The superannuation industry is in a constant phase of change – whether in response to the growing volume of funds, the appropriate assets to invest in, or how to respond to changing regulatory environments.
The challenge of providing suitable investment outcomes is part and parcel of the investment analysis. The question is: What is an appropriate product for investors, and when is it just a product created to earn fees?
One of the recent themes that has evolved is portfolio construction based on age. Mercer have described this as ‘lifecycle investing’, but I prefer to call it ‘age-based investing’.
Age-based investing is underpinned by the concept that as we age our investment goals change with us.
When we have worked for 40 years there is greater emphasis on retaining capital, whereas previously the emphasis would have been on capital accumulation.
People in retirement phases will start to consider drawdowns and budgetary commitments before winning trades.
The growth in aged-based investment funds has been, to a small extent, to the detriment of the traditional strategic asset allocation (SAA).
Though SAA is still the most popular allocation, under the MySuper reforms there has been a clear growth in funds that adapt portfolio construction to align performance with the investor’s age.
The MySuper reforms deal with the default options for superannuation contributions and came into effect in January 2014.
The implications are far-reaching for most asset classes, both onshore and offshore.
According to a recent Deloitte report entitled Dynamics of the Australian Superannuation System, growth in total funds invested in superannuation is expected to reach $7.6 trillion, with SMSFs contributing $1.9 trillion.
This volume of funds will provide a challenge for local equity markets. It will alter the shape of the Australian bond market with more corporates coming to the Australian market to issue debt instruments, either via the institutional market or through the SMSF sector.
The evolution in the Australian bond market is likely to feed into the demand for consistent returns from volatility-intolerant investors.
It has been clear for some time that corporate Australia has adapted its business models to provide dependable dividend returns. The most obvious examples of these changes are in the mining sector, led by Rio Tinto and BHP, with devastating consequences for the mining services sectors.
But while it makes good business sense to listen to shareholder concerns, it may be missing the point.
As clients age they look for less volatility, but regardless of the quality of the management, there is no management team that can permanently commute volatility.
The equity market will generally be volatile but the one asset class that serves to be steady and consistent is ‘boring’ bonds. Equity markets cannot have their cake and eat it too.
The bond market is structurally higher in the capital structure. Regulators have worked to highlight risks in fixed income for subordinated and hybrid issues, but the fact remains that investment grade senior debt will be widely sought after by customers who are looking for consistent returns over the long run.
Those consistent returns will be in higher demand as we see our older population grow to be a greater percentage of our total population.
The projections are sobering. According to Treasury’s 2010 Intergeneration Report, by 2050 the number of Australians aged between 65 and 84 will double from the present number – and the number aged over 85 will quadruple.
There will be greater emphasis on finding appropriate products for these customers.
Creating portfolios that match longevity risk will have greater emphasis as we deal with the outcomes of better health options and advances in medicine.
Which leaves us with the question: How do we build a portfolio that matches the client’s needs and goals?
Age-based investing provides a framework to construct portfolios, and as demand increases for consistent returns, corporate Australia will tap that demand by providing high-quality, low-volatility bonds.
Infrastructure providers, hospitals, roads, rail, airports – to name a few – will develop assets that will be funded by stable funding vehicles that will trade off return for duration and consistency.
The next step in the evolution of aged-based investing will be the development of a corporate bond market open to all investors.
Legislation is pending and is expected to be promulgated by mid-year; there is overwhelming support for a corporate bond market if submissions to the Murray Inquiry are any guide.
Age-based investing will be studiously critiqued, but if the first test is that clients want less volatility in retirement then age-based investing passes that test.
This article has been prepared for education and information purposes and does not constitute financial product advice.
Mark Todd has over 25 years’ industry experience and previously managed the sales function at the Fixed Income Investment Group. He champions the benefits of fixed income and debt securities as an important asset class for investors.
