Mar 27

Does our Super have too much in equities?

Over the last couple of weeks I’ve been asked to comment on the asset allocations of default super funds. There’s certainly been a very interesting debate through the print media which was probably started by David Murray, Chairman of the Future Fund, last year when he stated that Austrlaian Super Funds were too heavily invested in Australian Equities. More recently, Kenry Henry, previous secretary of the Federal Treasury, who suggested that the bias towards equities by super funds is leading to too much financial instability. There have been numerous responses stating that over the long run equities outperform so they should play a large part of a superannuation portfolio and also statements regarding the relative good valuation of equities versus the low yield currently available on low risk bonds. All arguments have some truth to them.

Personally, I tend to think default superannuation funds have too large an exposure to risky assets. Most default funds run a “balanced” strategy that has around 70% in risky assets, and whilst this could be argued as an optimal strategy over the long run, unfortunately, as retirement approaches this strategy carries the sort of risk that could destroy one’s retirement. As a result, for a cohort (or default fund) I have to admit to being in the lifecycle camp, whereby the risks of a portfolio change over time. So the risk of a portfolio is very high (i.e. high percentage of growth assets) in the early years when one can afford a large loss and in the latter years as retirement approaches the portfolio risks are lower as substantial losses, like a 2008 scenario, cannot be recovered once in drawdown phase.

For anyone interested, I wrote a blog post last year explaining asset-weighted returns whcih is the essence of a lifecycle fund….just click here to read…as opposed to a balanced fund which is all about time-weighted returns. So the key points I’ve made are that a younger person can recover losses whilst a person approaching retirement cannot.

Consider this…

…if a 25 year old has $20,000 in their superannuation fund and they are 100% invested in equities and another 2008 comes along and they lose 40% of their capital, they have lost $8,000. If they earn $40,000 salary and their superannuation contributions are $3,600, then their losses will be recovered from contributions alone in a little over 2 years when they’ll be 27 with many more years left before retirement. If things turn out well then the early returns for the 25 year old are accelerated thanks to the higher exposure to shares.

…if a 63 year old earning $100,000pa paying an inflated $15,000pa into superannuation has a balance of $400,000 and their balanced (70/30) fund experiences another 2008 and loses 20% or $80,000, they require more than 5 years of contributions to recover the losses from contributions alone which brings them to 68 years and well beyond the usual retirement age of 65. So this person has a less risky fund, higher contributions than the 25 year old and yet the chances of loss recovery is much lower and would obviously be more stressful..

These are simple examples as to why the lifecycle approach, in general, is more appropriate than the current balanced approach…and…I believe the lifecycle approach is best for a cohort, as opposed to an individual.

For an individual, i believe the best approach is to seek out the services of a good financial planner who can tailor an appropriate contribution and investment strategy to provide the best chance of meeting one’s individual retirement income goals. This could cover any contribution level and any investment strategy as it is client goal specific.

Unfortunately for the government’s future age pension liabilities, around 80% of individuals take little notice or action on their superannuation investments so ensuring the appropriate default strategy is important….and the balanced fund is not the answer.

Next steps…and probably next blog post…the retirement income solution!

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