The role of the super fund investment team for members in accumulation is straightforward: maximise risk-adjusted returns, and help the member accumulate the greatest account balance possible. But that changes when members enter retirement, and the Fiduciary Investors Symposium in Healesville last month heard that the investment task becomes substantially more complex.
The Conexus Institute* research director Geoff Warren said the job of investing members’ assets in retirement is so different from managing them in accumulation that funds even need to consider setting up new, separate teams to handle the different investment challenges.
“We think retirement is so sufficiently different [that] they’re a separate team, and a separate portfolio makes sense,” Warren said. “What everybody wants in accumulation is just as big a balance as possible. Maximizing compound returns is really the name of the game. When you go into retirement, you’ve got all these different needs and wants you’ve got to cater for.”
The Conexus Institute has published a draft paper, Investing for retirement: How investment teams of superannuation funds can support retirement income solutions, outlining the challenges and issues investment teams face as their fund shifts from supporting members’ wealth accumulation to supporting their income needs.
Warren, who is also a professor at the ANU, said funds are required to produce a Retirement Income Strategy (RIS) that outlines how they will help members reach their retirement income goals. One part of the RIS is support and guidance, and other is retirement solutions.
QAR complication
He said a retirement solution is very simply “a strategy by which you allocate your assets, and then you draw down on them to generate income”.
“And that’s one thing that changes significantly when we enter into retirement,” Warren said.
“[Within] the allocation strategy, as well as investments you can have lifetime income streams in there – annuities if you want; you have a drawdown strategy that it’s got to work in tandem with; and then that retirement solution will generate income.
“The trustees also have to provide support and guidance to members. They have to get them in the solution that’s suitable for them, through a range of tools, and who knows where the advice will go with the Quality of Advice Review? And out the end of that you end up with a retirement income strategy.”
Warren said members in retirement have very different needs from those in accumulation. If members in accumulation are relatively homogenous, retirees as a group are heterogenous.
“The second thing is the objectives, and these are written into the Retirement Income Covenant legislation,” Warren said. “And they comprise three parts: maximise expected income; manage risks to income; and provide flexible access to funds.
“So investments are operating now within an entirely different framework than what they have been to date.”
Aware Super associate portfolio manager Shang Wu said the fund has a team of four and soon to be five dedicated to retirement investing, and his own responsibility is for the fund’s retirement strategy.
“I look out for how we invest differently for retirement,” Wu said.
“Broadly speaking, we have three responsibilities in our team. Number one, we look after the member-first investment approach…and how we invest differently for retirement.
“Secondly, we contribute to the retirement income strategy of the broader fund. We’re actually part of the team that’s shaping that strategy, not just a stakeholder. And third, we manage a small defined benefit fund in my team, as well as my actual portfolio.”
Risk-managed strategies
Wu said Aware adopts a life-stage approach for investing members’ money in accumulation, with portfolios ranging from 87 per cent growth assets and members’ exposure to risk assets is dialled down over time to 57 per cent, in a conservative balanced fund, by the time they’re about 10 years out from expected retirement.
“When they move to retirement…phase then we move them to the pension version of the conservative balanced option,” he said.
“And that portfolio is invested differently, but [is] not a completely different portfolio. There are some sectors where we share with the accumulation portfolio, but there are also other sectors where we think it makes sense to create a different one for the retirement portfolio.” Wu says Aware calls them risk-managed strategies.
“In the illiquid, alternative sector, which is like hedge funds, we have a dedicated portfolio insurance for that sector, so the sector was not chasing alpha, it’s to provide the downside, and especially the tail-risk management for the broader pension portfolio,” he said. “It has a blend of 60/40 [split] between trend-following and long-volatility.”
“So the more the market goes down, the better the performance of these managers will be.
“And the sector has been protecting and functioning very well in the last few market drops. When the market hit in early 2020 [at the time of COVID], the sector was up 50 per cent. And at the bottom of last market fall last year, the sector was up 35 per cent and really delivering a better smoother ride and peace of mind to our members. So that’s how we contribute to the broader retirement income strategy of the fund.”
Wu said the fund needs a specialised retirement investment team because “if you think about the skills of the retirement income covenant, the three goals are just a mirror image of the investment problem but lifted to the member level”.
“And also the investment team decided to proactively contribute to that because we don’t want to be a stakeholder being told what the solution is, we want to [be] part of the decision making. And as retirement becomes a battlefield for large industry funds I think the funds that leverage expertise across whole fund will have the best opportunity to win that.
And last but not least, I think ultimately we’re trying to create a better solution for our members and providing the best outcomes to our members.”
‘Beautifully poetic’
TelstraSuper head of investment strategy David Schneider said a close study of how individuals think in retirement reveals stark differences with how investment professionals think – especially those responsible for managing accumulation portfolios. Schneider said the retirement problem is “massively fascinating”.
“It’s beautifully poetic, and it’s incredibly complex,” he said.
Schneider said that investment professionals think about markets, and the fundamental conditions valuations, sentiment, asset classes, expected returns, and the volatility and correlation of returns, “and we build portfolios to meet our objectives of over time”.
“Here’s a bit of a surprise: When retirees think about investments, that’s not what they think about,” he said.
“It’s a shock, I know. But it’s not and what they think about is not volatility or Sharpe ratios, they think about ruin, financial ruin, and the definition of financial ruin for not all retirees – it is a heterogeneous group – in many respects, is running out of money, when you’re too old to adapt, or just be forced to be wholly reliant on the age pension, so your spending might drop from 40,000 or 45,000, down to $20,000. And being a burden on your children. That’s risk – not volatility, not Sharpe ratios, but the of dignity in retirement.”
Schneider said retirees effectively have four levers they can pull to help them navigate retirement.
“You have an investment strategy lever: you can move up and down your growth/defensive split,” he said.
“You have a consumption lever: how much should you spend? How do you change that spending pattern over time – because you will adapt as circumstances unfold.
“You can purchase longevity protection. You could do it now you [or] could defer the purchase as well.
“And if you’re lucky enough to own a home, you can raise equity from that home. These four items impact your wealth, your wealth also impacts your age, pension is an interaction that because it’s means tested. And these four risk control levers are not independent. They are interdependent.”
For example, he said, the more a retiree increased exposure to growth assets the more they might expect to grow their wealth over time, but the more volatile the ride is likely to be and therefore their consumptions strategy and patterns will be affected.
“When we, as investment professionals, are sitting behind our computer screens and our large teams, thinking about what we’re going to do from a strategic perspective for investments, keep in mind that this is just one component of an interdependent system of levers that a retiree needs to execute through their retirement,” he said.
“And unlike Sam Sicilia, who doesn’t need to worry about volatility and valuations, interest rates or inflation, most retirees do need to worry about these considerations, because it will affect their, their wealth over time.”
*The Conexus Institute is philanthropically funded by Conexus Financial, publisher of Investment Magazine.
David Schneider points out that what retirees consider to be “risk” is not market volatility but running out of money. This is, to many of us, blindingly obvious but the industry continues to use volatility as a measure of risk for super funds. Myron Scholes among many others would saythat this is “crazy”.
How can this be consistent with Trustees’ fiduciary duty to act in the best interests of members?