LIFECYCLE INVESTING: TRENDS IN MYSUPER NOVEMBER 2013

Transcription

1 LIFECYCLE INVESTING: TRENDS IN MYSUPER NOVEMBER 2013

2 MYSUPER LIFECYCLE STATISTICS AS AT 31 OCTOBER of the 82 MySuper licenses approved to date (end-october 2013) have been for lifecycle investment strategies. MySuper lifecycle funds made up of Retail (53%), Industry (40%) and Corporate Funds (7%). Clear divergence of implementation approaches between Industry and Retail Funds. Only four MySuper lifecycle strategies will operate through, not simply to retirement. Average exposure of 89% to growth assets at beginning of lifecycle, average of 36% at retirement. Most funds have elected not to use the four price points allowed by APRA for lifecycle strategies. The introduction of MySuper in Australia has provided a catalyst for many Australian superannuation providers to reassess what is in the best interests of their members. Investment options with a static Strategic Asset Allocation (SAA) have traditionally been the mainstay of the industry, however the MySuper process has encouraged many to question this longstanding approach. The issue of defining what is in the best interests of members has led many to develop investment offerings where the underlying strategy is more aligned with a member s specific circumstances. Hence, the widespread discussion surrounding the pros and cons of a lifecycle investment approach. While there are many views as to what constitutes lifecycle investing, in simple terms it is based on changing a member s underlying investment strategy as their circumstances change. There appears to be little dispute that the objective to provide members with an investment strategy that is tailored to their circumstances is a worthwhile one. Where debate arises is over what personal circumstances can realistically be taken into account as part of the mass scale offering that is typical of most Australian default options. While there is significant on going innovation in this area, the tailoring of investment strategies offered to members today is predominantly based on their age. The Australian Prudential Regulation Authority (APRA) recognised this likely feature by specifically approving age-based lifecycle products under MySuper while also leaving the door open for other prescribed factors to be taken into account. The lack of guidance on what those other prescribed factors could include was indicative of the fact that, while lifecycle investment products are likely to see continued innovation, the changes to the underlying investment strategy will primarily be based on a member s age in most cases. The debate as to whether an age-based lifecycle investment approach can produce better member outcomes than the traditional static SAA offering has been thriving for decades overseas. The purpose of this paper is not to extend the debate, which has become quite topical in Australia, but to acknowledge there is clearly a growing domestic lifecycle market and to share some of the noteworthy trends that we have observed in this area to date. 2

3 IMPLEMENTATION OF A LIFECYCLE FUND For those super funds opting to offer members a lifecycle product, there are broadly two different implementation approaches being employed. 1. Member switching this approach typically involves using a super fund s existing diversified options and systematically shifting members from the growth oriented options (e.g. High Growth) to the more defensive ones (e.g. Conservative) as they get older. Examples of this approach are illustrated under exhibits 1 and 2 below. Exhibit 1: Member Switching (Mark I) Allocation to Growth % AGE 45 Member sells units in Growth Fund and... buys units in Balanced Fund. 10 Balanced Conservative Growth Fund Fund Fund Retirement Offering Age Exhibit 2: Member Switching (Mark II) Allocation to Growth % Member is initally defaulted into the Balanced Fund AGE 55 Member sells some units in Balanced Fund buys some units in Conservative Fund Age Balanced Fund Conservative Fund 3

4 2. Cohort Funds this approach involves creating a range of investment funds that are managed in line with what is deemed appropriate for members of broadly the same age. Rather than switching to different funds over time, members remain within the same cohort fund and the underlying strategy evolves as a member ages. This approach is illustrated under exhibit 3. While both approaches illustrated in exhibits 1 and 2 seek to reduce risk (measured by overall growth exposure) as a member gets older, we note that the first approach involves reducing risk via switches that are more infrequent and larger in scale. Given the principally systematic nature of these switches under an age-based lifecycle approach, it is generally accepted that gradually reducing the risk over time is preferable and a prudent way to minimise the chance of switching at the wrong time (e.g. just after a large fall in equities). Exhibit 3: Cohort Funds (5-year age bands) SAMPLE MEMBER: AGED 38 Member defaults into the fund based on the year of their birth and will continue in this fund throughout their life. Allocation to Growth % Age <1933 Cohort funds, as the name suggests, involves pooling members with similar characteristics (typically based on age) into an investment fund that is managed over time based on their common circumstances. A typical form of cohort fund is Target Date Funds where the underlying strategy is broadly aligned with the date at which they expect to retire. Given not all members will have a set time at which they expect to retire, an increasingly popular alternative approach, as per the diagram above, is to use the member s date of birth to determine which cohort fund is most appropriate. The example shown here uses five-year age cohorts whereas wider age bands for pooling members together have also been used. It is worth noting that at least one superannuation provider intends to create cohort funds that are based both on a member s age and super balance. It is often observed that not all static SAA default options are built equally and the same is true of lifecycle funds. As evident above, constructing a lifecycle fund can be implemented in a variety of ways and as noted earlier there are also a myriad of views on the shape that the glidepath should take in order to deliver the best outcome to members. MYSUPER LIFECYCLE FUNDS EMERGING TRENDS Although the pool of lifecycle funds available in Australia is in its relative infancy compared to other major pension fund markets such as the UK and US, it is interesting to observe the different trends emerging as to how lifecycle providers approach constructing and implementing their product. Our objective is not to assess the pros and cons of these different approaches but rather to provide an overview of how lifecycle products can vary in a number of key areas. Table 1: Approved MySuper Lifecycle Funds MYSUPER APPROVED APPLICATIONS MYSUPER Lifecycle 15 Static 67 Total 82 As at end October Source: APRA 4

