Life-cycle funds, or ‘target date’ funds as they are known in the United States, aim to de-risk portfolios by increasing allocations to bonds and fixed income as investors grow older.
But target-date funds lost US investors between 20 and 40 per cent during the global financial crisis, leading to a ‘please explain’ joint hearing conducted by the Securities and Exchange Commission (SEC) and the Department of Labor.
Two dangerous assumptions underpin life-cycle funds, according to Mr Matterson: firstly, that bonds are a ‘safe’ asset; and secondly, that diversification is the only way to manage risk.
“If you take valuations into account today, the amount of upside that’s left in a bond portfolio is relatively low given where rates and yields are,” Mr Matterson said. The spectre of inflation is also a real possibility, particularly given the quantitative easing measures that have been put in place around the world, he added.
Swapping equities for bonds doesn’t remove risk from a portfolio, he said; it simply swaps equity risk for interest rate risk, inflation risk and credit risk.
One of the responses to the criticisms made by the SEC and Department of Labor was that target date funds were not diversified enough, Mr Matterson continued. But diversification will not necessarily reduce the risks for investors – particularly when markets go south, he said.
“The more exotic assets we add to the mix the less confidence we have around how those things are going to behave in stressed environments. ‘Exotic’ assets will also increase the costs for investors because there is a smaller base of managers who run the assets,” he said.
“You get much better value for money by seeking to implement direct risk management approaches and methodologies on your existing asset classes than trying to seek additional diversification at a higher cost.”
The solution for MySuper products may well be to take the lead from the United States, where there has been a big push towards managed volatility investment options, he said.
Capital protection can also play a role for underfunded retirees who need exposure to growth in their portfolio, he added.
However, given the pressure with deadlines for Stronger Super, superannuation funds may well be making the decision to get a relatively simple MySuper product to market first and then worry about tweaking it later, Mr Matterson said.
