Gray, says the confusion is made worse by weak disclosure rules. Gray says: "At present there is no requirement for any disclosure of an Australian super or managed fund's underlying holdings of stocks, bonds, property assets and other securities.

"When you look across managers' websites you see a mishmash of approaches. Some give you an update of their top 10 positions on a monthly basis, some quarterly and some six-monthly. Some not at all.

"Periodic disclosure of full portfolio holdings would have a number of benefits. It would allow super fund members, investors and advisers to evaluate whether a fund is staying true to label. It would reveal poor investment practices, such as the window dressing that goes on before the end of a reporting period when there might be high turnover."

These issues are of more than academic interest to super fund members. Last year many people saw the cash portfolios of their funds lose money - something that is not supposed to happen.

What these fund members discovered was that the cash allocation in their funds was going into "enhanced cash" portfolios, which aim to boost returns over standard cash funds by holding short-term corporate debt securities, asset-backed securities (such as securitised mortgages) and credit derivatives.

Enhanced cash has its place in an investment portfolio. It allows investors to take a bit more risk for a return above cash. But the point being made by Gray, Bresnahan and Vamos is that fund members don't know the difference and would struggle to find the information they need to make an informed choice.

Among the enhanced cash funds that lost money last year are the Macquarie Income Opportunities Fund, Perpetual's Credit Income Fund and the UBS Enhanced Cash Fund.

Another part of the investment market where changes to the way funds are managed has caused confusion is fixed interest, which forms the backbone of capital stable fund options. With the reduction in government bond issuance over the past decade, fund managers have expanded their universe of securities to include corporate debt securities, asset-backed securities, hybrids and hedge funds.

As a result, fixed interest fund performance can be more volatile and more varied than in the past. When it came to the crunch over the past 12 months, many of the newer style defensive funds did not fulfil their role.

Some of the more unusual securities that were chosen for these funds did not perform as defensive assets. Some fixed interest funds include hedge funds, for diversification against the higher volatility of corporate credit.

Last year many of those hedge funds were hit by the liquidity crisis in the capital markets and had to sell assets while sustaining losses.

The accompanying SuperRatings table, setting out the performance of the top 10 capital stable fund options in 2008, shows that even the best-performing capital stable funds lost money last year. Capital stable funds lost nearly 8 per cent during the year while cash made a positive return of 5.5 per cent (see tables above).

Capital stable funds did not perform their usual function of protecting investors during periods when growth assets are losing value. This was due to the changes to capital stable portfolios.

Bresnahan believes there is a simple solution. He says: "I don't think this is a complicated issue.

"When the superannuation legislation was written it failed to spell out how funds should state their investment objectives but some straightforward regulation would fix it.

"When you talk to financial planners they will tell you they want objectives that are expressed as real returns, risk and a time frame."