Since the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, there’s been a lot of discussion surrounding the performance of superannuation funds and more specifically its regulation.
Some debate regarding the regulators role has centred around the performance of funds and whether APRA, in particular, should be reporting and therefore indirectly influencing member fund flows.
Let’s be clear, superannuation is a tax structure and needs to be separated from the investment strategy itself.
The performance of funds should not sit with APRA, however, the role of a regulator or ASIC as the enforcer of transparency is vital for consumers.
Here’s three focus areas the regulators should consider in helping build transparency.
1. Standardise and be consistent in the classification of assets
The first key area should be standardising the classification of assets as either defensive or growth. For example, some funds classify property and infrastructure assets as defensive assets when they own them directly and value them infrequently. However, this doesn’t correlate to low risk just because the asset isn’t valued every day.
Another example of asset misclassification is a BB rated bond which is termed sub-investment grade or conveniently ‘high yield’ post the GFC (previously it was referred to as a ‘junk bond’) with a long maturity, by comparison to a AA rated bond with a short maturity. They’re both referred to in the market as ‘fixed interest’ however the differences in terms of their role as a defensive part of a portfolio is chalk and cheese.
Convertible notes or hybrids are also conveniently classified as fixed interest or defensive assets by some funds. However, whilst they may pay a fixed margin above the BBSW, that’s really the only ‘fixed’ part of the investment, as they generally also have an embedded option to convert to ordinary equity should specific events occur. This conversion ‘option’ is part of the price of the hybrid and as such will move around more than traditional fixed interest, particularly in a down market.
For instance, for the 12 months to 31 March 2009 CBA Perls III (PCAPA) and NAB’s National Income Securities (NABHA) both fell more than 30%, which is not consistent with the characteristics of a truly defensive investment. It therefore shouldn’t be surprising that these notes generally are considered equity in the capital structure of a bank for instance.
All of these examples are legitimate investments in their own right, but let’s be realistic about what the risk is and where they sit in portfolios when managing the risk vs. return dynamic.
2. Clearly define investment option labels such as ‘balanced’
There’s been a range of studies done on the impact of asset allocation, however in every case, asset allocation is overwhelmingly the key determinant of return an investor can expect and indeed will receive.
A critical issue facing investors when choosing a fund to fuel their retirement is the asset allocation (strategy) and expected return. At present a member is not given a clear definition of what various labels like ‘Balanced’, ‘Growth’, ‘Aggressive’ or ‘High Growth’ really means when it comes to asset allocation strategy and investment risk.
One prominent industry fund for instance has a ‘Balanced’ investment option, leading the investor to believe it’s a relatively low risk and could reasonably imply a 50% defensive and 50% growth asset allocation. However, the fact is it’s anything but with 83% of the strategy’s assets invested in growth assets.
Unfortunately, this ‘balanced’ investment option (and others like it) is the default which means if you as a member don’t make a choice, this is what you’ll end up with. Not necessarily a bad thing if you’re in your 30’s as you’ve got time to ride out the volatility that inevitably comes with this type of strategy. However, if you’re close to retirement and a major market correction like the GFC hits, being in the default ‘balanced’ option could be catastrophic. To illustrate this point, the loss in superannuation funds with this type of asset allocation was around 28% for the 12 months to 30 June 2008.
The regulators need to look at ways they can accurately describe investment risk to the member (investor) and this starts with consistency of labels across funds. If members don’t have all the information (and what they do have is inconsistent across funds), how can they make an informed judgement about the risk they’re taking?
APRA has a role to play in ensuring that labels of particular strategies are accurate and do not lead a member to a conclusion of relatively lower risk than perhaps an ordinary definition of ‘balanced’ would suggest.
3. Measure performance after tax
If the regulator is going to measure performance of managed funds we should report the only number that matters – ‘performance after tax’ – as that’s what the member uses to fund living costs. If you have a high frequency trading strategy you’re less likely to have discounted capital gains and therefore pay more tax rather than being strategic about minimising tax whilst also running a sound investment strategy. I note reporting after tax returns is already common place in major markets such as the USA and UK.
In the absence of a lead from regulators, all superannuation members should review the asset allocation of their investment options and determine whether or not what they currently have is an appropriate strategy and indeed maximises your return for an acceptable level of risk. If they’re unsure, seek advice from trained professionals to assess the risk and expected return to determine if the current strategy is right for them.
If you need assistance reviewing your superannuation strategy, speak to your local expert today.