- On 24/06/2020
- investments, mySuper
Last year as global share markets neared their peaks, we questioned whether superannuation funds could continue to meet their target returns over the next decade¹. We also suggested funds communicate likely lower returns with their members. This is particularly relevant for those members within 10 years of retirement, as they are likely to withdraw some or all their benefit during this time.
At the time, we questioned whether asset prices had been bid up so high that future returns had to fall once growth rates reverted to long term averages. Alternately, it can be argued that the normal range of appropriate Price/Earnings ratios had been reset at higher levels in the light of record low interest rates. Either way, it was plausible to expect that future returns might be lower in percentage terms over coming years.
Within a few months, the markets crashed as the COVID-19 pandemic circled the world. The USA, UK, Europe, and Australia moved quickly into a steep recession with plummeting GDP and high levels of unemployment. Record government interventions threw all normal market trends awry.
Despite the chaos, the downturn so far has been brief. The weight of money sitting in huge liquid pools saw demand for equities emerge during May, and many share prices have risen back to levels they reached 6 months ago. The growth has been largely indiscriminate even though sections of the economy might need to be rerated. Across the country some sectors of the economy (such as miners and supermarkets) have remained busy through the crisis and will bounce back quickly. In these cases, their share prices do not look unusual. Others though, such as airlines, airports and REITS based on commercial properties, have also partly recovered, even though their medium-term prospects still appear dire.
No doubt, the valuations will stabilise as the economy recovers, but it could take a few years to get back to the new normal, whatever that might look like. This must impact on our expectations for asset classes.
All MySuper funds show a target (expected) return which they expect to earn above CPI, after deducting fees and taxes. This comparable metric assumes a 10 year time horizon, which is generally a good proxy for the long-term.
In recent times, some superannuation funds have reduced their target returns but most still believe they can achieve similar long-term results (relative to inflation) as they did in the past. However, given the world is in the deepest recession in 90 years, we should challenge whether the future will be as benign as the recent past.
Ironically, many consumers are still likely to use past performance as the logical basis for peer comparisons, even though all funds must emphasise that this is no guide to future performance. While the past can be a poor guide to the future, it has to be said that those funds with a 25 or 30 year history of earning CPI + 4% or even 5% must be doing something right, persistently.
The only other comparable metric is the target return, so it is important that this be calculated reasonably. If it is not consumers will chase the highest target without understanding the risk involved (or the basis of calculation).
The range in target returns between funds is large and some appear very optimistic. The layperson would not understand the peer differences in asset allocation and risks taken; the information in MySuper disclosure documents necessarily is dumbed down to meet broad community levels of financial illiteracy.
These metrics are based on each superannuation fund’s mid-range asset allocation, the likely returns for each asset class based on expert assessments, and some allowance for additional returns from Strategic Asset Allocation, including both dynamic and tactical tilts. These outcomes, however well calculated, are subjective (as funds use different techniques), and they will be subject to wide variations from year to year due to market volatility. Consequently, they are not a sensible base for peer comparisons.
Reviewing investment promises
Table 1 shows the range of target returns above CPI for MySuper products (assuming a 10 year time horizon). We have separated Industry and Retail funds as they have had different asset allocations in the past, though these are now converging. We also separate Small funds (under $5 billion), Medium ($5 billion to $25 billion) and Large (over $25 billion) – these results include Corporate and Public Sector funds too.
Table 1. Target annual returns above CPI (after deducting investment fees and taxes)
As underlying inflation is currently less than 2% per annum, the targets imply that funds will only need to earn 5-6% per annum to achieve these targets. While that seems plausible, these figures are likely to be disconnected from the realised returns over much of the next decade. For example, 10-year bonds now yield 1.1% and equity markets usually have dismal performance during recessions, so where will these high returns be made? If the targets are now too high, should they not be lowered?
Assessing the differences
The underlying target returns do not show the underlying risks of the fund. There is a separate Standard Risk Measure showing the number of negative years a fund might be expected to have, but this is a trivial metric and not of much value in peer comparisons of target returns.
Without a proper assessment of risk, perhaps through some stochastic modelling, the targets can be misleading both for members’ plans and for peer comparisons. The recent market turbulence provides a good reason for funds to review whether their MySuper asset allocation and design has performed as expected, is appropriate for the future and is delivering to the investment objective the trustee has for its members.