Superannuation funds have a suite of options to suit all types of investors. There is plenty of choice and something for everybody. Everybody except the majority of us who make no choice at all, that is. STEPHEN SHORE investigates the evolution of the default option.
With an average 82 per cent of industry and corporate fund members in a default option, many people are not actively engaged in managing their retirement savings. While this does not necessarily imply apathy, at the very least, the majority of members appear to be content for their fund to make investment decisions on their behalf.
For its part, the Australian superannuation industry has done much to earn this trust. Most funds’ balanced options have performed well, delivering high and stable returns. But investors have diverse needs and saving for retirement is not supposed to be a one-size-fits-all solution.
With the number of members sitting in default options, this has inevitably become the case. A few superannuation funds have realised that while a personally tailored retirement plan is not available to or desired by everyone, there are certain basic assumptions that can be made about the investment needs of members. Firstly, a person with 40 years until retirement can probably handle a substantial amount more risk and volatility than someone nearing retirement. And secondly, a person with 40 years until retirement is unlikely to be at all interested in planning for that retirement.
According to Paul Cahill, chief executive of Club Plus, the latter point is no assumption. The fund for club industry employees, the majority of Club Plus’ members are under 30 years of age. It has a default rate of over 90 per cent. Cahill says you can try to educate younger people about the benefits of taking an interest in managing their super, “but you will be running uphill”.
On January 1, Club Plus launched three ‘age-based default’ options. In the first, anyone under 30 joining the fund will now be placed in a high-growth default with an 80/20 growth/defensive split. People aged 31 to 45 enter the 70/30 growth option, and members over 46 will default into the 60/40 balanced option There is still plenty of time to decide what will happen to these cohorts as they approach retirement, but as it stands at the moment they will remain with their asset allocation until they decide to change it themselves.
Asked whether someone under 30 today could have too much exposure by the time they reach retirement, Cahill doesn’t appear to be too concerned. “Forty-six seems to be the magic age when people start to get interested in their super,” he says. “By that stage there is a decent account balance, people begin to understand its importance, and are likely to use our attached advisors to tailor their own retirement plan.”
Melanie Evans, head of BT Super for Life, thinks it shouldn’t be assumed that people will take interest in their super as they near retirement. “A lot of people retire with the same asset allocation they started with,” she says. Evans led two years of research prior to the launch of BT Super for Life on October 30, 2007, uncovering such uncomfortable facts as: “seven in 10 people never rebalance their portfolio”, “less than half of investors know the type of assets they are invested in”, and “half of people under 30 don’t know which fund their super is with”. These findings inspired BT to create a “Lifestage” fund.
Based on the decade they are born, members can choose a fund in which the asset mix automatically becomes more defensive as they get older. Members will have around 90 per cent of growth assets until they reach 57 years of age, at which point the allocation will gradually become more conservative until retirement. But surprisingly, despite its research findings, the Lifestage fund is not the default option. It must be actively chosen. So, for the 50 per cent of people under 30 who don’t know where their super is, if it is with BT it will continue to sit in a balanced portfolio.
Russell Investment Group has a similar offering to BT, but it is known as a “target-date” fund. In this version, members choose the date they wish to retire, such as ‘2030’ and the assets will gradually become more conservative as that date approaches. Linda Elkins, managing director of superannuation business, says Russell wanted a solution to the apathy it perceived among members, and to improve its suite of options.
According to Elkins, most young people should have 100 per cent growth. “Having too much cash is the biggest risk of all,” she says. However, like BT, Russell’s target-date fund doesn’t address a problem that supersedes apathy; obliviousness. Its unaware members still default into balanced options. Elkins would like this to change. “The default options in Australia are the envy of the world, but we need to take it to the next level,” she says. “The 70/30 [balanced default] has served members well, but we can do better. I don’t think we’ve developed something better than the default yet, but we’re working on it.”
Health Super, with its asset consultant Watson Wyatt, has come up with a solution called a “Life Cycle Default Strategy”, using its existing framework. Like most funds, it has a long-term growth option (90/10), a medium-term growth option (70/30) and a balanced option (60/40). But since 2003 at Health Super, anyone under the age of 50 who doesn’t make an active member choice will enter the long-term growth fund as their default option. After members turn 50 they are contacted and switched to the medium-term growth, and then at 60 they will be put into the balanced option. This moving about may incur some additional administration fees, but according to chief executive Chris Clausen, these are negligible. “We have a whole spectrum of members, many are busy in the health industry and don’t look after their financial affairs,” he says. “We believe over the long-term that they can handle a substantial amount of the volatility that comes with a growth oriented strategy, which should give them better returns.”
Before age-based/target-date/lifestage/lifecycle funds can become the ubiquitous default, there are several factors struggling for industry consensus. Aside from what to call them, there is also little agreement on how to determine the best “glidepath” – by how much the asset allocation should shift and at what age. Most of us have a fair idea of when we would like to retire, but no idea when we will actually die. Terry McCredden, chief executive officer at Telstra Super, points out that many people who retire at 65 will go on to live for another 30 years. Arguably that is enough time to handle any volatility a growth portfolio may bring. “Maybe target-date funds should aim at 80 as the age to begin becoming conservative,” he says.
BT’s Evans explains it in terms of behavioural finance. “At 65 ideally there would be more growth, but at that age people tend to monitor their super and worry more about the downside,” she says. Matt Smith, managing director of retirement services at Russell in the US says that the downside really does affect someone more at 65, even with 30 years of life expectancy. “There’s a big difference between a 25 year-old losing 6 per cent of a few thousand dollars and a 65 year-old losing 6 per cent of several hundred thousand dollars.”
Michael Blayney, investment consultant with Watson Wyatt, argues that age is not enough to determine the best glidepath. He recommends each industry fund set its own parameters tailored to its demographic. Then there is the benchmark problem. Comparing funds whose asset allocations change at different rates, over different periods of time, with a 40-year horizon, presents a whole other set of challenges.
It will be difficult to look at any such fund over a one to two-year period and judge whether it is on track to achieving what it has set out to do. Smith from Russell in the US estimates it might take seven to 10 years to tell if one fund is doing better than another.