Many superannuation funds that suffered losses to their alternatives portfolios during the global financial crisis were not using the asset class for its intended purpose – to diversify portfolio risk.
So says Simon Eagleton, Mercer’s investment head for Australian and New Zealand, who believes many of the alternative assets that funds invested in carried the same risk as the equities portfolios, which suffered big losses in the crisis.
Where true diversity lies
“Just because private equity, for example, is unlisted doesn’t really give you true underlying diversification,” says Eagleton.
“People were saying ‘I had private equity, hedge funds, credit but it all went to custard at the same time.’
“So I would argue that they weren’t really diversified. They had exposure to the equity risk premium, because typical private equity is even more highly leveraged.”
Eagleton’s perspective is that true diversity exists in assets such as infrastructure, commodities and in real assets such as forests.
“Trees don’t read the financial press,” he says.
“They don’t stop growing for a week because someone has told them the economic outlook is gloomy, they just keep growing and that is true diversification.
“If we had been more truly diversified, we would have got through the last few years a lot easier and without such big losses, I suggest.”
Embrace the lifestyle approach
Looking at the current investment environment, Eagleton’s sees the maturity of the Australian superannuation system as the main challenge, and one which requires an embrace of the lifecycling approach to match people’s life stages with the risk profiles of their investments.
“The issue we are facing is that people’s superannuation savings are becoming such a significant asset and the challenge now is questioning the wisdom of pursuing a single growth strategy for everyone,” he says
“Younger members are able to withstand greater volatility while those close to lump sum availability will not want to experience any decline in their accumulated benefit which might come from pursuing growth too aggressively.
“I think that a defined-contribution environment like Australia needs to start responding faster with innovation around product design, which should take this lifecycle approach with target dates.”
Eagleton does not see any problem in the fact that the Australian system has a higher proportion of its funds in growth assets than other nations.
“Some trustees have a view that they should go down the growth-asset path with their allocations a little bit, but this is a long-term multi-decade strategy,” says Eagleton.
“The reality is that most super funds in Australia only make small changes to their asset allocations over time, and they set long-term strategies in pursuit of a margin above inflation and essentially stick to it.
“I think it is best practice to alter your asset strategy over the medium term to exploit opportunities or avoid risks which might be emerging, but very few funds are making big swings.”
A major issue in setting expectation, say Eagleton, is “not to confuse next year’s economic growth outlook with capital market returns.”
“I look at our long-term assumptions, and they are fraction lower than they have been, but they are not much lower,” he says.
“There are some changes in approach around alternatives now, largely because there are a lot of asset classes available now which were not available 10 years ago.
“Overall, there is not a huge change and funds are still exposing themselves to growth assets – and quite rightly in my view.”