Thursday, 16 June 2016

We’ve spoken before about the low expected-return environment. And about how we’ve been adjusting the ‘sails’ of QSuper’s investment portfolio to navigate these unchartered waters. So given this what options are available to us in meeting the return objectives for each of our investment options? Here’s a bit more colour to how we’re thinking right now.

As a starting point the fundamentals underlying future financial market returns are sobering. Over the shorter term prospects for global economic growth seem tilted to the downside. This is for a couple of reasons. Firstly demand remains weak and is not expected to have a strong recovery. And secondly global fiscal and monetary policy settings have, at least in the traditional sense, just about been exhausted. 

Over the longer-term, we expect:

  • an ageing global workforce and population (particularly in the developed world) to structurally lower inflation and economic growth.  
  • the financial sector to have less capacity to drive growth and activity given post-GFC regulations (which needed to happen);
  • chronic debt levels (the hopeful remedy for which, ironically, is inflation!) to persist.

It’s this which underpins our expectation that, relative to history, investment returns will generally be lower going forward. We’re not alone in thinking this: check out the latest musings from the Organisation for Economic Co-operation and Development OECD1 on this issue as an example (there are plenty of others, including the International Monetary Fund).

Yet despite this, we still have to take investment risk in order to meet the return objectives for each of our investment options.  Packing up and going home, and coming back out to play when the weather has cleared up, is just not an option.  And this concerns all investors: other super funds; self-managed super funds, mum and dad and other professional investors.

The good news is we have some options on how we can hopefully better weather the storm. But we need to decide the path that’s right for our fund.  So, should we:

  1. Increase the amount of risk we take, and thereby increase the chance we will meet the investment objectives set for each investment option?
  2. Decrease the amount of investment option risk we take by banking some of the decent gains we’ve seen over the past few years and wait for better opportunities?
  3. Maintain our current strategy? That is, back ourselves that the structural changes we’ve made to the broader QSuper Fund portfolio over the past few years will hold us in good stead.

Looking at the first option, increasing risk, say by buying more shares, seems appealing at first glance.  Shares are generally considered riskier than most asset classes, so the returns we can expect from them are also generally expected to be higher.  So this would increase the probability we will meet our objectives.  But we’d also be increasing the amount of investment risk each investment option is exposed to at a time when the economic environment is generally risker and more uncertain.  And while the upside to shares is enticing, the downside can be painful.

At the other extreme, we could follow option 2 and decrease the level of investment risk we take. Market prices across the board have increased a lot over the past five to six years.  A patient, contrarian long-term investment strategy might therefore be to keep funds aside and wait for a relatively more attractive time to invest.  After all, it is usually better to increase risk (i.e. buy more risky assets) when prices of those assets are more, not less attractive.

The third option is to maintain our current investment strategy.  The QSuper Board’s primary objective is to seek consistent returns while providing a less volatile experience for our members.  And the return objectives of QSuper Lifetime and the ReadyMade2 investment options represent the QSuper Board’s expectations from strategies over very long periods.  As you might know, we have made substantial in-roads to building a genuinely more diversified portfolio over the past few years, and we’ve managed to do this without sacrificing expected returns.

For now the answer for the QSuper Fund is a combination of options, in this instance 2 and 3.  We believe it makes sense to maintain our core diversified portfolio structure. This is for the reasons that it increases the probability of meeting return objectives across a number of economic scenarios and because of the performance from this strategy we’ve seen to date. 

In addition to the long term strategy, we make shorter-term decisions3 to reposition asset class holdings as our near-term risk and return expectations change.  And this has seen the QSuper Fund overall hold more cash recently, in part for risk management purposes and partly in anticipation of better opportunities becoming available down the track.  Unfortunately, there is no risk-free path for any investor: each one simply exposes us to a different combination of risks.

Following this line of thinking, and if it’s of interest, in the next couple of posts I‘ll dive into the shorter-term decisions a little further, and also explore our current investment option asset allocations in more detail. 

1 QSuper Limited does not claim any affiliation with the Organisation for Economic Co-operation and Development (OECD) and the OECD has not approved, endorsed or otherwise supported the views in this blog.

2 This applies to the Balanced, Moderate and Aggressive investment options only.

3 This process is referred to as the dynamic asset allocation process. It allows the QSuper Investments team the delegated authority to move the asset class weights within the approved asset allocation ranges for each of the QSuper options and which are set by the QSuper Board based on evolving short term risk and return expectations.

The views of the author and those who provide the responses to comments posted on this blog are not necessarily the views of the QSuper Board. We’ve put this information together as general information only and you should get 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.