A scenario analysis tool developed by Frontier Advisors is confronting superannuation funds with the likelihood that their return objectives could be difficult to achieve over the medium term.

The consultant has been offering its web based Prism tool to clients since April to allow them to carry out stress testing of portfolios and to see return prospects for funds under several scenarios and liquidity testing.

Leigh Gavin, senior consultant for Frontier Advisors, said one of the more challenging outlooks was on the performance of conservative options.  Funds are now questioning whether these should state likely returns of CPI plus 1.5-2 per cent, instead of CPI plus 2-2.5 per cent.

“A lot of investors will be thinking about dealing with an outlook for the next five years which is not as strong as it was for the last five years,” he said. “Our analysis has revealed it will be hard to get CPI plus 2.5 per cent over the next 5 years on a conservative option without taking a bucket load of risk.”

Several Frontier clients have already communicated with members that the current low yields on cash and bond rates mean expected returns have to be revised downwards, especially on conservative options.

The only alternative for funds is to move conservative options up the risk spectrum. Frontier has been using Prism to help illustrate those trade-offs with clients in recent months.

One of the ways Prism can be used is to model how a portfolio would perform in a crisis scenario and stock market boom, as well as a base scenario. A new module currently in development will also allow clients to stress-test liquidity at the same time as returns.

Prism is designed to help super funds meet their APRA-required stress and scenario testing requirements.  However, it is also deigned to be used as a tool to assist dynamic asset allocation decisions, due to its historical and forward-looking scenarios.  Gavin said the tool should be used as the beginning of a conversation about risk in a fund and that the range of scenarios it offered were helpful in improving directors’ full understanding of their fund’s risk.

Leigh Gavin is to talk on scenario analysis at the Fiduciary Investors Symposium being held at Peppers Moonah Links, the Mornington Peninsula on November 17-19th. To find out more on the conference click here.

Join the discussion