Breaking the orthodoxy on how to invest default members might seem a risky career move, but Brad Holzberger is not showing any fear.
“I do not feel under threat. We have the leadership of our senior management, the support and encouragement of the trustees. If I felt under threat, there is no way we could do this.”
Indeed, if anything he is bullish about his fund’s plan to split default members into eight to 10 investment cohorts, each with a different risk profile depending on age, account balance or contributions.
“We are competent people. I know that my colleagues and I and the people that we lead are competent. We are dealing with a quite tractable problem that we now understand very clearly in a supportive environment.”
To some, this confidence might appear misplaced but there is a considered strategy behind it and, as will become apparent, QSuper believes it is one that many others should follow.
The root of many of the most popular investment strategies today has some profound lesson taken from the global financial crisis and QSuper’s approach is no different. Until then superannuation might have appeared as a get rich quick scheme and the shock inspired the trustee group to see the real error of their ways, says Holzberger.
“I remember them telling me that there were members who were just about to retire who have 20 per cent less in their fund, and they were saying, ‘Can we do better?’.”
Current chief executive, Rosemary Vilgan, was the prime mover for change.
“For years while we were at QIC she was challenging us about not doing a good job for our defined contribution fund. She had an innate sense that we were not doing the best we could.”
And once in house at QSuper, the former QIC investment team found itself energised for change.
“Instead of being the outsider who was being held to account, we were able to come in and say, ‘Hey, do you really think this objective is the right one?’.”
Holzberger and his team were asked not to over-engineer it, get it roughly right and make progress. “That is really good leadership from our point of view,” he says. Holzberger believes that tailoring strategies should come entirely naturally to any competent investment professional. This is the way defined benefit plans have been run over the last five years and QSuper’s strategy is heavily informed by the work they have already carried for its defined benefit scheme.
“There is a lot of intellectual expertise out there on how to manage a set of cash flows to an objective, and that is what we are trying to do. However, they are commonsense principles.”
The danger of average returns
Superannuation funds tend to emphasise annual average returns, but for defined benefit schemes, their funding ratio is key. An average return is a good indication of the competency and success, but this is simply an average of what members experience, argues Holzberger. Members who see more market boom at the start of their saving will do less well than those who experience a boom at the tail end, when their balances are largest.
“Some members have done extremely well, some have done abysmally badly, but on average they have all done OK. Peer funds out there look at the average and say, ‘It’s not too bad, it’s not broken, don’t fix it’.”
A common objection to this approach is that most of those reaching retirement are getting most of their income from Centrelink, an income that in its predictability and reliability has bondlike characteristics. So, the logic goes, one should not reduce equity or equity-like assets as this would give an overly cautious and low-growth investment exposure for members, who would subsequently miss out on growth.
QSuper’s counter-argument is that higher retirement ages and raising contributions to 12 per cent means young people saving today will accrue retirement savings close to $1 million that will exclude them from Centrelink benefits. This is particularly true for QSuper’s government workers, who accrue 17.75 per cent including a mandatory 5 per cent employee contribution.
Overall the team at QSuper thinks its fund can reduce the distance between those who do badly and those who do well. They emphasise the moral imperative of this action, but there is a legal imperative too: if a fund keeps broadcasting average returns for the default on the MySuper product dashboard, it is misleading members. By its own calculations, a default fund with an average rate of return of 9.7 per cent over a 10-year period could be disguising some members achieving 4.5 per cent, while others get 16.5 per cent, depending on their own different start and end dates within this window.
“Many superannuation funds tell people, ‘We have got 10 per cent’, but not every member gets 10 per cent,” says Holzberger. “Members might say, ‘You are actually telling me a return that I did not get’, but you only get that return if you are invested on the first day and the last day.” Clearly, even with tailored cohort funds, not everyone is going to give exactly the same return if members join and/or leave on different days, but QSuper is addressing this by emphasising personalised projections on statements.
Disengaged members are likely to be under the misapprehension their investments are tailored for them.
“I have a sense that our members think that we are doing this. I reckon they would go ballistic if they knew,” says Holzberger.
There is another legal threat. Damian Lillicrap, head of investment strategy, points out the risk from not tailoring appetites. He compares this to the liability management that takes place in a defined benefit scheme.
“There are not many DB funds that would not derisk at the moment, and if there was a global financial crisis tomorrow and you lose a third of your money, is that not a reason to sue? Members might say, ‘You knew that I was going to retire tomorrow and you lost a third of it’.”
Regulations already prescribe that trustees take into account the age of members and QSuper believes more directions will follow. This argument is put forward to strengthen their case, but they state that they would have done it regardless of regulatory pressure. “The fact that APRA legislation is leading this way is just a coincidence,” says Holzberger.
The division of members
QSuper has taken the easiest, most obvious first step in its creation of cohorts. In February it wrote to those in the default investment option over the age of 58 with balances of more than $300,000 each, informing them that their investment strategy was changing to a more defensive position and that they could opt out if they wished. So far only about 20 per cent have done so.
The fund plans further segmentation, seeking to apply more aggressive strategies for younger members, and to find new strategies for those with lower contribution rates and for women with disrupted work patterns. But it was the over-58-year olds with high balances whom were easiest to act on.
