HOW SAFE IS YOUR SUPER FUND?

Introduction

As this article is being written, news is starting to break across the wires of the release of the Cooper Review, more formally known as the ‘Review into the governance, efficiency, structure and operation of Australia’s superannuation system’. The review has been chaired by Jeremy Cooper, a former deputy commissioner of ASIC.

Two key reforms that have been recommended by the Review are the introduction of the MySuper default option for all employees and super fund back-office efficiency measures, based around the use of tax file numbers as a ‘key identifier’. These changes, and others discussed in the press over the last twelve months or so, are primarily targeted at reducing the fees and charges incurred by members of Australia’s super funds.

Asset allocation – the ‘elephant in the living room’

One issue that has not received the same attention in the mainstream press has been the asset allocation choices made by Australia’s super funds. This is a telling omission. There is no doubt that costs and fees can make a significant impact on a super fund’s total return over an extended period of time. However, there is also no doubt that an even more dramatic difference can be made by the investment choices made by the trustees.

In 2008-2009, the super fund industry data provider, Rainmaker Group, released its analysis of the Australian super fund industry. It revealed that the typical Australian super fund had about 50% of its funds invested in Australian or international shares. Some funds had a considerably higher proportion in these investments and self managed super funds are reportedly even more heavily exposed.

Shares and volatility

The problem with weighting a fund towards shares is that shares are a very volatile asset class – whether considered internationally or in Australia. For example, the US S&P 500 share index:

• Dropped by 33% as a result of the 1987 crash.
  
• Dropped by 49% as a result of the “tech wreck” at the turn of the century.
  
• Dropped by 40-50% as a result of the global financial crisis.

Similarly, the Australian S&P 200 share index hit a high of 6852 in November 2007, before plummeting as low as 3120 in March 2009 – a drop of well over 50%. Further, although Australia escaped the worst of the “tech wreck”, our markets dropped by almost 42% in the wake of the 1987 crash.

This should add some perspective to recent market events and the inevitable talks of ‘asset bubbles’. The collapse in housing prices in the US (of perhaps 40%) in the wake of the subprime fiasco has rightly been regarded as virtually unprecedented. But in the much more volatile equities sector, falls of this magnitude are actually not uncommon. Yet can anyone recall hearing talk of an ‘asset bubble’ in the share market?

Aging of super fund membership

The most common refrain one hears in defence of funds heavily weighted towards shares is that they are suitable for younger investors, who can afford to ride the share market rollercoaster in the quest for higher returns. This ignores at least two important facts:

• No matter how long the period one has to invest, being forced to draw funds in the aftermath of a 50% decrease in portfolio value is going to affect an investor’s investment outcomes substantially. This is doubly the case in the light of the extended periods it can take for the share market to recover after a collapse. We saw this following the 1987 crash, after which it took until late 1996 for the All Ordinaries Index to achieve consistently the heights it reached prior to the 1987 crash. If the commentariat is right in predicting an extended period of low growth globally, it appears that we will see at least a similar recovery period after the most recent crash.
  
• Australia’s super fund members are rapidly ageing, in line with the rest of the population. Regardless of the merits of a higher risk strategy for younger investors, many super fund members simply do not have the same ‘luxury of time’ to risk massive losses on volatile asset classes. For these members, increased exposure to fixed income investments would certainly seem more suitable.

Conclusions

No doubt much good will come of the Cooper review. A focus on transparency and efficiency will certainly benefit investors. However, perhaps it is also time to look at the asset allocation decisions made by super funds. Such a significant weighting to Australian and international shares is certainly questionable in light of their track record of volatility.

With many now predicting an extended period of low growth for the world, fixed income investments might assume a much more significant role in the investment industry generally.