5 Table 2: Lifecycle Fund Providers Market Breakdown MYSUPER LIFECYCLE IMPLEMENTATION APPROACH MEMBER SWITCHING COHORT FUNDS TO RETIREMENT THROUGH RETIREMENT Retail Industry Corporate Total As at 31 October Source: Mercer, APRA When looking at the lifecycle products being developed under MySuper, a clear division is emerging between the approaches taken by retail and industry super funds. Member switching appears to be favoured by industry funds, with all but one industry super fund selecting this implementation approach for their lifecycle fund. In contrast, all retail funds so far, bar one, have chosen to offer cohort funds to their members. It is also noteworthy that only four of the MySuper lifecycle funds available in Australia will go beyond ( through ) retirement. The fact that the MySuper legislation only covers the period up until retirement is a likely contributing factor to the relatively low number of lifecycle funds that provide members with the scope to remain invested throughout their retirement years. In the tables that follow, we have listed some of the key features that need to be considered when designing the glidepath for a lifecycle fund and how the group of Australian lifecycle fund providers have approached each feature. Table 3: Lifecycle Funds Key Features Frequency of de-risking switches* MINIMUM AVERAGE MAXIMUM Number of age cohorts** Age at which de-risking begins*** * Only applies to 7 lifecycle funds using a member switching implementation approach. ** Only applies to the 8 lifecycle funds that have opted for cohort implementation approach. *** Applies to both member switching and cohort funds. As at 31 October Source: Mercer, APRA De-risking switches refer to the systematic transfer from growth to defensive assets that occurs under a member switching implementation appproach. We note that there is quite a wide range in the frequency of de-risking switches underlying the seven lifecycle funds that have to date opted for a member switching implementation approach. For example, the fund that makes only one switch has opted to make a systematic move on behalf of members from a growth oriented diversified option to a conservative one once they have reached a pre-determined age. On the other end of the scale, another fund has opted to reduce member s growth exposure in increments of 4% each year over a 25 year period once they reach the age of 42. Effectively, this results in the member having 0% growth exposure once they reach retirement age. The number of age cohorts shown above is indicative of how broad the age band is for each investment pool available to members. The frequency of de-risking switches within each age-band is not readily available information at this stage. Of the eight funds that take a cohort approach to implementation, four pool all members aged within ten-years of each other into the same investment cohort, three use five-year bands while the remaining fund will initially divide members based on age (e.g. over/under 58) and superannuation balance (e.g. over/under $300,000) with additional cohorts expected over time. While it might seem intuitive that having one-year cohorts (investment pools for members of every age) would be optimal, this clearly can be an administrative challenge and potentially costprohibitive for some fund providers depending on scale. The age at which de-risking begins can be a key determinant of the overall outcome members can expect to achieve when investing in a lifecycle fund. As evident in the table above, some believe the process of reducing risk should begin very early in a member s working career whereas others see merit in maintaining a higher growth exposure for later into a member s working life. While maintaining a higher allocation to growth assets for longer generally results in a member having a higher expected balance at retirement, there is also usually greater uncertainty surrounding the outcome given the volatility associated with the higher growth exposure. This risk/reward trade-off is a constant consideration in the design of any lifecycle glidepath and highlights the importance of having clearly defined investment objectives. 5

6 The data in the tables that follow is based on the available information underlying the 15 funds in Australia that intend to offer a lifecycle MySuper option (therefore includes both member switching and cohort fund approaches). Table 4: Asset Allocation at start of Lifecycle ALLOCATION TO ASSETS MINIMUM AVERAGE MAXIMUM Growth Assets at entry age 70% 89% 100% Growth Assets at retirement age 0% 36% 50% If through retirement lowest allocation to growth assets 24% 31% 40% As at 31 October Source: Publicly available information, PDS, websites. FEE OBSERVATIONS Although the government s legislation has permitted there to be four separate fee levels ( price points ) under a MySuper investment option, observations to date indicate that most cohort funds offering a lifecycle option have decided to charge a single fee. It should be noted that the ability to use more than one price point was a late concession by the government and therefore was likely a contributing factor to there being a considerable proportion that have decided not to employ this flexibility. The absolute investment fee underlying each lifecycle fund will clearly be influenced by the level of active management used over time. While information in this area is relatively sparse for now, we have observed a number of retail funds opting to employ passive management in some or all of their underlying portfolios. CONCLUSION MySuper has provided a timely opportunity for all superannuation providers to reassess the investment strategy that is in a member s best interests. This has led many to question the static SAA approach that is typical of most Australian default options and consider the role lifecycle investment funds could play for default members going forward. While the MySuper approvals to date suggest that the established form of default will remain the preferred approach, there is clear evidence that lifecycle funds are growing in prevalence in Australia. There are many layers to the debate as to what constitutes a well-designed lifecycle glidepath but there is clearly a growing consensus in this market that the ability to take a member s circumstances (even if this is primarily their age) into account when setting their investment strategy is a step in the right direction. This paper has considered some of those key features underlying the design and implementation of any lifecycle fund and demonstrated that there are already a variety of different approaches being taken. On-going innovation in many of these areas is expected as the lifecycle market continues to evolve and grow in Australia. 6

7 FOR FURTHER INSIGHTS CONTACT: GRAEME MATHER PARTNER JP CROWLEY PRINCIPAL HENDRIE KOSTER PRINCIPAL

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