The debate on incorporating life-cycle strategies within a MySuper-compliant investment option has been given added impetus after more funds have declared they will adopt this approach.

Last week, wealth manager Colonial First State revealed it was going through the process of converting FirstChoice Employer Super into a MySuper option, and it was considering adopting a life-cycle strategy not dissimilar to the BT Super for Life product.

Suncorp Group executive general manager of customer distribution Vicki Doyle also said the financial services company was looking at going down the life-cycle path and was considering five-year intervals for adjusting asset allocations.

But the Association of Superannuation Funds of Australia (ASFA) said the proposed Stronger Super legislation stood in the way of widespread adoption, because of the requirement to charge a single fee across the MySuper member base.
 
"When you offer a life-cycle [option], for some funds the way they managed it you really need to charge a different fee for different portfolios," ASFA chief executive Pauline Vamos said in an interview with Investor Weekly.

"What they are trying to do is prevent cross-subsidisation."

The problem is that as members age their portfolio's asset allocation will incorporate more fixed-income products, which are generally cheaper to manage than growth assets.

But the legislation does not allow for charging older members a lower fee, which means they will subsidise the fee of younger members with more aggressive portfolios.

"The difficulty for trustees is that they will go: 'Well, as much as we would like to offer life cycle, we can't charge different fees and so it is not in the best interest of members who should be charged a lower fee. So we don't do it in MySuper,'" Vamos said.

"What we then see is that they might offer it in a choice product, but not a MySuper."

A focus on outcomes

This would be a missed opportunity because there are indications the global pension industry is moving towards products that focus more on the desired outcome for members than on performance, and life-cycle products are expected to play an important part in this development.

Earlier this week, CREATE Research published a report that showed defined contribution pension funds worldwide were shifting towards liability-driven and outcome-oriented investment vehicles.

"The trustee-led schemes . were historically overweight in equities. The poor returns of the past five years have been driving them towards either diversified funds or life-cycle investing," CREATE project leader Professor Amin Rajan said.

"The latter relies on advice-embedded products such as target date, target risk and target income funds. Some follow a fixed glide path on asset allocation that allows automatic rebalancing of portfolios in the event of turbulence.

"Some have a dynamic path that allows discretionary rebalancing. Some embrace LDI (liability-driven investment)-lite vehicles that benchmark members' liabilities. Some move growth assets into cash and use the collateral to buy interest rate swaps - instead of wasting growth assets to buy bonds when approaching retirement."

But all versions were likely to gain traction, Rajan said, because they had a number of significant advantages over traditional performance-focused products.

"All varieties are likely to grow, since their embedded advice features expressly counter clients' behavioural biases in periods of high volatility," he said.

"Their automatic rebalancing - buying low, selling high - is deemed a big plus."

Replacing advice

This built-in advice feature would become increasingly important as the Future of Financial Advice (FOFA) reforms would make advice prohibitively expensive for most people, Principal Global Investors Australia, which sponsored the CREATE research, chief executive Grant Forster said.

"With FOFA and all the regulatory changes, individual financial advice is going to be expensive for people," Forster said.

"Life cycle allows you to have some more individual tailoring. It might not be perfect, but it is better than what we have today."

The problem with the first generation of life-cycle funds, or target date funds as they are called in the United States, was that they were largely static and considered the retirement date as the end date.

This caused problems during the global financial crisis as these funds were unable to respond to the sharp declines in equity markets, while people who were already in retirement experienced a dramatic reduction in income as monetary policy reduced interest rates, causing a sharp decline in their purchasing power.

"One of the issues in the past was that the retirement phase was seen as the cashed-up phase, which was obviously bad in 2008 when markets fell," Forster said.

"There is now much more awareness about reducing risk over time.

"For our funds in the US which have a 2025 retirement date, you are not going to be fully cashed up until 10 years or 15 years after that date, depending on the vehicle."

"The reality is that an end-of-life date would be better than a retirement date."

The additional benefit for super funds is these types of life-cycle options have the potential to retain funds under management, as the incorporation of the retirement phase mitigates the need for pensioners to leave the fund.

Mass customisation

In Australia, QSuper has actively explored ways to incorporate life-cycle strategies in a MySuper option.

The key to the success of the product lies in finding an easy and cheap way of tailoring a mass product to individual members.

QSuper plans to do this through applying new technology that incorporates available personal information from members, including their age, income, account balance and potentially even gender, and then adjusts investment portfolios against pre-set goals.

It essentially embeds a form of simple advice in a default option.

However, some industry participants have warned this approach requires a large number of assumptions and access to data that members do not necessarily want to supply.

But Forster said he was optimistic about the ability of funds to continue the development of life-cycle options.

"As life cycle develops and we get more volume, you will see different strands of life cycle coming on," he said.

"Ideally, you will see those develop to even income life-cycle funds; 3 per cent over CPI (consumer price index), 5 per cent over CPI."