MTAA Super On Its Portfolio

The following, written by MTAA Super's executive director, Michael Delaney, provides an exposition of the fund's views on the issues raised by a simplistic classification of investment options on the conventional basis of exposure to “growth” and “defensive” assets.
The need for clarity on this issue has recently been highlighted in a variety of media articles, the thrust of which is summarised by the following quote from a principal of a research organisation: “You have the MTAA Super Balanced option coming in top of the pops but it has 95% growth assets. You would expect a fund with 95% (growth) to do better than a fund with 50% (in a rising share market)”.

These comments, relating to MTAA Super’s ranking in the SuperRatings survey for 2004-05, imply that MTAA Super has a greater than average allocation to equity markets '” which is incorrect. The fund actually has a smaller allocation to equities than the average fund and instead has an allocation to alternative assets.

The conventional definition of equities and property as growth assets, and fixed interest and cash as defensive assets, excludes alternative assets. The approach to classification by some research organisations regards alternative assets as growth assets. We believe that alternative assets can be growth, they can be defensive and, indeed, the same asset can be both growth and defensive! In our view, a properly constructed portfolio of alternative assets has defensive characteristics which the traditional “growth/defensive” classification overlooks.

In the recent media coverage there is a contention that by adopting its “Two Portfolio” strategy, MTAA Super is following a riskier strategy than its peers. In fact, we argue the reverse and there is evidence to support this. There are various parts to our argument but, in short, we believe that by diversifying the sources of growth, MTAA Super is better protected against market downturns than its peers.

This issue has become important in that it affects analysis of fund performance and creates confusion for investors. Typically, the researchers’ surveys classify funds according to their growth/defensive split. Rather than attempt to fit all funds into this increasingly confusing growth/defensive construct, why not consider the “default” member investment choice offered by each fund and compare risk and return, in the same way as manager performance is analysed? This approach starts from the premise that, whatever their asset allocation, what matters to members is the actual return achieved by a fund and the actual risk incurred in seeking that return.

The table below presents various risk measures for traditional asset classes such as cash, bonds and listed equities as well as MTAA Super’s experience with its Target Return portfolio. All the measures presented are based on monthly data for pre-tax returns for the five years ending 30 June 2005.

	Annualised Return	Annualised Standard Deviation	Worst Month	Worst Cumulative Performance	% of Negative Months	Correlation with Australian Equity
	(%)	(%)	(%)	(%)	(%)	(%)
Benchmarks
Cash	5.3	0.2	0.3	0.3	0	5.3
Australian Bonds	6.7	3.1	– 1.1	– 2.2	25	– 25.5
Overseas Bonds (Hedged)	9.0	2.8	-1.6	– 1.9	18	– 31.2
Listed Australian Shares	9.5	10.2	– 6.5	– 15.7	37	100.0
Overseas Shares (unhedged)	– 6.9	12.4	-9.9	– 35.9	48	54.7
Emerging Markets Equity (unhedged)	2.7	17.5	– 10.1	– 29.9	47	69.8
MTAA Super Target Return Portfolio	16.4	6.8	-1.2	– 1.2	7	– 4.0

It is clear on all the risk measures shown in the table that MTAA Super’s Target Return portfolio has a risk level midway between that of conventional defensive assets such as cash and bonds and listed equities. Importantly, as well as having a lower absolute risk than listed equities, the Target Return portfolio’s returns are also uncorrelated with listed equities. It is this lower risk and low correlation that results in MTAA Super having a lower risk profile than the typical “balanced” fund '” despite the higher allocation to conventionally described “growth” assets.

Importantly, the lower risk and low correlation with listed equities is not an accident. The policy framework MTAA Super follows in selecting investments for inclusion in its Target Return portfolio is focused on delivering this outcome. These policy guidelines include rules governing specific risk (ensuring exposures to individual assets are appropriate) and common factor risks (which covers exposures to inflation, economic growth, discount rates and other common factors) all of which are aimed at delivering the aggregate Target Return portfolio characteristics demonstrated in the table.

One further issue, raised by some commentators, is whether the frequency of valuation for unlisted assets masks the underlying volatility of investment returns. This argument is usually presented along the lines that as only a portion of the portfolio is re-valued at any point in time this effectively dilutes the apparent volatility of returns.

The frequency of valuation does have the potential to smooth returns, but the importance of this factor is often overstated. While revaluing on a rolling cycle through the year means only a portion of assets are re-valued at any one time (which reduces volatility) offsetting this effect is that the individual revaluations will be larger, as they represent the annual change in valuation (which increases volatility). Whether there is a net effect on measured volatility will depend, most importantly, on the correlation between asset returns. In MTAA Super’s view, as its Target Return portfolio is focused on assets with low correlations with listed equity markets, this factor is not particularly relevant.

This explanation seeks to provide some insights into MTAA Super’s views on the issues raised by a simple assessment of conventional growth/defensive asset classifications, to put into perspective the risk and return characteristics of MTAA Super’s default Balanced option and to clarify its positioning in a range of performance surveys.