This article contains the views of AMP, Mercer, ASIC, Frontier Advisors and Michael Drew professor of finance at Griffith Business School on the subject of target date funds.
Three to four million Australians are about to embark on a very exciting experiment. They are to choose a date when they envisage finishing work and then given a likely retirement income based on that date and their current rate of saving. Over the years they will get reports telling them how their investment portfolio is either on target or off target for their projected retirement income. The hope is that this personalised information will help the public engage with this outcome. They will start to question if they are saving enough or if they need to work longer to get, what to them, feels like an adequate retirement income.
To help keep the experiment on track, investment portfolios will be made increasingly diverse and risk averse as savers age. The logic runs, that the further down the path the saver is the more likely they are to become angry and disillusioned, if they experience a big crash. Large volatility when a saver is in their 20s can explained with the calming words that they are embarking on a long journey and have a great deal of time and future contributions to put good such setbacks.
The very pinnacle of engagement for those in a target date fund will be a form of self-actualisation about their retirement savings. The journey will have educated them and they will start asking smart questions earlier than savers in less dynamic funds. Ideally they will seek advice about their full financial picture, their home, their mortgage, their savings, inheritances, partner’s savings, their eligibility for the age pension, the suitability of annuities and their desired age of retirement.
The experiment has not been fully tested in Australia before. No one can say with certainty, that after a working life of high engagement with their retirement savings they will have made the right decisions at the end of it. The history of retirement savings in the developed world to date has largely rested around a paternal model built around the public’s natural state of inertia when it comes to sensibly planning for retirement. The target date model does encourage a level of involvement and the danger is that the public does not perform this role very well.
A defence of target date funds
When listening to proponents of the target date fund (TDF) approach, it is hard not to get caught up in their wide-eyed passion, for the revolution it poses in the way the public relates to their retirement savings. For them engagement is not about explaining the mechanics of individual investments, but a personalised journey that encounters varying levels of risk along the way and allows the individual to take actions that can influence the end outcome.
Sean Henaghan, head of multi-asset group at AMP Capital, and responsible for one million of account holders of AMP’s target date fund, says that prior to this account fund managers confused reporting with communication.
“What is exciting is starting to communicate in a context and a manner that the members can understand and giving them easily understood actions. All our communications are going to talk about that benefit in retirement.”
Of the dangers of member reacting badly to information, Henaghan and most proponents of TDF are quite clear. Firstly, it is worth the risk and secondly, the momentum towards providing greater information and transparency is unstoppable, so you might as well embrace it. Henaghan says: “You cannot be scared what they are going to do with that information, that is not the world we live in anymore.”
Furthermore he adds that the process allows a form of tailored communication that has never existed before. “If you have a 35 year old and their fund falls by 20 per cent, it should not matter as their future contributions will be bigger than what has happened in the past. So the whole way we engage will be more relevant. With a peer group [of balanced funds] success is defined by everybody else. With target date you can say if you are on course to deliver the final benefit, that is how success is defined.”
AMP argues that research on the way people are accessing their financial information and having a growing expectation of interacting with it online, makes a target date approach inevitable. Employing human centred design, AMP claims that feedback to its research has enabled communications to be designed to how the public would like to receive it.
Libby Roy, head of corporate super at AMP, says: “Customers are helping us design communication. Based on this we are launching a banking and superannuation App where an individual sitting on the bus, will be able to see real time what is happening to their super. We have piloting it internally with staff and we are seeing increased engagement. It offers customer friendly, quick soundbites, rather than a 100 page statement.”
Roy adds this offer information neatly dovetails into the trend towards self-managed super funds, where individuals seek greater control and information on their superannuation assets.
Crucially perhaps, the Australian Securities and Investment Commission (ASIC) sees a similar vision of the future for superannuation. Greg Tanzer, commissioner at ASIC, also sees that greater tailoring and transparency is inevitable.
“People are not all the same,” he says. “What some might need in retirement might be quite different to another, quite independent of when they retire. It is their money. So it makes sense for them to get engaged as early as they can.”
He argues this from a government perspective of a disengaged public making bad decisions on their retirement and therefore having a greater reliance on the age pension. He acknowledges that with higher engagement and knowledge some people will make bad decisions, but the prize for the greater number of people makes this worth it. “The investment literacy of your regular person on the street could certainly do with improving, particularly in cases where we have seen significant losses, you see at least anecdotal evidence that people did not understand the amount of risk or the nature of risk they were taking on, by virtue of the asset class they were invested in.”
