What are lifecycle and target date super funds

Post on: 11 Апрель, 2015 No Comment

Article utilities

This makes little sense. Someone at the start of their earning career can afford to take some risks with their super: a sharemarket downturn might look ugly in the short term but doesnt matter so much when one is thinking 40 or 50years ahead. But for those approaching retirement, a major shift in the value of the assets at the wrong moment can be utterly debilitating perhaps the cruelest lesson of the global financial crisis. For them, the emphasis would be on preservation, with a more conservative approach to growth.

Now coming to Australia

In the US, this approach has been common for years, with mixed results. It is rarer in Australia, but becoming more usual, in a fairly blunt way.

If you are a default investor in Telstra Super Personal Plus, for example, and make no other investment choice, you will be placed in a balanced option for most of your working life (targeting 74 per cent growth assets and 26 per cent what it calls financial assets, such as bonds and cash) and automatically shifted to a conservative option at the age of 60, moving to a 40/60 growth/income split.

At Health Super, if you dont make an investment choice, you are put in a long-term growth portfolio (90/10) up to the age of 50, a medium-term growth (70/30) allocation for the next 10 years, and balanced (50/50) from 60 onwards. Health Super writes to members before making the switch, but it happens automatically on their birthday.

These approaches stem from a recognition of how important the last years or even just the last year of a lifetime of accumulation can be.

Investment professionals talk a lot about sequencing, or sequential risk; this refers to the fact that the moment when an investor experiences market performance greatly influences outcomes so, for example, experiencing the GFC in an equity-heavy portfolio when on the cusp of retirement would be a nasty example of sequencing risk. The idea of moving into safer assets later in the lifecycle is to remove some of this sequential risk and protect the wealth thats already been built up.

The wrong question

In this interpretation, the hot topic of whether weve all got too much in equities is missing the point. Thats asking the wrong question, says Michael Drew, professor of finance at Griffith University. We seem to have framed this discussion in Australia around the 70/30 default options, which four out of five members are in, and which gives you the same allocation whether youre 15 or 85.

In fact, the answer depends on what end of that range youre at. Ifyou have a 40-year horizon, equities sound pretty sensible. If you have a short horizon before drawing on your retirement savings, they might not, he says.

Drop-kick funds

Viewed like that, the lifecycle approach makes a lot of sense. But not everyone is a fan. Some in the industry, mocking the arbitrary nature of a birthday as a pivotal investment moment, call them astrological funds or drop-kick funds, referring to the sudden shifts in allocation they impose. They draw particular fire in the financial planner community, which sees itself as a more informed gauge of when people should change their investments.

I am not a supporter of lifecycle strategies as they currently stand, says Paul Moran of Paul Moran Financial Planning. These strategies are all activated without a view to current market conditions. Portfolio changes occur based simply on the clients birthday. There is a risk in this itself, as changes may be at exactly the wrong time or exactly the right time but they are always based ona factor that has absolutely nothing to do with investment markets: the investors age.

The cautious card

To Moran, this is just missing the point. But they are arguably better than nothing. Lifecycle strategies are perhaps suited to nave investors who pay little attention to their investments, he says. In the absence of getting some advice regarding asset allocation based on their personal circumstances, this may at least play the cautious card.

It seems many in the planning community remain unconvinced. According to the research group InvestmentTrends, which published a study on retirement planning in April, less than 1 per cent of Australian financial planners said they had used lifecycle or target date funds in 2011, and only 4 per cent said they would use them in 2012 if they were made available tothem.

Tinkering is underway

Still, Morans objections, while relevant to lifecycle funds as they exist today, are not lost on product manufacturers who in some cases are already thinking along exactly these lines. Work is well under way on a second generation of lifecycle funds that take some of these concerns into consideration.

An example is QSuper. Chief executive Rosemary Vilgan says the fund is developing a lifecycle approach, which will become its default fund, probably later this year. Where were heading is lifecycle investing, but mark two, she says.

Meaning? Well, partly recognisingthat age is not the only differentiator among members.

Members have different profiles, so putting everyone into the same balanced fund doesnt take account of two key things: members time to retirement and the amount of money people have, Vilgan says.

End to arbitrary allocations

Russell Investments recently published a paper on lifecycle funds calling for exactly the sort of changes that QSuper is working on. Lifecycle investing isnt simply about reducing allocations to growth assets with age, the paper says. Additional demographic and financial information must be considered in addition to age. Russell suggests that new lifecycle funds should create customised strategies for each member, based not only on age but on income level, total account balance in super, current savings rates, total wealth and the nature of their job.

