Risks are matched with age

It's hard to find a contented super fund member these days, especially if they are close to retirement and discovered only recently that their "balanced" default fund was top-heavy with high-risk investments.

"The average punter would think of a 50:50 split [between growth and income investments] as balanced," says the chief executive of industry fund Health Super, Chris Clausen. But this is not the case.

Most Australians hold their super in their fund's default option, which typically contains 70 per cent growth assets such as shares and property and 30 per cent in lower-risk income investments.

Health Super was the first super fund to move away from the traditional "balanced" default option for its members to a lifestage default, and is still one of only two funds to do so (see box), but the concept of lifestage funds is gaining currency.

Lifestage funds adjust automatically your asset allocation, or the mix of high- and low-risk investments, as you age. The rationale is younger people can afford to take higher risks in return for higher potential rewards because they have time to ride out market highs and lows, whereas older people need to preserve capital.

Last week the superannuation minister, Nick Sherry, announced a thorough review of the super industry, including the design of default funds.

After last year's negative returns and the likelihood of more negative returns this year, investors and super industry insiders are beginning to question the design of default funds, especially for people nearing retirement who have little chance of recouping major investment losses.

The head of Russell SuperSolution, Linda Elkins, says the concept and performance of default funds have served Australians well and the diversification they offer has delivered.

Indeed, according to figures from researcher Chant West, in the five years to March the average balanced default fund returned 3.9 per cent a year, on a par with conservative growth funds and better than the 2 per cent return from all-growth funds.

Even so, Elkins says disenchantment with recent negative returns from default funds is a rational response.

"The question now is, where do we go from here? That's where the debate about the role of lifecycle funds or the more sophisticated construction of default funds is relevant. A lot of people are thinking about the next generation [of default funds]," she says.

When Health Super adopted a lifestage default fund in 2003, Clausen says most of the discussion points centred on dialling down investment risk as investors approached retirement age.

"But we said the discussion should be about when we leave this earth," he says.

The head of strategy at Barclays Global Investors (BGI) Australia, Justin Wood, agrees, saying: "Your investment horizon is death, not retirement, but there are fewer options when you retire."

Wood argues that when we choose an asset-allocation strategy for our super we should take into account financial assets such as our home and investments held outside super, our income-earning ability and even our access to the age pension. Hence, if you have a secure job with tenure and regular wage increases and/or you expect to receive an age pension, these are in effect an inflation-linked bond. Someone in this position can afford to take more risks with super and other investment assets.

"But if your job security is linked to the global economy then your human capital looks like equity and you need precautionary savings," Wood says.

As a result of the financial crisis and continuing economic uncertainty, he thinks many default funds and individual investors will take a more conservative approach in the years to come. But that is not without its risks.

"There are risks in becoming too conservative, too soon, when the average person will live into their 80s. Even in retirement it's not good to put all your money in cash, you need some growth," Clausen says.

BT also acknowledges this by offering a lifestage default pension fund in retirement. "If you can't afford to pay for advice then you may require lifestage investments right through retirement," says BT head of super Melanie Evans.

"Lifestage funds are good for young and old whereas default funds were built for the majority of workers in midlife."

Warren Chant of Chant West says he now believes lifestage funds make sense, especially for older fund members.

"Once you're in your 50s, if you're not in a lifestage product, you should ask if the default option is still appropriate and maybe move to a 50:50 [half growth, half income] option."

Getting the right mix

Lifestage super funds adjust your asset allocation as you age, from high-risk/high-return assets in your youth to lower risk closer to retirement.

At present, only industry fund Health Super and BT Super for Life offer lifestage funds as their default option, while Russell Investment Group and AMP offer lifestage funds as part of their investment options.

While the concept underlying these funds is the same, there are differences in the ages at which asset allocation is adjusted and the investment mix at each life stage.

Russell's Target Date products and BT's Super for Life automatically adjust your portfolio every 10 years.

In Russell's case, someone in their 20s with 35 years left in the workforce will have 96 per cent growth assets and 4 per cent income. The proportion of growth to income assets is dialled down every 10 years to a low of 36 per cent in your 50s. Health Super has 90per cent growth assets for the under-40s, 70 per cent from age 50 and 50 per cent for the over-60s.

BT's funds are linked to a Westpac bank account. There are no commissions built into the fees if investors apply directly.

BT's head of superannuation, Melanie Evans, says fees are comparable to, and in some cases cheaper than, industry funds.