Australia’s longevity tsunami is placing extra pressure on retirement solutions and portfolio construction as a major demographic and societal transformation forces the hand of policymakers.
According to the Actuaries Institute, almost a quarter of the population will be aged 65 or over by 2050 compared to 14 per cent now.
This steep increase has serious social policy implications for a range of sectors with income in retirement an obvious concern for investors.
Analysis conducted by MLC frames the extent of the problem following changes to the concessional contribution cap. It found older workers could benefit from investing more money into super from an earlier age.
On July 1 the federal government halved the cap to $25,000 per annum for people aged 50 and over.
MLC found that a 45 year old earning $100,000 with a mortgage of $300,000 could be more than $80,000 better off when they retire at 60 if they use their surplus cash flow to invest more in super rather than make additional mortgage repayments.
“The halving of the contribution cap has changed the game, making it harder for people to make larger last-minute contributions to super,” says Gemma Dale (left), head of technical services at MLC.
“Those who wait until they are debt free – typically as they approach retirement – could find they are significantly constrained by the cap.”
MLC ran several scenarios to see how the results would vary for people with different ages, incomes, mortgage balances, mortgage interest rates and investment return assumptions.
In many cases, particularly for older workers, the results favoured putting more spare cash in super from an earlier age.
However, Dale warned that putting every spare cent in super could be a mistake.
“Younger people in particular should focus on paying down as much debt as possible,” she says.
“It’s also important to consider whether the money will be needed before retirement. Super can only be accessed if certain conditions are met while additional mortgage repayments can usually be accessed at any time via a redraw facility or offset account.”
A lack of diversification
Global fund manager, Standard Life Investments, believes solving the post retirement conundrum will require Australian super funds to move beyond traditional balanced funds and consider objective-based strategies.
David Millar, investment director for multi-asset investing at Standard Life Investments, said profound developments in Australia’s superannuation sector and ongoing market uncertainty will force many Australian super funds to re-evaluate their investment strategies.
“The proportion of super fund members who will move from the pre-retirement to the post-retirement stage will increase three fold over the next decade, and with longer life expectancy we will face the ultimate post-retirement challenge – will members have enough to retire on?” he asks.
According to Millar, the typical balanced fund with its heavy weighting to equities enjoys positive returns when equity markets are strong.
However, the lack of diversification becomes especially apparent during times of market stress when the overall fund volatility increases and returns fall.
| “A large proportion of assets within a balanced portfolio are essentially risky assets. Some are more risky than others, but they all possess risk characteristics to varying degrees. There is increasing evidence that markets are differentiating less between asset classes, and adopting either a ‘risk-on’ or ‘risk-off’ stance,” says Millar.”If we face another GFC-like shock, the loss in superannuation could be up to 15 per cent (this was a typical decline in balanced fund balances during the financial crisis of 2008), and a member’s superannuation could run out about seven years earlier than might otherwise be expected.” |
Archaic portfolio classifications
The limitations of traditional portfolio construction techniques have also been the subject of much debate at this week’s PortfolioConstruction Forum Conference in Sydney.
Director, funds and advisory at Barclays, Caroline Saunders, believes Australian licensees are still alarmingly off the pace when it comes to asset allocation.
“Not all sovereign bonds can be considered a safe haven and this brings into question the somewhat archaic portfolio classifications that many dealer groups continue to promote,” she told delegates.
“Traditional asset allocation structures are really not providing the defensive characteristics that investors expect.”
Ramin Toloui, co-head of emerging markets at Pimco, says the principal objective of financial planners should be to build for their clients “portfolios that are robust in the face of a very different global environment than we’ve faced historically”.
“Australian investors have historically had very large allocations to equities – Australian equities and global equities – and in an environment of lower global growth there are important portfolio characteristics that emerging market bonds can bring to Australian investors – a combination of reliable income streams, while still retaining an upside on global growth that’s represented by emerging markets,” he says.
Toloui says the debate is not well developed on how emerging market bonds in some instances as an alternative to equity allocations, can reduce portfolio volatility while maintaining a high level of return.
“The level of familiarity is pretty low,” he says, and many planners believe their clients are adequately diversified when, in fact, it could be done much better.
That is particularly true when it comes to retirees who cannot withstand a high level of volatility.
“The important thing about thinking about retirement income is the income side of it. And when you own a bond then you are receiving a stream of income – of debt service – from the emerging market government or corporation that you’re lending to,” he added.
In particular, traditional approaches to asset allocation and portfolio construction fail when the expected correlations between asset allocations go out the window, resulting in diversification not help investors avoid losses.
This is especially true for investors who do not have the luxury of time to allow investment markets to recover losses.
Out of thin air
Greg Cooper (pictured), chief executive of Schroder Investment Management Australia, told the PortfolioConstruction Forum Conference that to have 90 per cent confidence that a traditional 70/30 investment portfolio will meet its objectives, an investor would have to hold the portfolio for more than 80 years.
Woody Brock, the president of the New York- based Strategic Economic Decisions, says a rule like the 70/30 rule “comes out of thin air”.
Brock says there is no logical basis for such an asset allocation – or, at least, none that has as its main objective what’s best for the client.
He believes planners should employ a process of “backwards induction”‘ which means starting with the question, “What are your financial goals with your money”, and then decide, “What do you do to get it?”
Some things have not changed, Brock says. Assets will go through period of both extreme overvaluation and undervaluation, for example.
“But what’s changed is that I am getting old at a time when what was good for my parents isn’t good for me,” he says.
And so all financial planners need to carefully rethink how they tackle the issue of providing adequate retirement income for their ageing clients.
Pippa Malmgren, head of Principalis Asset Management in London, says the current “normal” is not new – in fact, it’s old, she says, and it is the past 25 years that were “new” or unusual.
In many ways, investors are headed back to the future – but the good news is that it’s still possible to make “a ton of money” for clients in the current environment, she added.
Appropriate investment strategies for retirees are vital. At least equally important for advisers and their clients to is improve their longevity awareness. Discussions about “how long are we planning for” and “how well can I manage” frequently identify less intuitive strategies for managing their lives both economically and for greater satisfaction.
Such discussions also highlight the more likely time frame which surely underpins any worthwhile investment discussion.
Advisers need to understand more about longevity and their clients need to be helped to better understand their personal longevity issues. A focus on investments alone will not produce optimal outcomes for clients or advisers.