Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Problems with lifecycle strategies require a rethink
Lifecycle strategies have some problems. One, is how they compare their performance. Two, is how they explain their asset allocation. And three is whether they really fit APRA’s regulatory definition for a MySuper default fund.
Alex Dunnin, the executive director of research at Rainmaker Research, who has been studying lifecycle products for the several years since they started to gain in popularity with both retail and institutional super providers, believes their providers should adopt a new way of assessing and representing the strategies.
He believes that, given an imperfect world which prohibits individual product design for all-but the few members with very high account balances, lifecycle product providers should look at their offerings from a contributing employer’s perspective.
Rather than label them ‘high growth’, ‘growth’, ‘conservative’, ‘defensive’ and so on, they would be better off both for design and the marketing of the strategies to think primarily about the age group of the member(s).
“When lifecycle products are the default, they should be simple,” Dunnin said. “With a lifecycle product, isn’t the fundamental idea to design something which should reflect the person’s age… When managers show their products, they compare their performance with a balanced index, but that doesn’t tell anyone what is going on.”
He admitted that the range of products was so broad that true comparisons were difficult, that did not mean you should not attempt to make them.
In a release following the publication of Rainmaker’s latest report on lifecycle products, Dunnin said that some people have argued that it was only possible for a true comparison and whether or not the member had achieved his or her goal on retirement. “But that’s absurd. It will be like telling parents that the first time they will ever see their child’s school report is after their child has left year 12,” he said.
Dunnin believes the theory behind lifecycle strategies is compelling but there is a huge variation in their outcomes. As a group, they did not seem to be working properly, he said. He also believes that the regulator doesn’t quite have its head around the product range.
“If lifecycle products, as a group, don’t improve, there’s real risk that pressure could grow for the regulator to prohibit them from being offered as default MySuper products,” he said.
Rainmaker’s latest superannuation benchmarking report found that single-strategy lifecycle products which were MySuper default funds at least matched, and often beat, the lifecycle MySuper index across all age groups over the three and five-year performance periods to 30 June 2020. By ‘single strategy’ the researchers mean traditional balanced funds.
Dunnin said: “While the best lifecycle products perform very well, there is massive disparity between these and low-performing lifecycle products.” There was a 3.3 percentage-point differential between the top and bottom performer.
For its performance survey, Rainmaker looks beyond the managers’ descriptions to group the products according to the age cohorts which each targets for its investment parameters on an age basis. Dunnin said this was the way that employers, who typically select the product, would go about it, rather than relying on more vague growth-versus-defensive labels.
“I think that the providers may be overthinking their strategies,” he said. “A part of the problem with lifecycle funds is that their providers are not very good at telling their story.”
