Negative rates force Aussie super funds to review targets

The country's superannuation funds are telling members to expect lower investment returns, as industry experts say the concept of a risk-free rate no longer exists.
Negative rates force Aussie super funds to review targets

Putting aside the current political storm over Australia’s proposed changes to superannuation contribution and tax rules, the single biggest problem for Aussie superannuation funds is the protracted low-interest-rate environment and its effect on long-term returns, say local industry experts.

Aussie super funds are now reviewing long-term return targets in response to the 'lower for longer' outlook on investment yields.

The Sydney-based consultancy SuperRatings reports that the median balanced fund return fell from 9.7% in the 2014/2015 fiscal year (Australia's financial year ends each June), to just 2.3% in 2015/2016.

That average hides a host of negatively performing funds. SuperRatings chairman Jeff Bresnahan said: “We expect results to be between -1% and +6%, so some members will see red ink on their statements."

Fiona Trafford-Walker, director of consulting at Melbourne-based Frontier Advisers, says Australian funds are dealing with the downturn by reviewing their investment targets. "Institutions at chief investment officer and investment committee level are now thinking differently about their objectives and whether they are realistic," she told AsianInvestor.

“Rather than bringing the target down, they are advising members it’s going to be harder to achieve, but they’re still going to aim for that target,” she said, estimating that these funds typically target real returns of 3% to 4%, depending on their investment allocations.

Industry expert Gabriel Szondy, a director of the $10 billion CareSuper fund, agreed that returns needed to be revised down. However, he believes the Australian government is not helping by using outdated assumptions in formulating policy.

"When the government says it is going to restrict the amount of member contributions, it is still assuming that the superannuation fund long-term return is going to be between 8%-10% (annualised), and it’s not going to be anywhere near that," he told AsianInvestor. "It’s going to be 2%-3% higher than inflation, which means 4%-5% returns."

Several experts argue that the global investing environment has been so distorted by quantitative easing that traditional portfolio modelling and monitoring methods have become virtually useless.

Research Affiliates, a Californian quant house, is one. It has just issued a paper suggesting that the 'risk-free rate', a central plank of investment practice, is no longer useful in the real world.

“The persistence of negative real interest rates across developed cash and government bond markets contradicts our conventional understanding of a risk-free rate,” wrote Chris Brightman, author of the report. “We must therefore abandon our assumption that a positive real risk-free rate of interest underpins the long-term returns of our investment portfolios."

Brightman suggested investors reposition their investments, both to avoid low to negative returns and to protect against long-term inflation.

“Investors should diversify away from government bonds and US equities into higher-yielding inflation-sensitive asset classes such as commodities, bank loans, high-yield bonds, Reits and emerging-market equities,” he noted.

Szondy agreed: "I think that’s dead right. People have been saying since the global financial crisis the world has changed, and now they are starting to realise this is really the case."

Australian funds have not been slow to diversify away from traditional assets. Szondy said many had 10% of assets under management invested in infrastructure and private equity. Some have much more.

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