Following the introduction of the MySuper legislation in 2012, which set legal boundaries around default pension options in Australia, a significant number of providers opted for life-cycle strategies for their default MySuper investment option.
Although in the United States similar strategies, called target-date funds, have been around since the 1990s, the introduction in Australia was relatively new and was met with a barrage of criticism.
These funds were said to be unproven, exposing members to unknown risks.
Last year, the Productivity Commission in its final superannuation report acknowledged life-cycle strategies could help in addressing sequencing risk, but also criticised a number of existing life-cycle strategies for derisking too early and not being as good as many balanced fund options.
“In practice … many life-cycle products have simply ended up leaving members with lower retirement balances than they would otherwise have got in a fixed-strategy product. This is a combination of failing to adequately take account of members’ personal characteristics – as not all members will need to derisk ahead of retirement – and of dialling down risk too early in the life cycle,” the commission said.
Michael Block, Chief Investment Officer with Australian Catholic Superannuation in Burwood, Sydney, says much of the criticism misses the point.
“To always place a member who is 20 years old with a 60-year old member in the same strategy is clearly ridiculous,” Block says in an interview with [i3] Insights.
To always place a member who is 20 years old with a 60-year old member in the same strategy is clearly ridiculous
“Why would any fund use a one-size strategy that clearly does not fit all?”
He acknowledges not all life-cycle strategies are perfect solutions, but most of the criticism of them applies to poorly designed strategies and not to the concept itself.
“I absolutely concede, especially with people living longer, that moving members into a low-risk strategy at 60 is not a great idea. Even at 60 years old, a member is likely to have a 30-year investment horizon and should still have a decent amount of growth assets,” he says.
“However, I do believe that one can take any single-strategy default and improve its outcomes by giving it a life-cycle tweak, namely taking more risk when a member is young and less when they are older.”
Australian Catholic Super launched its life-cycle option, Lifetime One, in May last year and moved its default members into it unless they opted out. Less than 2 per cent of members decided to opt out, Block says, while some members in Choice options decided opt in to the new default.
The result of the shift is that half of the fund’s members now have a higher allocation to growth assets, while one-quarter, generally older members, have a lower allocation. The rest have retained a similar exposure to growth assets.
Asked whether he is afraid members may have been shifted at the wrong time – as many market observers have predicted lower returns going forward, while some even predict a correction in equity markets – Block says even if this scenario plays out, his members will still do better.
“This is because younger members have many years to recover from any losses and will get the opportunity to purchase quality assets at lower prices,” he says.
I believe that one can take any single-strategy default and improve its outcomes by giving it a life-cycle tweak, namely taking more risk when a member is young and less when they are older
Australian Catholic Super’s life-cycle strategy also doesn’t derisk in two or three lumpy transactions, as many life-cycle strategies do. Instead, it reduces members’ exposures to growth assets gradually from 90 per cent when they are 40 to about 40 per cent when they are 70.
It does this in small annual increments, so there are 31 steps in the derisking process (which all have to be individually reported to the Australian Prudential Regulation Authority).
“As long as you still contribute to your super, you’ll get a better outcome compared to a single-strategy investment option,” Block says.
“We, as an industry, should spend more time on educating people that even in a downturn it is important to contribute to super because in the long term you will end up with more in retirement.
“This gradual process of derisking also reduces a member’s sequencing risk as there is never more than a 2 per cent reduction in growth assets in any given year.”
Currently, Australian Catholic Super’s life-cycle fund is based on age only, but Block hopes to introduce more variables along the way, including account balance and salary.
“In a perfect world, you would ask everyone what they wanted out of a superannuation fund and tailor an individual portfolio for them, but if you don’t have complete information, then a life-cycle strategy based on age is a good attempt at mass customisation,” he says.
“We see the introduction of life-cycle investing as the first step towards purpose-built superannuation, where it is more tailored to our members’ needs.
“Additionally, Lifetime One was designed to dovetail nicely into Australian Catholic Superannuation’s pension strategy, called RetireSmart, which was also mentioned positively in the Productivity Commission report.”