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.
DB ain’t dead – and it’s still got lessons to teach
Defined benefit (DB) pension funds have been around since (at least) 1875, but in Australia they’re seen as a hangover from a time when pension savings were administered by individual employers and corporations rather than the public offer behemoths that dominate the retirement system today.
But while there’s a temptation to think them mostly vanished from the earth, DB funds still manage a significant chunk of Australia’s retirement savings – and there’s a lot at stake in making sure those savings are managed right.
“Some might think DB is dead, that it’s the dinosaur of the retirement world,” Meher Edibam, director of institutional client solutions at Challenger, told media on Tuesday. “It’s true that most DB schemes are closed, but there’s $462 billion in DB member benefits left in Australia. That’s 730,000 member accounts, and these DB payments are going to go on for the next 20-30 years. That’s a long tail for the dinosaur to manage.”
For corporate sponsors, managing that tail typically means wearing longevity, investment and interest rate risk when their core business might have nothing to do with it, often on behalf of former employees that they feel no particular responsibility for. So it’s time to derisk, Edibam says. The fact that many funds have achieved favourable funding levels due to higher interest rates and strong equity market returns means they’re well-placed to do it, while rising bond yields have resulted in better pricing for buy-ins, successor fund transfers or inflation-linked investment opportunities.
“Timing is everything in life and DB,” Edibam said. “Our thinking is that all DB funds will look to derisk; it’s not a matter of if but when they choose to do that.”
Even if, as Edibam said, DB funds are viewed like old VHS tapes gathering dust in the garage, they have features that are “really appropriate for our market-leading DC system”, and it’s important to keep them stable and sustainable. A VHS of Back to the Future recently sold for more than $100,000; the learnings from DB might be even more valuable.
Shang Wu, portfolio manager in Aware Super’s retirement strategy team, agrees. Aware inherited a defined benefit fund from its merger with Health Super in 2011, and ultimately derisked it in 2023 with the acquisition of a master life annuity from Challenger, leaving the fund fully self-funded with no need for future contributions. The learnings from that experience are now being applied to retirement solutions for its 1.2 million members.
“You need to be an expert in the liability side, which is a more of an actuarial skill, because even in the defined contribution world funds are exploring what their income solution will look like. It’s the same skill – you understand the liability, and the asset that will support the liability, and how they’ll come together to get a better outcome for the member.”
And in the provision of retirement solutions, many of the discussions are the same as in DB land, according to Richard Boyfield, head of consulting for investments and retirement at Mercer. The sponsor is now the individual member, and it’s all about helping them understand the trade-offs – giving them information about their entitlements to things like the age pension, and the tools to understand that information.
“You’re looking at following a similar kind of process as you would do with a DB scheme in terms of helping them along this journey, and if you wait for an individual to get to the point that they retire there’s not much you can do about it,” Boyfield says. “It’s about helping them along that journey – and as Shang says, you’re using the same kind of skillsets to address that problem, but it’s about engaging with the individuals.”
For Aware, its experience with Health Super also gives it DB bona fides when it’s looking for future merger opportunities that might come with a legacy DB offering that other funds will have trouble handling due to a lack of infrastructure or experience. Australian Retirement Trust has been hoovering up DB schemes like AvSuper, but in a time when many funds are still in growth mode, DB capability is increasingly important.
“It’s a different system; you’re adding complexity, and you need to build and understand that capability; there are different issues to address – all of these funding issues, for example. The expertise, the experience isn’t there,” Boyfield says.
“Maybe that’s good for consultants like me, but it’s a warning for them from a risk perspective; it makes them a bit more nervous around the requirements, even just dealing with the regulator. The regulator in Australia compared to the UK is far less involved in monitoring and in the requirements they have on DB funds; the UK is looking at every little inch of what’s going on.”
