Super fund trustees need to pay more attention to the distribution of returns during a member's accumulation period, according to QIC lifecycle strategies managing director Michael Drew.
Super fund options are currently designed around the average return over a set period, but how returns are obtained year in, year out has a great impact on the end result, Drew said during a presentation at a Financial Services Institute of Australasia seminar earlier this week.
"People don't have infinite horizons; they have some kind of liability, some kind of retirement date that they are working towards. So we worry about the sequencing and the distribution of these returns," Drew said.
He said that a member who experienced the global financial crisis (GFC) just a few years before retirement could end up with a retirement balance that is 30 per cent lower than that of a member who retired just before the crisis.
"If you have a GFC-like event five years from your retirement, what does that do? It destroys something like 1.5 times your lifetime contributions to super and lower the annuity equivalent value by about 30 per cent," he said.
Drew, who is also a finance professor at Griffith Business School, has conducted research on the impact of different return distributions patterns and concluded that the standard balanced fund still has large inherent risks.
"We find that these 70/30 funds over the last 120 years give you around a 40 per cent [chance] of not meeting a 7.5 per cent return in the last period, a one in four chance of not beating inflation, and a rolling a fair die [one in six chance] that the return will be negative," he said.
Drew argued that adjustments to superannuation products needed to be made 10 years before retirement. He said this does not mean every fund needs to switch to lifecycle products, but he argued trustees do need to address the issue of sequencing risk as part of their fiduciary duty.
"You don't have to like lifecycle - I'm a big boy, it's okay - but you do have to think about the sequencing risk," he said.
He said potential solutions would combine dynamic asset allocation and manager selection with downside protection mechanism in the last years of accumulation.
There is no point in offering downside risk protection to a 25-year old, Drew said, but these options become more relevant towards retirement.
"I see a deep, deep argument and sound foundation of why you might think about downside risk management for that cohort that is maybe five to 10 years from retirement," he said.
Super funds would need to come up with a range of products that allowed customisation to fit a member's needs, while these solutions should also take into account balance rather than just the age of a member.
"If this industry keeps serving up a 70/30 default for all members all the time, the economist in me suggests the only thing you can compete on is the price.
"The way we think about it is that industry funds can now deeply think about their cohorts and design solutions," he said.
