Pension industry experts have criticised proposals in Australia to introduce a new generation of lifecycle funds as mandatory default products and a more rigorous fund reporting and certification system.

“Lifecycle products are not a proven solution,” Pauline Vamos, chief executive of the Association of Superannuation Funds of Australia’s (Asfa), told AsianInvestor.

“They may suit some people, but many funds in Australia that have looked at lifecycle products say they are not for them and that they don’t believe such products would give the best outcome for fund members.”

Target-date funds are not popular with institutions because they put participants in the same cohort based on age and are therefore seen as a blunt instrument, one manager states.

In a recent report, EDHEC-Risk Institute argued that the introduction of increased choice and better scale economies had not resulted in a more efficient superannuation system. It further noted that the system was not designed to provide life-long income.

As a result it said fund providers tended to offer simple products rather than sophisticated asset-liability management solutions. Meanwhile, individual accounts expose participants to investment, inflation and longevity risks and do not create the same cost efficiencies as pooled pension plans.

EDHEC’s findings follow the release earlier this month of the Murray Inquiry’s report on the superannuation scheme’s equity and efficiency.

The government announced the appointment of David Murray to head the inquiry into Australia’s financial system last November. It is designed to make recommendations to foster an efficient financial system, and result in less costs, lower fees and greater efficiency in the allocation of capital.

In an interim report, the inquiry has found pension fees in Australia to be some of the highest in OECD countries.

“We think the Australian system is not easily comparable, and the OECD figures are difficult to confirm,” said Vamos.

She pointed to the recent introduction of data standards that are enabling providers to switch from manual to digital data-keeping systems, which she said would bring down costs.

“You need to look not so much at the fees but where the costs go, such as delivering call centres and regulation inefficiencies. We are not allowed to communicate with our members electronically, and there has been a large amount of regulation we’ve had to implement over the last few years,” she added.

The inquiry also took issue with the expansion of self-managed super funds and use of leverage in superannuation funds, and proposed that the latter practice be prohibited as it could pose a risk to the financial system.

Further, it proposed that retirees ought to take annuity income rather than a lump sum, which would reduce longevity risk. Also, there was little evidence of fee-based competition, it added.

A final report on the inquiry’s findings will be handed to the government by November, to be finalised and announced in mid-December.

“Superannuation doesn’t have a design for post-retirement. You can’t invest through retirement, and innovation in products is very limited. We expect to see the findings around post-retirement to be implemented,” Vamos said.

Meanwhile, EDHEC suggested portfolio and asset allocation selections should be regulated because of investor behaviour.

During the financial crisis, 7% of all investors in balanced funds in Australia switched products, going into cash or bonds, noted Mark Wills, head of State Street Global Advisors’s (SSgA) investment solutions group for Asia Pacific. They locked in destruction of about a third of their capital, he added. In some funds, 50% of members switched or inquired about switching.

The institute advocates the introduction of sophisticated products as standard and default superannuation funds that would provide annuity-like income through retirement, hedge risks and provide diversification.

But similar funds are already on the market. In July last year, SSgA launched three low-cost retirement products, with each having a defined total return and downside protection. Milliman also offers a similar product.

“There are three problems. First, drawdown; everyone hates drawdown. Second, from an investor’s perspective you want enough money to last you your retired period. Third is asset allocation,” Wills told AsianInvestor.

“You can only tick two of those. If you want drawdown mitigation and longevity, then you have to be prepared to radically change your asset allocation. If you aren’t prepared to change that, you have to pick one of the others. You are either going to run out of money because you’d be all in cash or you would have massive drawdown to maintain longevity.”

EDHEC’s proposed second generation of funds should focus on downside risks, with investors guaranteed an absolute minimum of consumption in real terms, it said.

“We use strategic allocation with an annual review – no four or five year review cycle. And we change asset allocation meaningfully. We think static allocation has been the problem with balanced portfolio since they came into existence,” said Wills.

To foster innovation, EDHEC advocated the implementation of a certification scheme that measures funds against commonly accepted best investment and governance practices. It suggested the initiative could be led by industry members, with certification conducted by independent auditors.

Proposed criteria include suitability as lifecycle solutions, sufficient risk and horizon customisation, transparent fees and adherence to best industry standards.

“We’ve been measuring ourselves against our peers and against the market. We must look at different measures. How well have we formed capital? What contributions to the real economy have we made? How many jobs have we created?” said Vamos.

The institute further proposes the introduction of a reporting system that would require providers to make public risk and performance indicators, fees, expenses and non-financial risks

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