Dr David Knox, Senior Partner at Mercer reveals the results of a global comparison of pension funds asset allocation; the factors influencing Australian superannuation funds asset allocation; and identifies some possible future trends.
The question of whether Australian’s superannuation savings are too exposed to growth assets placing unreasonable risk on the provision of adequate and sustainable retirement incomes for Australians long-term has been debated for some time and is indeed a very valid question.
However, the additional question that should be addressed is why Australian super funds have a higher allocation to growth assets relative to many other pension systems around the world, and importantly what are the future trends in pension funds’ asset allocation that can we expect.
A new research report – ‘Asset Allocation of Pension Funds around the World’ – produced by Mercer and commissioned by the Financial Services Council (FSC), offers data based insights and predictions on the topic.
A global comparison
The report confirms there is considerable diversity in the asset allocation of pension funds around the world. Australia’s superannuation industry has about two-thirds of its assets invested in broadly defined “growth” assets, where the actual returns are related to economic performance and therefore may be volatile. On a global comparison, this result is higher than any of the countries included in the report1 , except for Hong Kong. However, the Australian growth assets are more diverse than in Hong Kong where they are restricted to equities.
Generally, when considering the well-established pension industries, we observed higher exposure to equity investments in the Anglo-Saxon markets such as Australia, the UK, the USA and Canada but less exposure to equities in some European countries such as Denmark and the Netherlands. However even this pattern is not uniform with Switzerland having a similar exposure to equities as the UK. The importance of equity investments for Japanese and Chilean pension funds is between these two groups of developed economies.
The developing pension markets also have range of outcomes. In mainland China and Korea we see a heavy dependence on fixed interest investments while in Hong Kong we observe the highest exposure to equities of any of the specified countries.
The exposure to property investments also varies, ranging from zero in many countries to approaching 10% in Australia, Canada, Chile and Switzerland.
Reasons for our high exposure to growth assets
As noted above Australia’s superannuation funds are heavily weighted in growth assets, but this asset allocation is the outcome of a number of important factors within our retirement savings system and our local investment markets.
Contributing factors that may increase the exposure to growth assets in Australia include:
● Australia does not have any requirement to convert lump sum benefits into an annuity or pension benefit at retirement. This means individuals do not need to de-risk their investments as they approach retirement to protect them from a market decline as they approach the required annuity purchase date. This “freedom” and the longer term investment horizon reflecting the retirement years also means there are good reasons to maintain a broad asset allocation.
● The relatively immature Australian superannuation system means the investment time horizon for most superannuation fund members (including many retirees) is at least 15 years, which increases the need to invest for capital gains and not just income.
● Our dividend imputation system increases the attractiveness of Australian equities. This can lead to investors, such as SMSF pensioners, who are seeking regular income (i.e. not capital gains) and may perceive the dividends paid by the four AA-rated major Australian banks as an attractive investment and almost as safe as term deposits in these institutions.
● Australian households have a relatively high level of direct share ownership, partly arising from past de-mutualisations. In 2012, 34% of the adult Australian population (or 5.98 million individuals) owned shares directly2. This exposure provided them with an awareness of the growth potential as well as the volatility of equity prices which provides some comfort and understanding of the potential volatility of the value of their superannuation benefit in a DC fund.
● The limited availability of corporate bonds and index-linked bonds within the Australian market restricts the investment options available for some funds, where there may be a reluctance to invest a significant portion of the fund offshore and thereby introduce currency risk.
● The means-tested age pension can encourage retirees to maintain exposure to the share market and the associated potential capital gains. If there is a loss in asset value, then their age pension may increase due to the means tests (thereby partly offsetting any loss) whilst if there is a gain, they perceive it as a clear benefit.
● Assets attributed to defined benefit (DB) schemes now represent less than 11% of all superannuation assets3 and there are very few funded DB schemes paying pensions. The pressures to match assets with pension liabilities or to de-risk is largely absent from Australia when compared to many other countries.
● The long term growth and future prospects for the Australian economy mean most DC schemes believe they will provide higher retirement benefits to members if they have a stronger emphasis on long term growth assets rather than fixed income investments.
It is clear there are valid reasons why Australian superannuation funds have a relatively high exposure to equities and other growth assets when compared to many other countries. As the superannuation system matures and there is a shift in funds towards retirees, it is likely that this exposure will gradually reduce. The current overall allocation, which provides a high level of exposure to potentially volatile assets, will become less appropriate as the baby boomers retire and begin to drawdown their funds. A broader range of assets, including corporate bonds and credit, is likely to provide a better long-term outcome for these members. Of course, for active employees the current approaches may remain valid or be replaced a lifecycle strategy which could see the allocation to growth assets increase in some cases. However the trustees of every superannuation fund have the responsibility to consider their own members and to make the most appropriate decisions.
We have also observed that some countries have a relatively low exposure to growth assets. This is likely to limit the return achieved by the pension plans over the longer term which, in turn, affects the retirement benefits provided. It is recognised that in some economies, the capital markets are still developing and it may be impractical to invest a significant proportion of the assets in growth assets at this stage. Other countries also impose restrictions in investments in equities.
Whatever the current situation in each country, the goal from an industry-wide perspective should be to broaden the asset allocation over coming years in all countries.
Future global trends in pension fund asset allocation
The future asset allocation of pension funds over the next decade or two is difficult to predict but several trends are likely:
● A continued decline in the exposure to potentially volatile assets such as equities for closed defined benefit schemes as many of them move into pension payment phase with the corresponding need to more closely match assets with these liabilities
● An increase in the exposure to a broader range of assets that provide steady returns for retirees, which may include more fixed interest, property leases and private debt
● A continued broadening of the asset classes used by pension funds including hedge funds, private equity and infrastructure
● A growth in equity investments is some emerging markets as these capital markets continue to develop
● A growth in equity investments in some markets as DC funds expand in importance with the related focus on individual investors.
1 Countries in the report included: Australia, Canada, Chile, China (Mainland), Denmark, Hong Kong, Japan, Korea (South), Netherlands, Switzerland, United Kingdom, United States of America (USA)
2 ASX (2013), Australian Share Ownership Study 2012
3 APRA (2014), Annual Superannuation Bulletin, Table 16
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