Life-cycle investing

The markets have been highly volatile over the past few weeks with big swings on local and overseas shares and fixed interest markets. But what about your super fund? Is it exposed to these risks and should you change your portfolio option to have greater security?

Super fund members should have different attitudes to risk, depending on how old they are and how long they expect to have their money invested before they retire.

The younger you are the more risk you can afford to take. That is because the risky assets are the ones that tend to produce higher returns over time.

But as you get closer to retirement your priorities change.

You start thinking more about capital preservation. Your super fund investment option should have more defensive assets to reflect that.

These are things that every super fund member should think about but few do.

The 2009 Super System Review (the Cooper Review) reported that about 85 per cent of super fund members have their investment decision made for them by someone else.

They are put into the default option of their employer's fund - usually a growth or balanced portfolio - when they start a job and that never changes.

MEMBERS NOT CAUTIONED

The super funds don't help this situation. A report by Rice Warner Actuaries in August 2009, Appropriate Asset Values for Superannuation Funds, says few funds tell their members about the risks they are taking.

The report says: "Funds are almost silent on volatility.

"Even though they could not have predicted the extent of the global financial crisis, the funds should have cautioned members that negative results were more likely following the sustained out-performance of the markets [in the years leading up to November 2007].

"The cohort particularly affected during 2008 were the older members ... They are particularly sensitive to a short-term negative returns. Despite the growing numbers of people within and approaching retirement, not one superannuation fund deals with the issue adequately."

Since that damning criticism, there have been changes. A number of funds have introduced what they call life-cycle or life-stage investment products that automatically adjust the risk exposure of the member's portfolio over time.

At a simple level, this can mean switching a member from a growth into a balanced or capital stable portfolio once they reach retirement age.

This is what First State Super does. Members in the default option have a 70 per cent growth and 30 per cent defensive asset mix up to age 56 and then the mix changes to 50 per cent growth and 50 per cent defensive.

The chief executive of First State Super, Michael Dwyer, says: "The idea is to de-risk at retirement age. Anyone who took 20 per cent of the equity investments out of their portfolio would have had a better outcome during the GFC."

Dwyer says it is hard to design a system like this that suits the needs of all members. There is work going on in the super industry to develop more sophisticated life-cycle products and he expects there will be ongoing developments. In the meantime, his focus is on educating members to make choices for themselves.

At the moment, fewer than 15 per cent of First State Super's 770,000 members are in investment options that they choose the rest are in the default option. Dwyer says the figure is a little misleading because a proportion of those in the default fund may have decided it was the best place to have their money.

Still, it does suggest that the vast majority are playing no active role in how their super is invested. That is something Dwyer and other super fund managers would like to change.

SHIFT TO SAFETY

In 2008, BT Financial Group launched BT Super for Life as a low-cost entry-level fund and included an investment option called the Lifestage Fund as the default option. More than 75 per cent of the fund's 230,000 members are in Lifestage.

Lifestage is a more sophisticated version of what First State Super does with its default members. The main difference is that the transition from high growth to defensive assets is done gradually over time. There is no sudden jump from one portfolio to another, which might bring its own risks.

The head of super at BT, Melanie Evans, says members born in the 1990s have their money invested in a pool that has 90 per cent growth and 10 per cent defensive assets. People born in the 1960s have a 75 per cent growth and 25 per cent defensive asset split. People born in the 1940s have a 35 per cent growth and 65 per cent defensive split. "We are happy that these funds are delivering the right risk and return, given the asset allocations," she says.

The transition is managed, rather than being a rigid formula. BT has a team that reviews the portfolios and makes adjustments to the asset allocations according to the age of the members but also after considering market conditions.

Mercer takes a different approach with its Mercer Target fund. The fund starts with as much as 100 per cent invested in growth assets when the member is young and ends up with 50 per cent in growth assets by the time the member reaches 65.

This change is managed in a long series of steps that adjust the asset allocation by 2 per cent or 2.5 per cent a year. The idea is to make the transition as smooth as possible.

The head of post-retirement solutions at Mercer Asia-Pacific, Martin Stevenson, says Mercer Target has been offered as an option, but not the default, in the corporate funds that it operates.

It has not had much take-up and Mercer is in the process of making some changes to the product. When it relaunches Target, or its successor, later this year its aim will be to have it used as the default fund by its clients. Part of the change will be to extend the product into retirement. "The emphasis will be on whole of life," Stevenson says.

