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.
Why super’s return machine will need to shift gears
Australia’s superannuation funds are some of the most productive asset accumulation machines in the world, with the powerful combination of mandatory inflows and compounding returns creating an average member balance at retirement of $402,838 for men and $318,293 for women.
But as the first generation of compulsory superannuants reaches the end of the accumulation phase the investment teams that have helped get them there will need to shift gears and integrate into a broader retirement function.
“The role is so different,” Geoff Warren, ANU associate professor and Conexus Institute research fellow, tells ISN. “And the key difference is that in accumulation, the investment team basically wears the pants in the organisation – every member would like higher returns and a higher balance in retirement. And then when you move into retirement it goes from that single point of focus to these more personalised outcomes.”
“The investment team then sits within a broader retirement solution that will have investments in it, but they’ll be considered in conjunction with the age pension, any lifetime income stream products and the drawdown strategy. (The investment team) is almost a service provider to whoever designs the retirement solution.”
Warren and David Bell, executive director of the Conexus Institute, have produced a paper outlining how superannuation fund investment teams can support retirement income solutions and how their role – and place – within the fund might evolve.
Because while retirement will require a change of mindset, it’s also an opportunity for the investment team to “partner with the broader organisation”; Warren and Bell think that funds should maintain a single investment function but create a team of specialists within it that engages more closely with the retirement segment. And that investment team won’t just be delivering a range of balanced funds but a set of differentiated retirement “building blocks” that can be put together in different ways to meet different member needs.
In creating those building blocks, the investment team might design “a different kind of growth portfolio” – one that maximises franking credit capture, smooths volatility, and delivers inflation hedging. The defensive side might be a capital stable portfolio – a lump of cash that is always available for access.
“I’ve had this view going back that you didn’t need a range of balanced funds – you need a growth fund a defensive fund and some sort of lifetime income solution, or maybe a couple of types; an annuity, if you want,” Warren says. “And then you can serve a number of different retirees by combining them in different ways. So the account-based pension would be different portions of the defensive and growth portfolios, and then you’ve just got to decide how you actually draw down from it.”
But what Warren and Bell believe is key is that investment teams can “make a significant contribution to member outcomes during retirement” and should get more involved with planning for the retirement phase.
“They’ll probably need to integrate a bit more into the retirement effort and, like everything with retirement, you’ll end up with some people who are very advanced and some people lagging behind and some people doing nothing. It’ll be in fits and starts – as the industry has done already with retirement.”
