New life-cycle products more flexible


By Wouter Klijn

Lessons learned from target date funds in the United States and their performance during the global financial crisis (GFC) have resulted in much more flexible life-cycle products, Australian wealth managers say.

The new life-cycle funds established in Australia in response to the MySuper legislation have more scope to adjust to market conditions than the largely mechanical method traditional target date funds use to adjust allocations.

Colonial First State’s (CFS) FirstChoice Life Stage product does not just bluntly shift allocations to defensive assets based on a certain date, CFS head of FirstChoice Investments Scott Tully tells theinstoreport.

Instead, it looks at the investment experience of a group of members born over a 5-year timespan.

“As people get close to retirement, they have a sequencing risk,” Tully says.

“If markets happen to go badly for that group of members leading into retirement, then the risk is that they panic and pull out of markets and lock in their losses.

“We want to avoid [that] for members by de-risking their holdings as they get closer to retirement.

“You can take into account what the member’s experience has been and where they are going.

“For example, some members in their late 50s had very strong market returns, so their balance is higher than where they were expected to be.

“What you can do is take some of the return and lock it in and maybe de-risk it a bit more quickly.”

To assess the proper strategy for a specific cohort takes some analysis and Tully expanded his team with two investment professionals, investment manager Guneet Rana, who joined early last year from ipac, and graduate investment analyst Leroy Qian, who joined in October 2013.

Compounding effect 

Yet, there has been much criticism that de-risking a portfolio can be detrimental to the end result, as the compounding effect of returns really works its magic when there is a substantial account balance.

Tully says CFS has addressed this issue by reducing risk only from the age of 50 and increasing risk in the younger years.

“For our FirstChoice Life Stage, we have broadly speaking 90 per cent exposure to equities for people under the age of 50 and that gradually comes down to 40 per cent at age 60,” he says.

“If you are a retiree somewhere around the age of 60 to 65, then a few years out to their retirement point we have de-risked their portfolio.

“What a lot of people miss is that we are actually starting at a higher level of risk for those younger members.

“If you think about a typical balanced fund, they probably have 70/30 for their entire life, which actually means that from ages 20 to 50 they are less exposed to equities than we are in our funds.”

Tully also rejects the criticism that life-cycle funds are still a largely unproven strategy in Australia.

“It is not that life-cycle funds do something fundamentally different in terms of managing risk in the portfolio,” he says.

“As a country, we have been managing diversified portfolios for 30 to 40 years, so we know the experience with a 90/10 fund and the return a 40/60 fund will have in different environments.

“All we are saying is that we know that a 90/10 fund is more volatile but should generate higher returns.

“For those younger members they should take that risk then.”

Levels of active management

ANZ’s Smart Choice Super also uses a life-stage approach based on a member’s year of birth.

ANZ head of direct super and investments Patrick Clarke says the company’s product has three levels of active management to determine the best approach for a specific cohort.

“ANZ Smart Choice Super’s life-stage funds not only change the mix between growth and defensive assets over time, they also change the mix within growth assets and defensive assets depending on the outlook for markets and the needs of investors depending on their age,” Clarke says.

The bank’s investment specialists determine the weighting between growth assets and defensive assets based on a forward view of markets and also use this forward view to determine the weighting within the specific asset classes, for example, to shift between more and less aggressive growth assets.

Finally, the team determines the weighting within growth assets and within defensive assets based on the investment needs of customers within each life-stage fund.

“ANZ's specialist asset allocation team adjusts portfolios regularly if they believe growth assets will outperform defensive assets, or vice versa, in the medium term,” Clarke says.

“Similarly, if a particular asset class is expected to outperform in the medium term, for example, Australian shares over International shares, then the portfolio will be adjusted accordingly.

“Superannuation investors in their 50s and 60s also have a greater need for capital preservation and income and, therefore, asset classes such as Australian imputation shares or low-volatility international equities are more appropriate than small caps.

“Portfolios are structured accordingly.”

Lessons learned

In the United States, life-cycle funds have been in existence for much longer and are largely known under the term target date funds.

These funds do not segment members by birthday as the ANZ and CFS products do, but rather target a particular date of retirement.

This approach caused many problems during the GFC, especially in funds targeting retirement dates between 2008 and 2010, with losses during the crisis amounting to 30 per cent to 35 per cent only a few years out from retirement.

But since then, much research has been done to improve the life-cycle approach, while also accounting for increasing life expectancy.

Milliman financial risk management practice leader Wade Matterson says the Australian products are still somewhat simplistic compared to some of the newer US products, partly intentionally so because it is an easier story to tell than marketing a more sophisticated product.

“In the US, people have spent a lot of time looking at alternative approaches and where I think Australia hasn’t caught up is that the glide path needs to be a bit more sophisticated in terms of how they try and look at risk,” Matterson says.

“The simple way that most funds here look at risk is that as you get closer to retirement you want to de-risk.

“The problem with that is it will give you capital stability in the period to retirement.

“But if you then retire and you’ve got a 30-year time horizon, this disconnect happens because you have a need for substantial growth above where that target date fund has positioned [the member].”

This not only sets up the member for an unnecessary low-risk investment portfolio upon retirement, but also makes it hard to get them out of there again, he argues.

“They have 35 per cent growth assets in this fund at age 65 and now we are all of a sudden going to tell them that they need to double the growth allocation because their retirement will last 20 or 30 years,” he says.

“That is an emerging problem that people have to deal with.”

Measuring risk

Matterson says the core problem of simple life-cycle funds is they only look at risk through the prism of asset allocation.

“Measuring risk in a simple way – risk is either on or it is off – isn’t the way to think about it,” he says.

“You need to think about managing risk.

“Once you start thinking about managing risk, then you end up with a much more dynamic type of approach and that is where wide asset allocation bands are a useful first step.”

But a wider asset allocation band should be accompanied by strategies that manage volatility, manage capital drawdowns and provide insurance against negative returns.

Tully, however, hopes that by the time a member turns 50 they have become more engaged with their super.

“For those people that are really not engaged this is an alternative, but what we really hope for is that people after age 50 look for financial advice,” he says.

“If you are 60 and you want to take more risk, then, absolutely, go for it.”

There are currently 22 funds that offer a life-cycle product as their MySuper option, according to research published by Mercer  today (see below for report).

Retail funds account for 14 of them, while four industry funds offer these products.

On average exposure to growth assets starts at 88 per cent and is gradually reduced to reach 38 per cent at retirement.

Although the legislation allows for four price points to be charged for different cohorts, most funds have elected not to use the maximum number of price points.

Mercer MySuper Market Trends Mercer MySuper Market Trends (215 KB)

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