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.
Super’s problem with the ‘misunderstood middle’
Super funds can’t rely on the demographic and financial data already available to them to cohort members for retirement, according to research from Challenger and Capital Preferences, and will need to learn more about what they really want in their golden years to provide personalised retirement income.
The research findings “highlight the importance” of recovering individual preferences as part of the member experience.
“Simply relying on demographic data to predict income certainty preferences will almost certainly misdiagnose members – and hinder superfunds in providing fit-for-purpose retirement income assistance,” said Shachar Kariv, Capital Preferences co-founder and chief scientist.
The survey of 4000 members identified that 64 per cent of them belonged to the “misunderstood middle” and faced a tension between their financial needs in retirement and the financial resources with which they enter it. Members in the misunderstood middle require “deeper understanding and the most personalised assistance” from their fund despite many of them being the same age and having the same balance as other members that feel more comfortable with their super.
For example, one member might be willing to trade higher income for a more certain income, best served by a guaranteed lifetime income (GLI) product, while another member is happier with the opposite and might prefer an account-based pension with a nominal drawdown and 50 per cent growth assets.
“Digital and scientific innovation can play a significant role in solving this potential issue, allowing super funds to recover essential information on their members… Members can’t self-report their preferences in areas of risk, but they can show us with their decision making,” Kariv said.
Funds should measure a representative sample of their members’ income certainty preferences and incorporate them – alongside “holistic member resources” – into cohorting for product strategy purposes while engaging them with more interactive digital experience as well as adviser assistance.
Challenger and Capital Preferences also suggest that a significant chunk of members could benefit from having part of their balance placed into GLI products to provide certainty that their money won’t run out, an amount the research puts at around $145 billion.
“When GLI is in a member’s retirement income strategy, it is associated with feeling much more prepared for retirement and having lower anxiety about outliving one’s savings,” the report says. “When we conducted deeper regression modelling against feelings of retirement preparedness, it shows the association for GLI product ownership is on the same order of magnitude as renting vs. owning one’s home free and clear.”
