Superannuation funds have a role to play in navigating market shocks to protect their members’ retirement wealth. Funds must balance risk with return to help members grow their nest egg.
However, risk appetites aren’t static and so it makes sense for investment strategies to change at different life stages, too. Lifecycle funds do just that, making them the most appropriate default investment strategy, particularly for a largely disengaged membership.
While younger people with longer time horizons typically have the appetite and are more suited for high growth, higher risk strategies, this isn’t the case for members nearing or in retirement, who are on average, more risk averse. A recent survey Mercer conducted of over 55s found that only six per cent were willing to accept a loss of more than 10 per cent in any one year.
This is consistent with the investment theory that the impact of a market fall late in an individual’s career has a greater impact (reduction) to member retirement incomes than an equivalent market fall early in their career. It’s an important point because many members nearing or in retirement may not stay the course in times of volatility. And, once a member switches to a more defensive option - effectively locking in any losses they have experienced - it is very difficult to convince them to switch back. If members are no longer invested, it doesn’t matter how quickly markets recover. They will miss out.
For example, research by Aware Super that was highlighted in the Retirement Income Review found that eight in 10 members over the age of 50 who switched to a more defensive option during the GFC missed the rebound in markets and had not switched back by the end of 2009-10.
It’s therefore critical that in designing default investment strategies, a strong alignment with risk profile and stability of balance exists, particularly for those more engaged members who are approaching retirement. This is the role of lifecycle products. Designed well, they ensure the right balance of risk and return and delivery of superior whole of life outcomes. They generate wealth by investing in high growth assets when members are younger and have the timeframe to weather short term losses, and gradually transition to lower-risk investments as members approach retirement. For those less engaged members, it mimics the behaviours that an informed investor is likely to take.
Lifecycle funds can also deliver returns superior to typical balanced strategies without increasing the downside risk to retirement incomes. In a well-designed lifecycle strategy, the growth allocation in younger years will be higher than that of a balanced strategy. Members can therefore take more advantage of the free lunch that is compound interest. Earning higher returns in earlier years, even if by a small amount, can have a significant and cumulative impact on retirement balances later on.
And, owing to the higher growth allocation in younger years, lifecycle funds can still deliver superior lifetime returns despite growth allocations gliding down in later years. The below modelling (Figure 1), from the fifth to the 95th percentile of outcomes, shows the lifecycle fund achieved a higher balance at retirement than a comparable balanced fund. The median member is expected to have a balance at retirement of over $70,000 more on a real basis. Even if investment returns are very strong throughout the member’s lifetime (the 95th percentile), the well constructed lifecycle strategy still adds over $60,000 more to a member’s balance at retirement, in comparison to members of a balanced fund.
And, crucially, the probability of a return below minus 10 per cent in the lead up to retirement was reduced by more than 40 per cent.
Members will naturally have different levels of engagement, investment objectives, and varying risk appetites as they get older. It therefore makes sense to have a MySuper strategy that adjusts to a member’s changing needs – and even better, without the need for direct intervention from the member. What’s important is that this can be achieved without compromising the balance at the point of retirement and the risk of that falling short of expectations. Members really can have their cake and eat it, too.
This article first appeared in Financial Standard magazine, June edition.
Superannuation Client Segment Leader, Mercer Australia
Superannuation Client Segment Leader, Mercer Australia
Clayton Sills is a Principal within Mercer’s Institutional Wealth business. In his role as Superannuation Client Segment Leader, Pacific, Clayton is responsible for ensuring superannuation clients receive the best ideas from Mercer’s research and that this research addresses the specific needs of these clients. Clayton also provides strategic investment advice to a number of large institutional and government clients. He is based in Sydney.
Clayton joined Mercer in August 2013 with 22 years of experience in the investment and superannuation industry. This included eight years with the Queensland Investment Corporation (QIC) where he was the director of strategy and capital markets with responsibility for the provision of client centric strategic investment advice, as well as client relationship management and product and institutional business management. Prior to QIC, Clayton was a senior investment consultant with Mellon Investor Solutions where he led the NSW asset consulting practice. He has also held a range of other investment, superannuation and actuarial consulting roles at AMP and Towers Watson.
Clayton holds a Bachelor of Economics (Actuarial Studies and Finance) from Macquarie University, and a Graduate Diploma in Applied Finance and Investment from the Securities Institute of Australia.
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