“We picked the point where there is the most moral authority to act and the most need for those who are bearing the most investment risk,” explains Holzberger.
The members who are furthest from retirement are likely to end up with a higher than standard 70-per-cent risk/asset ratio.
“They have smaller account balances and they have huge amounts of future contributions,” reasons Holzberger. “Their balances might be only $30,000 to $40,000, but a 30-year old should build up to $800,000 to $1 million. So we can take huge risk and in a total sense it means almost nothing. If we felt that risk was to be rewarded, then we would risk them up and over time we would monitor that, because over time their future contributions decrease and their account balances grow, and they become more circumspect.”
For simplicity’s sake only eight to 10 initial cohorts are planned, but Holzberger sees no limit to the amount of tailoring members could take. He reasons that wherever members have different contribution rates or retirement ages, then there should be different strategies.
One extraordinary hypothetical scenario is where an individual has successfully built up a large retirement balance and is then informed that they might want to consider making smaller contributions and prioritising spending elsewhere.
Segmenting starts with a letter to each member informing them that their investment strategy is about to switch. Forcing members to engage is a welcome byproduct; QSuper describes it as a ‘wake-up call’. Using behavioural finance techniques, they will question those who have already opted out of the default fund about whether they have taken the wisest step. Members who have made active investment choices will be informed how the average member in their age and salary bracket is investing.
“We will be able to say that members who are like you are doing this,” Holzberger (pictured far right) says. “At the moment we cannot do that because everyone is doing the same. Now we are able to say, ‘In your circumstances, we are doing this’. That will be a powerful way of applying to the choice members. We think it will be very powerful. Because people want to know whether they’re the same as everyone else.”
The cohorts will have the flexibility to be managed dynamically. In the over-58, over-$300,000 balance bracket, members are having their equity exposure reduced, but it will not be on a gradual glide path as in lifecycle, and where clear opportunities arise, QSuper plan to re-risk.
Nothing to lose
One question that begs asking is that with all these different cohorts, isn’t there a risk of acting like investment geniuses, for example, for the over-58s but being disastrously wrong for those in their 20s? The QSuper team is philosophical about this and answers that with a one-size-fits-all fund it is already automatically failing some of the cohorts in the default fund. They reason that chances are they can only do better and point out it is not about obtaining perfection.
“We are not trying to be optimisers,” says Holzberger. “We have an old cohort of members; it is morally bankrupt to leave them exposed to massive equity risk. So how much do you derisk them? You could agonise over that forever. Whether we are precisely right, I am not the slightest bit concerned.”
A straightforward exercise
Another question that begs asking is whether managing all these different cohorts will make for a governance headache. The investment team is keen to emphasise how relatively easy the task of having different cohorts will be, especially as stated before similar thinking is already carried out for the defined benefit scheme.
“If you asked other super funds and said, ‘Do you think you could do it?’, I bet none of them would say, ‘It’s too hard’,” says Holzberger.
“It is quite a straightforward exercise. The fund managers won’t know what we are doing and the mandates we are writing for them are quite straightforward.”
Resistance to change
This all begs the question that if this is truly as logical as the QSuper team makes out, why are not more funds taking its approach?
QSuper has been talking to superannuation funds in the hope that others will follow and has also spent a fair amount of time testing its hypotheses abroad. The team has received feedback from the US target-date providers and from Nest, the UK government-backed target date fund. QSuper claims that no one else is doing anything quite like it, although people are interested.
The team members reason that they will learn faster if there is someone to compare against. “If the whole industry is talking about that, we will get better outcomes.”
But in Australia QSuper is seeing much resistance to change.
“We have visited every consultant and every major fund in this country to explain what we are doing and we have invited them to help us by criticising what we are doing, but none have. They all just say we are not going to do it because we have this peer-risk issue,” says Holzberger.
“What we see as broken, they do not see as broken. It is not always that obvious as default members do not leave the fund – they tend to sit there and cop it – so there is this ironic situation, where many Aussie superannation funds say, ‘We do not want to rock the boat and move away from our comfortable peer-relative strategies, because superannuation members will leave’.
“For a start that is a defeatist attitude; it assumes you are going to do badly. Most members have shown no facility to leave; in fact they have stayed through thick and thin. They have displayed loyalty and confidence. We believe that the trustee needs to look beyond that peer-relative benchmark.”
He takes some assurance from the way banks treat their customers. “What banks says, ‘We do not care what age you are, what aspirations you have; we will give you the same bank account’? We do it and we seem to glorify in it.”
There are some signs of change. The number of lifecycle funds is increasing and feedback to QSuper’s claims that no one else is following them is treated with a certain amount of scepticism from some in the industry. AustralianSuper is rumoured to be debating this internally, while others state that they would have taken this route if not for compliance with MySuper holding them up.
There is also the excuse that QSuper’s membership is more homogenous, which makes creating the cohorts more acceptable and that it has a better data on these members. Whether it goes it alone or not, it seems fair to presume that other funds will look to follow where QSuper succeeds most in segmenting its members’ investments.