Rethinking the investment options for retirees

Lack of appropriate investment options forces too many retirement investors into unsuitable investments. It’s time for a rethink - and the Cooper Review offers the ideal opportunity for fresh ideas to be laid out on the table, writes David Jones-Prichard.

Lack of appropriate investment options forces too many retirement investors into unsuitable investments. It’s time for a rethink — and the Cooper Review offers the ideal opportunity for fresh ideas to be laid out on the table.

Recent superannuation investment performance and the scrutiny of the Cooper Review have highlighted many issues of concern for Australia’s investment and superannuation industry.

The difficulties faced by members of default superannuation funds when they’re placed into asset allocations that are unsuitable for their life stage, risk tolerance and other personal circumstances is one of these issues. Default fund members comprise up to 90 per cent of total superannuation investors.

One consequence of not actively choosing a fund option to suit their needs (for whatever reason — and that’s a different story) is that they may find themselves either earning too little or risking too much.

Typically, a fund’s default option comprises an allocation of 70 per cent growth assets, with the remainder in cash, bonds or other lower risk investments.

The net effect of this ‘one size fits all’ approach in a plunging market is that investors on the brink of retirement are left without sufficient time to recoup losses when the market recovers.

We saw precisely this situation unfold during the dramatic market downturn of the last two years, when many older fund members were forced to review their retirement plans when their super balances plummeted.

Meanwhile, in the US and UK, the situation following the downturn was very different. In these countries, under a different system, reverse allocations are likely to apply for investors approaching retirement.

These older investors will generally have a maximum of 30 per cent — and often far less — invested in growth assets. This is due to the operation of what’s known as ‘lifecycle’ or ‘target date’ funds.

These funds have asset allocations that change automatically over time according to the age of the investor. Initially, they begin with a significant exposure to growth assets such as shares and, as the member ages, are automatically reweighted to a more conservative asset mix until, by around age 60, members have a very low exposure to those growth assets.

This style of retirement fund is finding increased acceptance, outside of the UK and US, in Europe — but not here in Australia.

So why have we not accepted this fund type as a solution?

Many argue that while at first glance the life cycle fund seems ideal, in practice it also poses a number of difficulties that may disadvantage investors.

One is that this approach delivers very low growth when investors are most in need of it.

When you consider that the typical retirement will last 20 or more years, the imperative to maximise every investment penny, for every hour worked, is very strong.

The automatic downshifting of returns over time that life cycle funds entail, coupled with the cyclical nature of the market, means it’s more than likely that investors will, as a consequence, miss out on returns that could make a real difference to their ultimate retirement situation.

Another disadvantage is that the automatic disposition of funds into certain allocations based purely on age might force investors to unnecessarily crystallise some losses if, through sheer bad luck, their automatic reallocation occurs at a time of market lows.

Ironically enough, this is not a dissimilar, albeit milder, situation to that faced by Australian default fund members whose retirement date comes at a time of underperformance — as we’ve recently seen.

And neither the life cycle approach nor the default fund option takes into account the impact of other assets, investments or savings on a member’s risk profile, taxation situation and so forth.

This is especially the case in Australia, with its high level of home ownership and direct share investment, which may require a more considered and tailored approach to maximise returns and meet diversification needs.

What seems clear — and what has been underscored by the stream of submissions to the Cooper Review and industry scrutiny that’s taken place since its launch — is the real need to find some middle ground for retirement investors; options that are more closely tailored to their dual needs of risk protection and growth.

For the key industry players and those who are responsible for managing superannuation — the trustees, fund managers and advisers — this is an opportunity to cast the net a bit wider and look for opportunities to cater for retirement investors, because the solutions are out there.

In today’s investment market, there are forms of investment that have strong growth exposure while placing a floor on losses.

These can be intelligently structured with various parts, including highly rated debt and insurance components, to meet very specific investor needs.

They allow investors to automate or manually make adjustments to meet changing risk profiles over time and deliver features such as minimum income levels or capital protection — and still provide growth exposure.

In short, it’s time our financial services industry seriously considered including more options in the retirement investment mix. It’s clear that, despite the best intentions, one size does not fit all — or certainly not all the time. We need some more tailor-made options to give investors what they really need.

David Jones-Prichard is executive director, equity derivatives and structured products, at JP Morgan.