The significant increase in investment market volatility over the past six months has adversely impacted most, if not all, asset classes globally. As such, PAUL KESSELL believes it is an ideal time to reflect on how investment risk is managed and presented to fund members in Australia’s defined contribution (DC) retirement provision environment and whether there are opportunities for it to have a greater influence on the investment strategies offered by superannuation funds.
Having recently returned to Australia, after four years managing pension fund investment portfolios in the UK, I wanted to briefly reflect on the increasing importance of investment risk management in the UK’s defined benefit (DB) retirement provision system, which may provide a useful comparison with Australia.
Pension funds in the UK have been increasing their commitment to investment risk management, which has become a key input to development of the investment strategy. This really came about due to three key events; poor investment performance resulting in significant funding deficits, the pension fund moving onto the corporate balance sheet and the liabilities being discounted at a market-based rate.
DB corporate sponsors are liable for the fund’s investment risk and so have increased their active involvement in the management of all aspects of the investment strategy, including the fund’s risk profile. In practice, the corporate sponsor sets a risk budget relative to the fund’s liabilities seeking an improved investment outcome.
However, in DC arrangements members take much greater responsibility for their own retirement saving with investment risk placed wholly on the individual members rather than the fund or sponsor. This transfer of investment risk to members by the DC fund still requires of the fund a fiduciary duty to provide a robust mechanism for the investment of retirement savings. However, it would fair to surmise that members of DC funds are not comfortable with investment issues and whilst the ultimate investment choice is made by the fund members, the range of investment options offered can have a significant impact on those choices made.
A well designed scheme with appropriate governance arrangements will be better positioned to meet member expectations and display appropriate ‘due diligence’ in the event that investment performance or other circumstances lead to members being disaffected. This risk should not be underestimated in the current volatile investment market environment.
So what questions should be asked by funds to ensure appropriate ‘due diligence’ in developing the range of investment options offered: