Great restaurants have a knack of satisfying their customers' appetites, even when diners aren’t exactly sure what they want.
But instead of a restaurant menu describing each dish, imagine a list outlining taste category (sour, salty, sweet, or umami); temperature (hot, cold, or room temperature); energy source (carbohydrates, protein and fat); and nutrients (vitamins and minerals).
Without a better idea of the outcome, choosing a meal isn’t so simple.
This is the conundrum many working Australians face when it comes to their superannuation. Their central goal is to maintain their current lifestyle through retirement with some degree of certainty.
However, funds’ core balanced portfolios are typically constructed to outperform inflation (CPI) by 3 per cent to 4 per cent a year over the medium to long term (3-10 years). Meanwhile, risk is disclosed as the chance of posting annual negative returns (typically four or five) over a 20-year period assigns equal weights to annual losses of 0.01 per cent and 10 per cent.
The ingredients are there but whether this retirement dish proves satisfying to members is little more than guesswork.
Asset allocation decisions distorted through an investment lens
Portfolios are constructed through an investment lens, looking at returns and standard risk measures, rather than to meet the objectives of members. Returns are at the pinnacle, whereas for most retirees a sustainable income is what matters most.
The question of how much each member needs in retirement is either a one-size-fits all answer or ignored entirely, despite data revealing what retirees spend at a level of detail never previously imagined.
We know the age of members, yet the impact of time is indeterminate.
A typical balanced fund, which accounts for more than 80 per cent of members, has a recommended investment time horizon of three to 10 years. However, a 67-year-old will have an investment time horizon of 20 years on average while a 20-year-old will have an investment time horizon of more than 65 years.
Other common issues that work against members’ fundamental retirement goals include:
• Allocating assets in silos (such as domestic equities, international equities, fixed income, alternatives, infrastructure) without a fund-level view of how sources of return and risk overlap (such as currency, sector exposure, interest rates).
• Spreading bets among fund managers who inadvertently make bets against each other, producing passive-like outcomes for active costs.
• Running super funds with formal or cultural separations between member services and investments.
• Emphasising investment returns against rival funds, rather than member needs, creating a perverse incentive to take on more risk.
• Herd-like asset allocation decisions creating very little diversity in fund returns across the industry.
Divisions entrenched from the start
It’s no surprise that a significant gap has developed between investment portfolios, member services and member outcomes.
Super is one of the three pillars of Australia’s retirement income system, yet funds were initially built to accumulate assets. While there is broad industry consensus that the purpose of super is “to provide an income in retirement”, resistance to a formal definition remains.
The existing system is so geared toward preparing for the future that it’s lost sight of it becoming the present. To this day, the focus remains on accumulation rather than drawdown – even as a generation of Baby boomers retires. Many pension products either mirror the asset allocations of funds’ accumulation products or their assets are co-mingled. Proposed default Comprehensive Income Products for Retirement (CIPR) forced funds to grapple with their retirement offerings but remain in the too-hard basket. It’s no surprise that the CIPR’s push has faltered.
Funds must outline their investment objectives (as required under prudential practice guide SPG 530 – Investment Governance). Investment professionals are incentivised to outperform investment targets which may or may not relate to the goals of members.
For example, the investment decisions of many professionals are measured against rival funds or against pre-tax benchmarks rather than post-tax benchmarks. It is far easier to measure whether a fund is meeting these objectives than whether it is meeting the retirement goals of individual members.
It’s rational behaviour but not necessarily in the interests of members.
New member outcomes legislation and APRA’s Prudential Standard SPS 515 – Strategic Planning and Member Outcomes are forcing change but the dominant industry mantra remains fees and returns, not member outcomes. There is a long way to go.
In a future article we will explore how a super fund would look if it was built from scratch solely to meet the goals of members rather than achieve the proxy measures we use today.
Only through eliminating the arbitrary distinctions between member outcomes and investment decisions will we fulfil Australians’ retirement goals.
Jeff Gebler, financial risk management consultant, Milliman