Volatility in an equities portfolio can be a potential double whammy for superannuation fund members, says Raewyn Williams, Director – Research & After-Tax Solutions, for the US fund manager Parametric.
Speaking today at the leading conference today for superannuation funds- ASI 2016, she said it’s critical for superannuation funds to recognise that volatility is a complex issue that sows doubt and uncertainty about how their members plan for retirement (the “journey problem”), as well as eroding retirement balances (the “destination problem”).
Williams observed that too many responses to volatility are “one-dimensional” and look only to smooth out the journey for members, ignoring the damage that volatility, or expensive volatility responses, can do to end retirement balances.
“It is imperative that superannuation funds recognise this is a two-dimensional problem – that the they need to solve both the journey and destination problems that volatility causes.
“All approaches to volatility need to stack up against their ability to solve both problems for members. Funds should not be willing to casually trade off their members’ destination (retirement savings) for a smoother journey, assuming they cannot deliver both.”
As Williams details in a recent research released, “Managing Downside Risk in volatile times – an equity perspective”, existing approaches to volatility all appear to fall short of solving the journey and destination problems. [The research report published by Parametric compared two hypothetical simulated $10 million equity portfolios, one with volatility and one without, that illustrated a clear return drag from volatility – in this example, 61 basis points over a five-year period. Larger portfolios, higher returns, higher volatility or longer time periods could all increase this leakage.]
“The Financial System Inquiry gave us a retirement solution (‘CIPR’) blueprint that recognises the need for risk management in any retirement solution, as well as delivering income (with underlying capital growth) and flexibility to the retired member – what I call the ‘CIPR triangle of needs’.
“This blueprint shows that it is not ok for a fund to deliver risk management at the expense of the member’s income needs, or vice versa. The CIPR blueprint should further encourage superannuation funds to look for solutions to solve the journey and destination problems, especially as a growing number of their members move towards transition to retirement or retirement itself.”
Williams says the Productivity Commission’s recent draft report on how to assess the competition and efficiency of the superannuation system noted the retirement solutions landscape is sparsely populated.
“This should give us the license to innovate. Equities have to be part of the solution because of the ‘lower-for-longer’ investment environment – we need to invest in equities and deal with the volatility that it creates in an innovative way.
“One option is Parametric’s Defensive Equity solution that takes an innovative approach to protecting the member’s destination while smoothing the journey. It shows that it is possible to solve the volatility problem in all its dimensions and meet all of the features of the ‘CIPR triangle of needs’.
“A viable equities approach to downside risk in volatile times is a solution that genuinely protects the member from the risks he/she cares about (like volatility or downside risk), but avoids costly protection solutions that undermine the member’s capacity to keep building a retirement balance.”
