InvestSMART

Mandatory risk labels

New standards aim to provide a truer representation, writes John Collett.

New standards aim to provide a truer representation, writes John Collett.

Super-fund members will know how much investment risk they are taking on after the superannuation industry's development of guidelines to standardise the disclosure of investment risk.

During the GFC, Australians' super account balances fell more than most other countries because of their high exposure to shares and small exposures to government bonds and bank bills. Now, under the guidelines, super funds will provide a "standard risk measure" ranging across seven risk bands - from "very low" to "very high" - for each investment option they offer.

The move also comes after members switched to the "safety" of their funds' "cash" options during the GFC only to find that some lost money as the options were exposed to higher-risk corporate debt.

Investment options labelled "balanced" can have anywhere between 45 per cent and 75 per cent of the money invested in growth assets, such as shares and property. For some members close to retirement, the losses during the GFC have meant they will have to continue working for longer than they had planned.

The Financial Services Council and the Association of Superannuation Funds of Australia produced the standard risk measure after prompting from the superannuation regulator, the Australian Prudential Regulation Authority (APRA).

"Having a clear understanding of risk is just as important as being aware of fees or returns," the chief executive of the Financial Services Council, John Brogden, says. "With a wide variety of investment options available ... it is essential that investment risk is fully disclosed and comparable.

"The standard risk measure will ensure consumers are more aware of the investment risk in the option they have chosen and will enable them to compare apples with apples when looking at different investment options."

How it works

Under the standardised risk measure, each investment option will be assigned one of seven risk ratings: "very low" will be expected to produce no more than six months of negative returns every 20 years "very high" will be expected to produce negative returns in at least six years of every 20 years.

In determining the expected frequency of negative returns, the regulator will require that each fund can show a proper basis for the conclusions reached. APRA expects funds to adopt and disclose the risk measure in their product disclosure statements by the middle of next year.

The founder of SuperRatings, Jeff Bresnahan - who first called for risk labelling three years ago - welcomes the change. "It will help consumers identify incorrectly labelled funds," he says. "Unfortunately, some [investment options] have had 'high risk' positions and have been able to get away with it."

APRA and the Australian Securities and Investments Commission, which also had input into the risk standard, decided not to extend the standardisation of risk to labelling.

Superannuation researchers say the labels can be misleading. Bresnahan says that while risk standards are a step forward for consumers, there needs to be standardised labelling of investment options.

Tricks

"Labelling tricks a lot of people if it is called a 'balanced' option, people genuinely think it is balanced, even though it could be more accurately labelled as 'growth' or 'capital stable'," Bresnahan says.

The standard risk measure does, however, stop funds labelling an investment option as "conservative", if the estimated number of negative years over any 20-year period is more than two years.

The co-founder of superannuation researcher Chant West, Warren Chant, says the standard is a "stumble in the right direction, at best". He says superannuation funds should be compelled to state the expected returns, above inflation, over the long term.

Fund members want to know the expected risk but they also want to know the expected return. "The two go together," he says. Chant also says that a single method should be used by funds in assigning the risk measure to their investment options rather than allowing each fund to choose its own method, which can result in options with identical asset allocations being assigned different risk measures, potentially confusing those trying to compare funds.

Drawbacks

The general manager of policy and industry practice at the Association of Superannuation Funds of Australia, David Graus - who worked on the development of the risk standard - says it will help fund members make better decisions but he acknowledges the standard risk measure is imperfect. One of those imperfections is that the measure says nothing about the potential size or severity of any negative returns, Graus says.

The regulator can be expected to make inquiries of any "outliers" - funds that have a risky investment option that is given a low risk measure and where the label on the investment option is misleading. The risk measure will be reviewed by APRA and the Australian Securities and Investments Commission to ensure it is working as intended.

However, the standard risk measure may not be the final word on the issue. Last week, the superannuation consultative group led by former Future Fund general manager Paul Costello, handed its "Stronger Super" recommendations to the federal government on how to reform Australia's $1.4 trillion superannuation industry. One of the group's tasks was to consider how investment risk can be better communicated to members.

The dangers of disclosure

Most people have been able to choose who manages their super since 2005. But those wanting to exercise choice have faced obstacles in making informed choices.

Since the advent of choice, most funds increased the aggressiveness of their "balanced" investment options, which are the default options in which most people are invested.

The problem for fund members is they have had no way of knowing how risky an investment option is. In the lead-up to the GFC, no one cared as investment markets were booming and funds were able to report outsized returns. But when the GFC hit, account balances went sharply into reverse.

Australian superannuation funds produced the third-worst performances during 2008 and 2010 of the 26 OECD countries that have reported their returns to the OECD. Only Portugal and Estonia did worse. The account balances of most Australians still have to recover their pre-GFC highs.

Under the standard risk measure, it is likely many "balanced" options would have to be classified as "high" risk as they could be expected to have between four and six negative years during any 20-year period the definition of "high risk" under the standard. That could prompt a big shift in investment options as fund members switch to investment options with lower risk ratings.

That's of concern to Fiona Reynolds, the chief executive of the Australian Institute of Superannuation Trustees, which represents non-profit funds.

"We need to be careful that in communicating risk to members, we don't encourage a wholesale flight to conservative investment options, as this may not be an appropriate strategy, particularly for a young person with 40 years ahead of them in the workforce," Reynolds says.


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