Risk carries an age factor
Industry fund AustralianSuper is concerned the "standard risk measure" designed to help inform fund members may lead them to choose the wrong superannuation investment.
Under the standard risk measure, each investment option is labelled from very low risk to very high risk with graduations in between, according to the expected frequency of negative years in any 20-year period.
Super funds have a range of investment options with varying trade-offs between risk and returns. The standard risk measure is a well-intentioned attempt by regulators to bring consistency in the way investment options are labelled. But as it stands, investment options can be mislabelled and fund members misled about the risks and the returns they can expect from investment options.
The 2 million-member AustralianSuper fund is concerned the standard risk measure has the potential to send the wrong message. The problem is that a 20-year-old is likely to have different objectives to a 60-year-old approaching retirement. For older members, the risk is they will be hit by losses and not have enough time to recover before retirement. Preserving capital is more important for them than 20-year-olds who have another 40 years, or more, in the workforce. Younger fund members should be focused on growing capital and have the luxury of time to ride out market falls.
AustralianSuper decided to road-test the standard risk measure. The fund commissioned a poll of more than 800 people with super, aged between 18 and 64. The survey found, in the absence of any other information except the standard risk measure, half of young fund members would choose an investment option labelled "low-risk". That is despite the fact these options will not earn much more than inflation. The problem is the standard risk measure is based on the volatility of an investment option and so "low-risk" equates to low volatility of returns, but says nothing about the expected returns.
In assessing an investment option, fund members need to consider the return objectives of each investment option as well as the volatility of those returns.
Funds will give expectations of the returns of their investment options, but sometimes these are vague. For example, some funds will say of their cash options only that the investment aims to outperform inflation.
That is not good enough. They need to say how much the option is expected to outperform inflation.
AustralianSuper has developed what is calls an "enhanced" risk measure. The risk measure of an investment option will change depending on how much time there is before retirement. For a fund member who is planning to retire in the next five years, the fund's balanced option is labelled as "high-risk". But for someone who is not planning to retire for at least 20 years, the balanced option is flagged as "low-risk". Regulators should take note.