‘Lifecycle’ investment strategies are commonly found in default MySuper products – particularly in the retail sector – but they may be causing lower balances at retirement, an analysis has found. Better product design could address this.
Superannuation funds should review and reconstruct their lifecycle strategies, independent advisory Frontier Advisors argues in a research paper titled “Lifestyle investing – a refresher”, to avoid sacrificing too much investment performance in their efforts to address the sequencing risk those nearing retirement face.
Frontier Advisors also found some retail funds are using lifecycle strategies to transition members into cheaper, more defensive asset classes, but still charging the same fees as for more expensive growth assets.
David Carruthers, Frontier’s head of member solutions research and principal consultant, says there is still a place for lifecycle products but many are lacking in how they are designed.
“There are lots of different ways to design a lifecycle product,” Carruthers says, “and it doesn’t necessarily need to end up with the expectation that members’ balances in retirement will be less if you go down [the lifecycle route] compared to just a single, default balance-type fund.”
Lifecycle products automatically de-risk members’ portfolios as they age, moving from a higher-growth and higher-risk profile to a more defensive profile when the member hits certain age milestones.
Frontier and other critics have argued the problem with this strategy is it misses the best time to enjoy the returns of an aggressive strategy – that is, when balances are at their highest. Giving up investment performance too early can significantly reduce a portfolio’s final balance.
Life doesn’t end at retirement and retirees draw down on their final balance over decades. A long-term investment horizon is still in place and there should still be some room for well-performing investments, Frontier argues.
Carruthers says mass-customisation approaches don’t take into account the widely varying needs of different members with different situations. A member with a lower balance that they plan to take as a lump sum at retirement will require different strategies to another with a higher balance that will be drawn down over time. The latter member will want to enjoy gains on what is still invested.
“What we’re trying to encourage the funds [to accept] is that there’s no one-size-fits-all type of approach, it depends on the membership characteristics, how much money the members have at retirement, how do they use it – all those types of things go into how they design it.”
Frontier’s report states that enhancements to lifecycle products could come from better defining member cohorts, going beyond age to other factors, such as gender, salary contribution rates and time to retirement, as Brisbane-based QSuper has done.
This increasing complexity could, however, increase fees, making a product less suitable as a MySuper offering and more ideal as a ‘choice’ product, the report states.
But Carruthers still believes lifecycle strategies can be used effectively in default options.
Lifecycle products should also have a greater focus on post-retirement income, the report argues. Rather than focusing on a target return such as CPI plus 3.5 per cent, they could instead focus on achieving a desired income after retirement, allowing the member to better gauge whether it is the correct strategy.
They should also be more tuned in to the prevailing market environment, rather than shifting into defensive investments irrespective of the return outlook, the report recommends.
The impetus for Frontier’s research came from the Productivity Commission’s draft report as part of its review of the superannuation system, which stated that most members would maximise their retirement income with a balanced portfolio before and after retirement, and that lifecycle products were better suited to the ‘choice’ segment of the market.
About 30 per cent of MySuper products use lifecycle strategies, Australian Prudential Regulation Authority figures state, and this approach has gained particular popularity in the retail sector.
One issue Frontier discovered, predominantly with retail funds, was some were grouping members into funds based on the year or decade they were born. These funds would gradually shift their allocation from high-growth to more conservative investments. But the fees weren’t changing, even as the investment mix shifted to cheaper investments.
“If you are stuck in a 1960s fund, and they’re still charging you the same as when they had a whole lot of growth assets, which are more expensive, but now you’re all in cash, which is cheap, the fee should decrease along the way,” Carruthers says. “We don’t know that that happens all the time. You might end up in a conservative fund that is charging you a high-growth-comparable fee.”
Lifecycle products may also perpetuate a low level of engagement from members, if funds consider the job done instead of actively checking in with older members and customising strategies to fit their stage in life, Carruthers says.
Funds Investment Magazine has contacted in recent months, including Sunsuper and First State Super, stated they were mulling changes to their lifecycle products.
A recent Rice Warner analysis argued lifecycle products should be redesigned, but not “relegated to the dust bin”.