2008 – A year of volatility and opportunity

With most forecasters believing that markets will remain highly volatile through at least the first half of 2008 and possibly longer, key executives within the superannuation and funds management industries in Australia are urging the abandonment of ‘short-termism’.

By ‘short-termism’, they mean the pursuit of returns over much shorter timeframes than have traditionally been the case in the superannuation industry — something that has tended to go hand-in-hand with steadily rising markets and year-on-year double digit returns by superannuation funds.

There has been a growing view in some sectors of the superannuation industry that four years of double digit returns, when combined with the plethora of league tables issued by ratings agencies, has caused some superannuation fund investors to become too concerned about short-term appearances rather than long-term results.

According to the managing director of BNY Mellon in Australia, James Gruver, the nature of superannuation investment should mean little to investors unless they are on the threshold of retirement.

“And even then they can probably mitigate the impact of the downturn by phasing the way they access their funds,” he said.

“It simply should not matter that much to most of the population,” Gruver said in reference to the headlines dealing with rapidly declining superannuation returns.

Gruver’s sentiments are consistent with those of the chief executive of the Association of Superannuation Funds of Australia (ASFA), Pauline Vamos, who pointed not only to the long-term view taken by most superannuation fund trustees but to the diversification inherent in most superannuation fund investment portfolios.

“We cannot forget that superannuation is a long-term investment and invests in a broad range of assets,” Vamos said.

“The market returns and overall superannuation returns may not be the double digits we have had the last four years, but we’ve had very good returns over the last 10 years and that provides the industry with a very good base going forward,” she said.

“We also have to remember that because of their diversification and the types of investment opportunities that have emerged in the last few years, a fund’s mix is very different to that which existed in 1997,” Vamos said.

The ASFA chief executive also pointed to the distinct differences between the product-sets within the investment portfolios of traditional funds and those within self-managed superannuation funds.

“Because super trustees are wholesale purchasers they don’t buy a lot of the synthetic products you see, and that means if a lot of these of products implode that will have very little impact on super,” Vamos said.

A similar view has been adopted by major consultancy Watson Wyatt, which in late January issued an analysis based on the theme that difficult economic times oblige long-term investors, such as superannuation funds, to think carefully about whether they make changes to their asset strategies or simply hold on through the turbulence.

The Watson Wyatt analysis said that while the company could see some interesting opportunities emerging from the liquidity crisis in recent months, it did not believe that immediate changes to superannuation funds’ investment strategies were required.

“Rather, now is the time to consider a number of options so that they are prepared to take quick and appropriate action in the future,” it said.

The Watson Wyatt analysis suggested that investors should be realigning their investment strategies to match their governance arrangements, having accepted that efficiency is forfeited and value destroyed if they remain out of kilter.

For his part, Gruver believes that with the markets having hit tougher times, the more challenging environment will suit active managers such as BNY Mellon.

“I am expecting a pretty challenging 2008-09, and that is when active managers earn their money,” he said.

While Frontier Investment Consulting is not suggesting that any of its client funds dramatically alter strategy, it believes that their high levels of liquidity allow the luxury of being opportunistic.

Frontier deputy managing director Kristian Fok said it was in the nature of most industry superannuation funds to have very strong cash flows and, therefore, the ability to take advantage of opportunities as they arose.

However, he said Frontier would be urging a highly selective approach to those opportunities in circumstances where the volatility was expected to be ongoing.

The chief executive of Skandia parent Old Mutual Group, Jim Sutcliffe, is another who believes that the downturn has to be placed in the appropriate perspective, remembering that the fundamentals have not really been altered.

“What we are seeing is a downturn, but I do not see anything changing with respect to long-term economic fundamentals,” Sutcliffe said.

He said he believed that the current situation was more about a lack of knowledge than any major changes.

For its part, the Investment and Financial Services Association chose to join with ratings house Morningstar to issue a fact sheet on managed funds, with the bottom line being that people should not be tempted into knee-jerk decisions.

The fact sheet, issued in early January, said that while many people might be tempted to move their money out of the share market during times of volatility or weakness, it was important to remember that markets moved in cycles, with peaks and troughs “being an intrinsic part of investing”.

“While the cycle is unpredictable, history has shown us that recoveries always follow downturns, and vice versa. If you move out of the market then you won’t be there for the recovery, which can sometimes arrive unexpectedly and take off quickly,” it said.

“Throughout any market cycle, those people who hold their nerve, who remain focused on their long-term goals and resist making snap decisions are likely to be the winners,” the fact sheet said.

Despite the advice to hold their nerve and avoid any knee-jerk strategy changes, there will be plenty of superannuation fund executives who vividly remember the negative return years of 2002-03 and the manner in which this impacted on member sentiment.

Data compiled by the Australian Prudential Regulation Authority and research conducted by ASFA points to the fact that it was those negative return years that gave rise to the boom in establishments in self-managed superannuation funds and higher level of fund switching.

Indeed, research conducted by both Roy Morgan and ANOP suggests that one of the reasons for the low levels of membership churn since the introduction of choice of superannuation fund has been the high levels of returns being generated by most superannuation funds.

However, on the basis of the latest data provided by SuperRatings, there are clear signs that returns have come off the boil and member attitudes are likely to change.

According to the SuperRatings data released in mid-January, the average superannuation fund balanced investment option was estimated to have lost 6 per cent since the beginning of January 2008 — a “correction that has already wiped out the financial year-to-date gains for nearly all funds”.

It also said that for a number of funds the correction had wiped out a part of members’ 2006 earnings, before pointing out that, despite the doom and gloom, most Australians have still seen their superannuation fund account grow by well over 10 per cent a year for the past five years — well ahead of the expected 6.5 per cent a year that would normally be expected given current inflation rates.