Mooted prudential standards give trustees an opportunity to better align investment strategy with fund goals, writes RICHARD BRANDWEINER, board member of the CFA Society of Sydney. At the end of September, APRA released its discussion paper, Prudential Standards for Superannuation. This paper outlines the Stronger Super reforms that the Government has recommended APRA implement through prudential standards. The standards cover a wide array of areas from governance to risk management and outsourcing. It continues the year in which the financial services industry nervously braces for the impact of changes in regulation, and superannuation members stand by confused, wondering what happened to their balances. In the middle of all this I can’t help but wonder whether we are missing the wood for the trees. The discussion paper states: “At a minimum, APRA proposes to require RSE [Registrable Superannuation Entity] licensees to articulate realistic investment objectives in a specific and measurable way.”
I would be surprised if there were many default superannuation options that didn’t already articulate measurable investment objectives. As you might be aware, most default “balanced” funds will have an implied return objective of beating inflation by 5 per cent before fees and tax. Most, of course, have not come close to meeting this objective for some time. So the real question is more about how realistic (or otherwise) they are. Herein lies the wood. The APRA paper goes on to talk about trustees having explicit regard for the expected costs, taxation consequences and the availability of timely and independent valuation information. All very important, but really elements that only go a small way towards achievement of the returns members need. It will be up to the trustees to consider how realistic their investment objectives are and, of course, for policymakers to deal with any shortfall in retirement incomes that remains at the end.
For a typical asset allocation, what do trustees have to believe to determine that an investment objective of 5 per cent above inflation is realistic over a reasonable time frame? Firstly, given the fact that fund returns are a simple weighted average of underlying returns, they need to believe that their highest returning asset, equities, will beat inflation by more than 5 per cent. In fact, for a 70/30 fund with no alternatives and a real return on bonds of about 1.3 per cent (note 1) it means they need to believe equities will deliver towards 7 per cent above inflation. That’s not a small feat and quite a bit higher than the world’s realised real return for equities since 1900. On top of this, there is, of course, no direct link between equities and the fund’s real return objective. Traditionally, trustees who believed that their real return objective was realistic put 80-90 per cent of their risk in equities (note 2) and just hoped that it would deliver what they needed.