Tanzer says that sometimes this was because people were not given all the information, or they did not read the information provided, or because they did not have the capacity to understand the difference and sometimes because they were misled. “All of that suggests there is room to improve the financial literacy of Australians,” he says.
“A little knowledge might be a dangerous thing, but I would say it is overwhelmingly a good thing for people to get information about their investments,” he says. “There are some people who will make poor investment judgements, and that is tragedy and no regime can set out to completely prevent that because it would be a stupid promise to make, but it is overwhelming in the people’s interests they have information about their investments and that they can make decisions about them, even if it is a passive decision.”
Another argument in favour of target date funds that says they are appropriate for the unengaged member as a whole of life plan that flips them into an income bearing account upon retirement as a default setting, with all the appropriate investment mixes for that age group.
This is a path taken by Mercer. Graeme Mather, head of investment consulting at the firm, sees it as a simple, cost effective solution. “One of the benefits of TDF or lifecycle is it should give the member peace of mind that the investment is being managed on their behalf and they do not worry about it. Around 80 per cent of members in Australia disengage and end up in the default. It is those members who should be in this sort of solution.”
He is of the school of thought that change is inevitable, saying within 10 years every individual in Australia will be defaulted into a specific investment strategy to suit their circumstances and their desired income in retirement. This will be based on technology which will use a members age, if they are married, how much they earn, whether they have assets outside of super and the percentage
of their salary they want as an income in retirement.
A counter argument to the logic of target date fund proponents says that while most members should indeed be derisked shortly before retirement, as plans such as Sunsuper are doing for members between age 55-65, there is less need for derisking earlier in their working life.
Kim Bowater, senior consultant at Frontier Advisors, says: “A danger of TDF is that you over prioritise the risk element and you give up a lot of potential balance accumulation as a result and you are swapping downside risk for the risk of not having sufficient savings.”
The modelling Frontier Advisors has done shows an asset allocation that changes at certain ages gives up a bit of growth potential in trying to be conservative. The firm believes funds should think about their member profile first, their average balance size and their investment philosophy. Bowater adds as modelling tools and communication improves, a target date fund might be too blunt an instrument for the many different paths a member might take in the years closest to retirement.
The debate will continue, but in pioneering its approach, TDF has already created one aspect of appeal to Bowater. She concedes: “One good thing about TDF is that you have segregated managers near retirement and if you think there has been significant outsize profits in a strong market environment, you have the ability there to take some profits there for some members, because you know they are at the end of their accumulation phase.”
Who is in a target date fund?
There are 5.3 million member accounts with the eight retail funds that have adopted a TDF/cohort fund solution according to APRA statistics published in January. Graeme Mather, head of investment consulting at Mercer, says if one assumes that 80 per cent of these are in the default then over 4 million member accounts will be in TDF/cohort funds in Australia. This figure does not include QSuper members or other lifecycle offerings that implement the de-risking on a member by member basis (by switching members from one fund to another).
ChantWest breaks down this estimate further. By its estimates there are 1.9 million people in what it describes as ‘cohorts lifecycle’, where a member is part of a group based on age and growth assets reduce progressively as the member gets older. That there is a further 1.2 million in switching lifecycle, where a member is switched from one option to another at a certain age and lastly a further 1 million using ‘smooth switching’ lifecycle, where members gradually switch from one option to another over a number of years. This latter option is used by Sunsuper and the Aon Master Trust.
The academic view
Michael Drew, professor of finance at Griffith Business School, says international research suggests that educating fund members on the investment process is not as effective as education centered on investment outcomes.
“Researchers at the University of Minnesota recently completed a major study on how retirement income projections affect the retirement savings decisions of over 17,000 employees. They found that individuals that were sent retirement income income projections increased retirement contributions (when compared to a control group). The group that received the income projections were provided education such as, “If I begin making additional contributions now … how much additional savings at retirement can I expect to have” and, “how much additional annual income in retirement can I expect to received from these additional savings”. The outcomes were presented in a simple bar chart with additional contribution amounts per pay period of $0, $100, $200 and $500. This research supports the importance of superannuation funds framing retirement outcomes (and using this kind of educational approach to nudge fund members into better decisions). Outcome-oriented education, working in concert with product design, can be a powerful combination for good in improving retirement outcomes.”