Maynard Keynes famously wrote that “it is better for reputation to fail conventionally, than to succeed unconventionally”. His scorn for the mediocrity which arises from layers and layers of governance, coupled with the innate tendency of boards and committees to take comfort from doing what everyone else is doing, is no less relevant today than it was ninety years ago. Failing conventionally is endemic in our society, not just in investing. As a friend and former colleague once said, running with the herd means “you have more mates at the pub”.
But when it comes to superannuation, delivering the right outcomes for members is what’s important.
Does anyone involved in the industry today really think this is happening?
More importantly, has there been any material progress on developing investment strategies and solutions that allow for income generation, and the mitigation of inflation and longevity risk, since the retirement income covenant was introduced in July 2022?
These are, of course, rhetorical questions. We all know the answer.
It’s clear who’s to blame for this failure, and it’s not those at the coal face. There is a highly capable pool of investment talent in Australia, and a disproportionate number of Australians managing retirement pools and endowments all over the world. There is something about our culture that enables us to manage and understand risk.
In my view, the failure rests with politicians, well-meaning but over-zealous regulators and the inherently bureaucratic nature of the governing boards and committees of super funds.
Starting with politics, the Coalition has sought to undermine the dominance of the industry funds since the Superannuation Guarantee was born. The absurdity of the Your Future, Your Super (YFYS) performance test and the draconian penalties that failure entails has served only to reinforce the inherent tendencies of trustees and CEOs to run with the herd.
The “tweaks” made by the last Labor government were little more than a grudging acknowledgment of the industry’s justified grievances. Maybe the new one will be more bold.
When it comes to regulation, the ongoing failure to address the critical issue of return versus risk means that members nearing or in retirement are in products which have a high probability of significant loss of capital. While one can understand that explaining the nature of risk to end investors needs to be simple the Standard Risk Measurement (SRM) was already dated when it was introduced in 2011. Measuring the probability of loss on a one-year basis and multiplying it by 20 ignores the magnitude of the potential loss. But more importantly, common practice is to assume that asset class returns are normally distributed, ignoring the reality that the higher the proportion of growth assets in any portfolio the more likely are “fat tail” outcomes. Also overlooked is that negative returns often “cluster”, just like positive returns.
Use of normal distributions, standard deviations or value at risk (VaR), was jettisoned globally in the wake of the GFC. So, it would be astonishing if risk management systems in any super fund did not involve use of non-parametric, or empirical return distributions, with conditional value at risk (CvaR) or other tail-risk measures as their standard measure. There is no reason this could not be explained simply to fund members and other retail investors. Identifying the number of years where returns could be negative means nothing. What is important is how much you could lose and the likelihood of that happening.
State-of-the-art risk management in the hedge fund industry has reached even more sophisticated levels, applying network theory, AI and agent-based modelling, with complex and interactive dynamics that seek to explain shifting correlations and fat-tail events. So, even some new SRM using CVaR and empirical distributions will soon be out of date. But at least it will drive home just how much more risky most super and other retail portfolios really are.
As for governance, there is simply too much bureaucracy. More responsibility should be delegated to those making the investment decisions. Fewer board and committee members with more expertise is what is required, and more responsibility should be delegated to those making the investment decisions.
Such a shift is not as irresponsible, reckless or radical as it might sound.
More and more institutional investors are making the subtle but important move away from the strategic asset allocation (SAA) model of investment strategy to the total portfolio approach (TPA). Though the differences are mostly related to a higher degree of delegation in the governance model, TPA is also inherently more flexible, often leading to much more material changes in asset allocation, including exiting some asset classes altogether.
Any investor faces a sometimes impenetrable fog of uncertainties. The SAA approach addresses uncertainty by assuming that the short term “noise” in economies and markets somehow washes out over time and that some mysterious force steers long-lived metrics to mean revert. TPA, though not often recognised as doing so, seeks to identify strategies and opportunities where there is less uncertainty about outcomes. In this sense, it is more short term but also more realistic.
All the economic and financial theories we have been taught are underpinned by the assumption of “general equilibrium”. That such a thing has never existed, and could never exist in evolutionary time, is conveniently overlooked. Though rarely recognised, it implies that we know more about the distant future than the near future. Obviously, this defies common sense.
For Australians to reap the benefits of one of the best conceived retirement systems in the world, urgent change is needed.
Politicians needs to foster competition among providers rather than overtly or covertly seeking more and more consolidation.
Regulators need to throw out the textbooks they have read and start thinking ahead rather than perpetually fighting the last war.
And those responsible for investing other people’s money need to look inward and face up to the reality that bureaucracy is the enemy and that empowering those in the trenches is the key to success.
Wayne Fitzgibbon is an investment commentator who has held economist, asset management and consulting roles at Mercer, Macquarie and BT over the course of his 40-year career.
