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.
Mergers, yields, retirement drive big super back to bonds
Higher yields, an aging member base and the Your Future Your Super (YFYS) performance test will push super funds deeper into fixed income, particularly Australian Government Securities (AGS), according to a new report from the Australian Office of Financial Management (AOFM), which manages the government’s debt portfolio.
“The most significant impact on financial markets since 2022 has been rapid central bank monetary policy tightening in response to rising inflation,” the AOFM report says. “This has led to yields rising across the Treasury Bond curve from the record-low yields experienced in 2020 and 2021.”
“Some investors had commented that higher yields enhance the diversification benefits of adding fixed income to a portfolio compared to when yields were extremely low in 2020 and 2021. Several super funds have indicated that they have or intend to increase their allocation to fixed income because of an expected global growth slowdown and concerns over the liquidity risk of some growth assets in a more volatile market.”
The rising presence of AGS in the Bloomberg AusBond Composite 0+ Year Index – included in the YFYS benchmarks – is another factor, with AGS rising to 56 per cent of the index in June 2022. While that number fell slightly in 2022-23, the AOFM expects that AGS will remain “well above” 50 per cent of the index even with increased semi-government issuance.
“The current MySuper performance benchmark excludes Treasury Indexed Bonds (TIBS), discouraging holding TIBs in these portfolios. Following a public consultation of the ‘Your Future, Your Super’ laws, the Government has proposed new benchmarks for fixed income allocations for MySuper products.”
“The ‘composite’ index is proposed to be the Bloomberg AusBond Master 0+ Yr Index, which has around a three per cent weighting by market value to TIBs. It will also include specific benchmarks for credit and government bonds (excluding TIBs). This would result in modest allocations towards TIBs by super funds, which in a relatively small TIB market, could be impactful for overall investor demand for TIBs.”
The spate of mergers creating fewer but “much larger” funds and the gradual shift towards more defensive allocations to service an aging member base will also drive allocations to AGS, the AOFM says.
“The domestic superannuation sector is an important source of demand for AGS. Structurally the Australian pension system will continue to have a lower allocation to defensive assets, including government bonds, than defined benefit systems; however, even a small proportional shift toward fixed income and AGS will be significant in absolute terms.”
Super funds’ allocations to fixed income are relatively low by global standards and in the context of other defined contribution systems with similarly high allocations to equities; Australian funds have on average just a 13 per cent allocation to bonds, while the US has an average of 29 per cent. Still, that 13 per cent allocation is “significant” in outright terms; at December 20220, the allocation to Australian fixed income by funds with more than six members is around $237 billion.
