The managing director of Innova Asset Management has slammed superannuation funds’ approach to risk, saying that “when risk is ignored, eventually investors will have to pick up the tab when the next market downturn strikes”.
Speaking in the firm’s November portfolio insight, Dan Miles said funds are ignoring the impact of increased risk on future returns.
“It’s happened before: the OECD estimates that Australian funds lost 21.6 per cent as the global financial crisis routed the industry in 2008 and 2009.
“We know it prompted a significant number of older investors to switch investment options at the worst time while many, wanting greater control, switched to self-managed super funds.”
Continuing, he said that “little has changed” eight years later and that the industry has a “distorted focus” on monthly return tables and an emphasis on performance.
He said: “It is misleading: the GFC showed that risk matters.”
Further, he condemned funds’ current risk measures as “meaningless” and warned that investors are making choices based on funds’ returns tables.
He elaborated: “Some recent strong performers have had a near-zero allocation to cash and fixed income (replacing that ‘defensive’ exposure with infrastructure and other assets) while other funds have maintained a more traditional 30-40 per cent allocation.
“What’s more, we know that equity exposure is still the underlying driver of at least 90 per cent of most balanced fund returns.
“There is no industry-wide accepted way to define the underlying risk (which is often equity risk) driving portfolio returns.”
Acknowledging that funds do include the industry-developed Standard Risk Measure in their product dashboards, he nevertheless argued that this measure does not “convey the magnitude of losses”.
Explaining that the Standard Risk Measure estimates the “likely” number of negative yearly returns over 20 years, he argued that the measure is flawed as it doesn’t take into account that one year of -12.7 per cent – as the average balanced fund recorded in 2008-09 – is “far worse” than two years of -1 per cent.
“Investors are also likely to be misled by the nature of odds,” he continued. “If a fund estimates the likelihood of annual negative returns as one in 20 years (5 per cent) and it occurs, most investors will mistakenly assume the next 19 years are plain sailing.
“In fact, the odds of a negative year remain 5 per cent every year, regardless of past performance.”
Mr Miles said the industry should report a “measure of performance per unit of risk taken” along with performance numbers.
He recommended that rolling volatility and maximum drawdown measures be incorporated into risk-defined portfolios, as Innova does.
“These are only two of the measures we use, and in fact we benchmark ourselves against these measures instead of typical capital market benchmarks,” he added.
“This conveys crucial information to investors about risk (assuming funds have a long enough track record). It also gives an indication of manager skill, rather than current performance tables, which ignore the role of luck and good timing.”
Speaking in Sydney this month, the chairman of Challenger Limited’s retirement income arm, Jeremy Cooper warned that the Australian super system is “not up to the task” and questioned whether it was even “fit for purpose”.
He suggested that: “A super fund needs a retirement income philosophy. You will not be surprised to hear that I don’t think this amounts to: being great investors”.
“The return of a member’s money in the form of regular income and better managing their risks in retirement is not the same as the time-weighted returns achieved by the fund as [a] whole.”
Warning that not everything can be addressed through asset allocation, he said trustees need to understand their position when it comes to probability-based outcomes and risk-free retirement outcomes.