An effective strategy against sequencing risk in superannuation

Stephen Richards

Stephen Richards

Ability Capital has demonstrated a new approach to tackling one of the most intractable problems facing superannuation investors in its white paper: The Search for El Dorado: New Strategies for Better Superannuation Outcomes.

The white paper shows how a new type of equities strategy offers an effective solution to the problem of sequencing risk, which is increasingly recognised as a major threat to super funds’ investment objectives and therefore the retirement outcomes of millions of workings Australians.

Sequencing risk is the risk that the timing and order of investment returns is unfavourable. The timing of returns can have a dramatic impact on super account balances, particularly for investors in the retirement phase who need to draw down on their savings.

Ability Capital CEO Stephen Richards said sequencing risk was overshadowed by threats like the GFC but could be much more devastating in the long term. “People approaching retirement are really facing a sequencing risk lottery,” he said.

An analysis in the paper shows that for super fund members, sequencing risk can result in a difference in account balances of up $1 million by aged 70, even though the average return for each member is very similar.

Mr Richards said it was widely recognised that investors needed to maintain a substantial exposure to equities in order to produce the kind of returns needed to fund a dignified retirement, but they also needed to be able to manage the risks.  “This is especially true if you consider that people are living longer and will increasingly need that exposure to growth assets to see them through their retirement,” he said.

The paper discusses a new variety of downside protection strategy for the Australian equities component of a portfolio that substantially reduces sequencing risk but without the prohibitive cost that undermines the effectiveness of other derivatives-based strategies.

The analysis finds that when such a strategy is appropriately implemented, a superannuation fund member would be more than four times as likely to achieve a $500,000 balance by age 70, assuming equities met their long term return assumptions. Even if equities experienced a prolonged period of low returns, the so-called “New Normal” future many believe we are facing, the investor was still more than twice as likely to reach $500,000 than if they adopted a passive equity strategy.

“The new approach in this paper gets us much closer to the investment ‘El Dorado’ of higher returns with low volatility and low sequencing risk,” Mr Richards said.

Ben Samild, Director of Alternatives and Fixed Interest at the Future Fund, said Ability Capital’s approach to downside protection was a real innovation.  “The strategy could be of be of great appeal not just to institutional superannuation portfolios but also to endowments, private ancillary funds and retail SMSFs if they can get access to it,” Mr Samild said.  “I see a lot of strategies every year and I really haven’t seen anything like it.”

This inexpensive downside protection strategy has been implemented in Ability Capital’s Turquoise Downside Protection Fund, recently awarded an “A” rating by leading investment research house van Eyk Research, which has also invested in the Fund through its Blueprint multi-manager series.

van Eyk CEO Mark Thomas said the Turquoise Fund had a compelling investment thesis – inexpensive and tax effective downside protection with an aligned fee structure. The strategy has delivered as expected and as promised.

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