Mass customisation

The idea is to recognise, as Russell points out, that not only is the same default investment strategy inappropriate for a 40-year-old and a 75-year-old, but the same default strategy may be inappropriate for two 75-year-olds with different account balances and spending requirements. This is a big ask for manufacturers to deliver in a cost-effective way. The industry term is mass customisation.

Opinion is divided on just how easy thats going to be to achieve. Russell argues that much of this information is available on an investors administration platform. I can only speak on behalf of our own platform, but there is a richness of member information there that can be used to create a more dynamic and thoughtful investment approach, says Chris Corneil, Russell Investments Australia chief executive.

For her part, Vilgan draws a parallel with Amazon, who tries to understand customer needs and talk to them about those needs. This is happening in every other business. Its just that the pension world hasnt caught up. We believe this is a 20, 30, even 50-year vision.

Lifecycle version seven

At the extreme, US-based fund manager Dimensional is understood to be considering bringing technology to Australia that would create a truly individual, yet largely automated, allocation for every member. While admiring the principle, one manager says: Thats lifecycle version seven. Were still working on version two.

Lifecycle investing is under particular scrutiny as we move closer to the launch of MySuper default products. Its still, somewhat alarmingly, unclear just what the final legislation for MySuper will eventually say but if draft bills go through as proposed, then lifecycle funds will certainly be permitted as defaults, and will be allowed to operate based on parameters other than age, provided APRA approves them. There is a sense that, just as the US has allowed lifecycle options in its 401(k) defined benefit plans, the time is right to bring lifecycle ideas to the masses in Australia.

The spirit of change

Nobody is suggesting lifecycle funds should be mandatory, says one fund manager. But if in July 2013, after all the effort of the Cooper review and so on, all we endup with is the same funds we already had, that will not be in the spirit of change we were expecting.

After 20 years of the superannuation investment management industry, nearly everyone has exactly the same 70/30 allocation for life, he says. Are we not smarter than that?

Discussion of MySuper brings us to the fee question: since the single biggest driver of government policy on MySuper has been low cost, is a lifecycle format achievable?

Probably the best indication that it is comes from BT, which despite being a commercial operation commonly considered higher cost than industry funds has managed to launch a successful lifecycle product at a fee of just 0.99per cent, about the level the government wants to see in default funds. BTs Super for Life product, which takes investors through super into a transition phase and then into a retirement product, offers its Life Stage product as an investment option. Melanie Evans, who heads BTs superannuation and platforms team, says four out of five new customers take up the option.

Were not surprised at that result, Evans says. When we researched this five or six years ago prior to launching, we found that most Australians understood they needed dynamic asset allocation over time, but acknowledged they didnt have the technical capabilities, knowledge or time to do it themselves.

Two extremes

The BT approach is to divide investors by their decade of birth and set an asset allocation accordingly. So, if you were born in the 1990s, BT would currently have you 90.18per cent in growth assets and 9.82per cent defensive; if you were born in the 1940s, very likely putting you in retirement or approaching it, you would be 34.69per cent in growth and 65.31per cent defensive. The other decades vary between these two extremes.

Her comment on Australians knowing they need to do something but not having the time or knowledge to do it is important alongside Morans view that financial planners are better equipped to tell people when to move their money. In fact, there is room for both to be right.

Not a financial planner

BT Super for Life is specifically designed for a segment of the market that doesnt necessarily haveaccess to a personalised financial planner, Evans says.

Its not designed to take the place of that, nor do we say it is equivalent to a customised financialplan. It is for those people who would otherwise be taking a typical default investment strategy.

Vilgan takes a similar view. This will help people get better engaged with their super. I dont think this undercuts financial planners, and for those who engage with them, thats wonderful; but for the ones that dont engage, we want to put them on the best path.

On the way up

Theres no question lifecycle products are going to gain traction. Vilgan, looking five years ahead, says she can imagine it being the dominant approach in super funds. And asset consultants such as Mercer, Russell and Watson Wyatt are talking with funds about the approach every day.

We know a number of organisations that are considering lifecycle, says Tim Furlan, director of superannuation at Russell. Theyre probably not the majority at this stage, but there are many who are thinking: is this something we should be doing?

So expect your super fund to be looking at lifecycle approaches, and be ready to assess what they offer. Because autopilot is a great invention provided youve got someone there who knows when its a good idea to turn it off.