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Meltdown exposes flaws in super system

Australia's super funds are not failing members. But they do need to shake off their complacency that the optimum long-term portfolio - as identified by them - is always best.

Australia's super funds are not failing members. But they do need to shake off their complacency that the optimum long-term portfolio - as identified by them - is always best.

Whether the markets finished up or down last night (and at this stage, it hardly matters), it has become abundantly clear that while many people like the idea of being forced to save for retirement, that view can soon sour when they see their retirement savings at the mercy of irrational investment markets.

The average super fund had still not regained the losses suffered during the GFC when markets started to fall in April. And any brownie points that funds hoped to gain with solid returns for the year to June 30 were soon wiped out by the madness of the past week or so.

It doesn't matter that growth portfolios, which are where most Australians have their super, performed brilliantly in the 1990s and early 2000s, with returns better than long-term expectations.

What matters to many investors is that having listened to their fund and held their nerve during the GFC, they're being urged to go through it all again. But trust is harder to come by this time around.

In the short term, the funds are probably right. It's impossible to make rational decisions when markets are ruled by panic. One thing this week's lunacy (sorry, there's no other word for it) has shown is that what might seem like the right decision now, can look dumb within a few short hours. Running for the exit gate when there's a crush trying to get through is rarely a smart move.

But it is also time the super industry paid more than lip service to the fact that one size doesn't fit all. With a high bias to "growth" assets such as shares, the majority of super funds are offering what can be a wild ride and a level of short-term risk for which many of their members did not consciously sign up.

One player who believes Australia's super funds are at the extreme end of the risk spectrum is the man who chaired the government's review of the super system, Jeremy Cooper. He is now employed by the Challenger financial group and has a vested interest in promoting alternatives, such as annuities, but believes many fund members are unaware of just how much risk they are taking on.

Cooper says risk can be assessed on three main levels. I'd say there are four. The first - a critical one that he doesn't list - is that super in Australia is compulsory. It's not a risk we voluntarily take on. The government forces us to sacrifice 9 per cent of our wages to fund our retirement but with no guarantees the money will be there - or enough - when it's needed.

As Cooper points out, our system is defined contribution, rather than defined benefit. While there is still a lucky minority in schemes that promise a fixed amount of income in retirement, most of us are in accumulation schemes. What we get at retirement depends on how much we put in, the fees we pay and what we earn on investments.

Despite this, Cooper says, there are no guarantees backing our contributions. Germany has a guarantee that contributions won't be lost Switzerland guarantees a nominal return each year. We get what markets deliver.

And then there's the question of investment. With the average super fund holding about 46.5 per cent of its investments in equities, according to a recent Organisation for Economic Co-operation and Development report, Australian fund members are highly exposed to sharemarket movements. The average for the 27 OECD countries surveyed is closer to 20 per cent.

Unlike some countries, Australia has no restrictions on super-fund investments. Cooper says Chile, for example, has a ban on equities for members aged 50 or older.

A further level of risk is what happens in retirement when members are most vulnerable to losses, as they are drawing an income from their investments rather than feeding money into them. Gut feeling says retirees should be investing differently but a recent Towers Watson survey found while the average accumulation fund had 74 per cent in growth assets, the average default pension fund didn't have much less (67 per cent).

Cooper believes the combination of these risks is something the industry needs to address. Is it fair to ask people who didn't choose to be in super to take such risks with their savings, even if the long-term prospects are sound?

Part of the problem, as the chief investment officer of IPAC, Jeff Rogers, sees it, is the "right" investment strategy from the industry's point of view may not suit the psychology of all members.

He says the challenge for default funds is to learn more about individual members so it can modify what's on offer to suit their needs. Age is a piece of information that funds can access easily and has led to so-called "life-cycle" funds, in which members are automatically moved to a more defensive portfolio as they near retirement.

But two 60-year-olds can have vastly different needs, depending on things such as health, lifestyle and whether or not they have other assets outside super. A financial planner can tailor a personalised portfolio but we need a middle ground. Rogers is hoping the Costello committee charged with working out how to implement the Cooper reforms will provide some suggestions.

Not everyone has the stomach to see their retirement savings being walloped we shouldn't expect them to. Nor is it fair to say these members should take more interest in their super - that they can always choose a different investment option.

Super is compulsory and, like it or not, most people expect their default fund to look after them. If they feel let down, they lose confidence in the entire super system.

Debt by numbers

Sometimes a picture or table tells a story better than words.

This table, provided by the head of investment market research at Perpetual, Matthew Sherwood, was compiled by the International Monetary Fund in April and lists the net government debt to gross domestic product ratio of a number of (then) AAA-rated countries.

Sherwood says the IMF considers a ratio of less than 60 per cent to be sustainable.

There are three key things to take from this:

Australia does not have a problem with debt, despite political claims to the contrary.

The deterioration in debt to GDP is expected to be worse in the US in the next four years than it will be in the AAA countries listed.

As the US was, other countries face being downgraded.

NET DEBT-TO-GDP RATIOS OF AAA-RATED COUNTRIES

COUNTRY 2010 (%) 2015 (%)

Australia 5 6

Austria 50 51

Canada 32 34

Denmark 1 7

Finland -57 -39

France 76 80

Germany 54 53

Netherlands 27 35

Norway -156 -182

Sweden -15 -15

Switzerland 53 45

UK 69 76

US 65 83

SOURCE: INTERNATIONAL MONETARY FUND APRIL 2011


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