EQUITY ALLOCATION QUESTIONED

There is plenty of debate about life-cycle investment strategies. People who are planning to take lump sums at retirement are more likely to want capital protection than people who plan to convert their accumulation fund into an account-based pension.

Uncertainties around life expectancy make it hard to judge the level of growth assets that people should still be holding in their 60s and 70s.

There are also challenges to the common assumption that investors with a long-term investment horizon should accept the higher risk of holding growth assets in the expectation of receiving higher returns. Some recent research suggests that the risk might outweigh the potential gains.

Earlier this month Morningstar published long-term asset risk and return data. Over the 30 years to this July, the highest return was from Australian shares - 11.2 per cent a year.

But Australia shares also had the highest risk over that period - a standard deviation of 17 per cent (standard deviation is a measure of how far returns will vary from the mean in any given year).

Australian fixed interest (the core of capital stable portfolios) produced a return of 10.4 per cent a year over the 30-year period. Its standard deviation over that period was much lower - 4.9 per cent. In other words, the return from fixed interest was not much less than equities but the risk was very much less. Over the five years to July, the return from Australian shares was 1.9 per cent a year, with a risk of 15.8 per cent. Over the same period the return from fixed interest was 6.8 per cent a year, with a risk of 2.9 per cent.

The tendency of Australian superannuation portfolios to have very high equity allocations has been noted in a number of studies, most recently in a report published by the Organisation for Economic Co-operation and Development (OECD) last month.

The OECD report, Pension Markets in Focus, says that our super funds have the third highest allocation to equities among the 27 countries surveyed.

In terms of investment performance in 2010, the OECD puts Australian funds in the middle of the pack but it also shows that our funds produce volatile results, compared with pension funds in many other countries.

Our funds are right at the bottom, when the three-year average return from 2008 to 2010 is measured.

The OECD says: "Equity holdings in investment portfolios were a key channel through which the financial turmoil affected investors."

What is the right asset allocation for your age?

- One rule of thumb is that you subtract your age from 100 and that is the portion of your portfolio that should be in growth assets, i.e. at 50 your exposure to growth assets should be down to 50 per cent.

- People are living longer, so financial planners tend to advise those in their 20s and 30s to have 100 per cent of their portfolios in growth assets and then start introducing defensive assets in their 40s and 50s.

- Super fund portfolios have labels such as high growth, growth balanced and so on, which are not always helpful in terms of describing risk. After being urged to do so by regulators, the Financial Services Council and the Association of Superannuation Funds of Australia have come up with a risk-labelling guide based on the number of likely negative annual periods over any 20-year term.

- On this scale, a low-risk portfolio (which would equate to a capital-stable portfolio) would have less than one negative year in 20 a medium-risk portfolio (which would equate to a balanced option) would have two to three negative years in 20 and a high-risk portfolio (growth or high-growth options) would have four to six negative years.

When you havent got the time or expertise

When Rose Fox, left, went on maternity leave to have her first baby, she made a to-do list for when she had some free time. One item was to consolidate her superannuation accounts.

Fox, in her 30s and a marketing executive with Optus, has done quite a bit of temping during her career and knew that it would be a smart move to bring all her retirement savings accounts together.

That was three years ago. Fox went on maternity leave last year to have her second child and super consolidation was still on her to-do list. Three months ago, she saw a sign in a Westpac branch window offering a super consolidation service, so she went in and asked them to do it.

"It took about two hours," she says. "They did a search. They got all the paperwork together."

The bank's staff found 10 funds with a total of about $45,000 not counting her Optus fund. Fox put all the money into BT Super for Life and opted for the Lifestage Fund, which automatically adjusts the mix of growth and defensive assets in the portfolio as the member gets older.

"I had a discussion with a planner and we both recognised that I was not going to spend much time managing the account," Fox says. "It makes sense to take risks and go for growth now, and then pull it back later when I need more security.

"And it makes sense for me to be in a fund where someone is making those changes for me, rather than leave it up to me."

She realises she does not have time to research her super investments. "With a family, I am not going to have the time. I would rather leave it to an expert," she says.

One thing that surprised Fox was discovering how many of her friends were in the same boat.

"I thought it was just me, getting my super into a mess. But when I told friends what I was doing, lots of them said they had to do the same thing."