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Since 2011, QSuper has invested in a “risk-balanced” strategy which focusses on risk allocation not asset allocation – this diversification approach is different to that taken by most other superannuation providers. Our short and long-term returns are direct result of this strategy.
Financial markets were noticeably more volatile in 2018 following a period of unusual calm during 2017. Share markets were whipsawed in January/February 2018 and again more recently in late October. In both cases, international shares lost between 7-8% and Australian shares lost between 4-7%. The causes of each episode are many and varied but probably collapse to a change in the investment landscape as global central banks withdrew the excess liquidity deemed vital in response to the global financial crisis, combined with high valuations in many asset classes due to this sustained period of excess liquidity.
"Whatever the causes, the consequences can hurt."
The older and the closer to retirement you are, the bigger your pot of superannuation is likely to be. The norm in the Australian marketplace is to have around 50-60% of the asset allocation of a Balanced option invested in listed equities. Given the high risk associated with listed equities, this means that 80-90% of the risk in these Balanced options tends to be driven by equity risk. Almost all their eggs are in one basket. If your fund’s asset allocation is so heavily concentrated in shares, sell-offs of the kind we saw last year can have a devastating impact on the level of retirement income you’ll be able to enjoy.
The history in Australia over the past few decades is that volatility doesn’t really matter; the belief being that markets always bounce back. But that isn’t always the case. Australia has been the lucky country, we now have the world record for the longest period (27 years) without recession. As dramatic as the GFC was, markets bounced back relatively swiftly.
If we step away from recent local history, we get a better appreciation of the risk associated with being concentrated in equities. It is not uncommon for equity markets to have losses and not recover to previous levels for a decade or two after accounting for inflation. This was the case for the US following the tech bubble in the early 2000s and Japan following the euphoria of the 1980s when they were the envy of the world. Returns of course are always worst from the time when things feel like they will go up forever.
This piece isn’t a forecast that such a period of returns is imminent. Rather, it aims to remind that such periods do occur. History tells us that the timing of such periods is difficult to predict. Imbalances can build up over long periods. Markets that are overvalued can become even more overvalued. As such, overvaluations don’t provide a good forecast of when a market will fall but they give an indication of the pain that could be felt when they do.
Most in the industry see the US share market as significantly over-valued; are concerned about structural issues in Europe; and are cautiously looking at how China deals with its range of imbalances. So, while it is hard to forecast if a significant equity sell-off will happen, we know they happen relatively regularly (say every decade or so) and now is not a time without risks.
A well-respected approach to managing risk is diversification. The problem with diversification however is there is usually a cost to it. Taking allocations away from shares usually means either investing in an asset class with inferior returns (think typical government bonds or cash) or investing in asset classes that purport to be diversifying only to fall in value at the same time as shares (think corporate bonds or alternative funds with lots of equity beta).
While bonds tend to do well when equities fall, normally the gains from bonds are much less than the losses from equities. So, having bonds is only marginally better than having cash. However, not all bonds are equal, and you don’t have to be tied to the standard indices.
At QSuper we have sought out Longer Duration Bonds, which are typical bonds with longer terms to maturity than offered in the standard indices. The longer the duration, the higher the return you tend to get when rates fall, and the bigger the losses when rates rise. The bonds we seek out are high-quality government bonds, but because of the longer duration they have similar risk to equities and therefore also have higher average returns than standard bonds.
As per the stylised chart below, when equities fall these bonds tend to have great returns, much better than standard bonds. The see-saw works both ways: when equities are doing well theses bonds tend to give back returns. In effect, at the portfolio level they tend to smooth out returns in both directions.
It is true that rising bond yields have been at least partially responsible for the last two bouts of volatility, resulting in losses from both bonds and equities. However, the relationship tends to hold when equities really fall out of bed (unless there is entrenched inflation that must be quelled, which is not the case in the foreseeable future). So, we continue to expect that these bonds will provide true diversification when required.
Stylised Relative Performance in a Typical Equity Sell-off
Source: QSuper Limited
Diagram is not to scale and provided for illustrative purposes only.
So, by not taking the off-the-shelf bond exposure, we have been able to add an exposure that helps more when you need it and that also has higher returns than a standard bond. The higher returns allow us to have less exposure to equities than a typical fund - reducing downside risk even further - while maintaining similar likely long-term returns.
Since the GFC, we’ve also increased our allocation to unlisted property and infrastructure. These assets generate strong, stable, inflation-linked return streams that are also less correlated with share markets than your typical REIT-style investments. And throughout this period, our allocation to cash has been about the same, meaning we have remained fully invested, rather than sitting on the sidelines shunning risk.
Similar long-term returns with less risk sounds a big claim. However, the results are clear to see in the table below. Considering Balanced investment options, our deliberately more diversified approach that targets strong long-term returns and keeps our members better protected from ups and downs, has performed as well as or better than a typical equity-heavy super fund, but with much less volatility.
At time of writing, QSuper’s Balanced Option is the best performing balanced fund over the 10 years to December 2018.1 This is not a surprise though – it’s confirmation of our long-term strategy in action; our aim is to deliver strong, long-term returns for members.
QSuper Balanced option returns vs. median balanced fund (SR50)
Source: The table above shows the after fees and taxes return for the accumulation account of the QSuper Balanced option. It also shows the after fees and taxes return for the SuperRatings SR50 Balanced (60-76) Index using median returns. SuperRatings does not issue, sell, guarantee or underwrite this product.
Equities are still the largest exposure in our portfolio, so when equities have fallen, our returns have been lower than normal, just not as low as others. Of course, the reality is that equities haven’t really had a bad year in the period covered in the table above. The worst years for the Traditional Balanced portfolio above are 0.4% and 2.8%, a far cry from the minus 10% returns seen during the GFC. So, the real benefits of the more diversified QSuper approach are yet to be seen.
Over the very long run, on average, we’d expect both QSuper’s strategy and a typical, share-heavy Balanced strategy employed by most Australian super funds to produce similar returns. However, most people don’t get the average. If you happen to retire when equity markets have been on a boom, then the equity-heavy approach that most funds follow may see you ahead of the more diversified approach. But equities can have not just a bad year, but a bad three years and even a bad decade. While some people might choose to delay retirement if markets are down, many simply won’t be able to do that and will have to retire with less.
Our strategy lessens the probability of that timing risk.
The views of the authors are not necessarily the views of the QSuper Board. This information is 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. Visit qsuper.qld.gov.au for more information.
1 SuperRatings SR50 Balanced Index (60-76) median based on cumulative returns compounded annually after fees and for initial $50,000 invested over the period to 31 December 2018. Past performance is not a reliable indicator of future performance.
After the Global Financial Crisis (GFC), QSuper did a lot of research and thinking into developing a different investment approach for members. Doing the right thing by members was our motivation.
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