Wednesday, 10 June 2015

As crises have a way of doing, the GFC raised some important questions. For the super industry, the big question was how can we better position our members to weather these kinds of large negative market events? Because ultimately, these flow through to the standard of living we will all experience in retirement.

And while the GFC was one of the biggest market downturns we saw for a generation or so, these types of events are a part of the cycle. They are inevitable. We have to be able to work within any part of an economic cycle and where necessary, around it. Here I’m going to share with you some of the key learnings and influences we have taken from history and which we have practically applied to our investment strategy for a few years now.

1. A typical ‘balanced’ investment option experiences significant volatility

This volatility or risk is largely attributable to shares. A typical balanced-style super fund traditionally comprised up to 70 per cent shares before the GFC. This is all well and good when share markets are contributing strong returns. But it’s a problem when they are delivering relatively large, consecutive, negative annual returns. To ensure portfolio outcomes are not so tethered to the fortunes of share markets, the source of market risk needs to be more diversified. Yet to target the same investment return objective, shares need to be replaced with assets with a similar risk/return profile. But importantly, replaced with assets which are uncorrelated to share market performance.

2. Super fund members are vulnerable to sequencing risk

The sequence or order in which annual investment returns are earned can have a dramatic impact on a super balance over time. Another way of putting this is that we as members experience risk in real-time. Let me explain. Within the super industry we often see funds’ investment returns presented as a compound average growth rate over one, three, five, seven year timeframes. This can be a bit academic and ignore what an individual member actually experiences; particularly in terms of the impact that large negative returns can have on those about to retire or already in retirement. The investment strategies for our Lifetime and Balanced options are designed to give some protection to those most vulnerable to this risk.

3. Recovery from a drawdown starts from a lower capital base

When you experience an investment loss, the starting point from which recovery begins is from a lower capital base. This means you need to earn more than you lost in order to return to your original position. For example, if you had $100 and made a 25 per cent loss, you now have $75 but to recover the $25, a 33 per cent investment return is needed (i.e. 25/75 = 33 per cent). It is this type of impact on retirement savings that we want to minimise as much as possible. 

To summarise, we are targeting increasingly diversified returns with increased certainty and lower volatility in part to mitigate sequencing risk. If you’d like to know more about any of this thinking, please let me know.

The views of the author and those included in the responses to comments posted on this blog are not necessarily the views of QSuper. This information is for general purposes only. It is not intended to constitute advice and persons should seek professional advice before relying on this information.

Past performance is not a reliable indicator of future performance. Each of our investment options has a different objective, risk profile, and asset allocation.

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