When risk is ignored, eventually investors will have to pick up the tab when the next market downturn strikes.

Superannuation funds are ignoring the impact of risk on returns when we all know there is a clear link between increased risk and expected future return. Unfortunately, when risk is ignored, eventually investors will have to pick up the tab when the next market downturn strikes.

It’s happened before: the OECD estimates that Australian funds lost 21.6% as the global financial crisis routed the industry in 2008 and 2009. We know it prompted a significant number of older investors to switch investment options at the worst time while many, wanting greater control, switched to self-managed super funds.

Fast-forward eight years and little has changed. The industry’s distorted focus can be regularly found in monthly return tables and marketing based on performance. It is misleading: the GFC showed that risk matters.

Current risk measures are meaningless

Whether funds admit it or not, investors turn to super fund performance tables for an indication of the ‘best’ fund.

But the only measure of risk is a flawed proxy: a flexible label (such as balanced) based loosely on a fund’s asset allocation. As we explored recently, this hides significantly different portfolio construction approaches.

Some recent strong performers have had a near-zero allocation to cash and fixed income (replacing that ‘defensive’ exposure with infrastructure and other assets) while other funds have maintained a more traditional 30-40% allocation.

What’s more, we know that equity exposure is still the underlying driver of at least 90% of most balanced fund returns^[1]. There is no industry-wide accepted way to define the underlying risk (which is often equity risk) driving portfolio returns.

What funds do include in their product dashboards is the industry-developed Standard Risk Measure, which estimates the likely number of negative annual returns over a 20-year period.

However, it does not convey the magnitude of losses. For example, one year of -12.7% (as the average balanced fund posted in 2008-09) is far worse than two years of -1%. APRA has been encouraging the industry to develop alternative risk measures, according to a Productivity Commission submission.

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[1] The most cited paper on this topic is likely Brinson, Hood and Beebower (1986) but it is widely misunderstood. Their findings were that asset allocation accounted for more than 90% of return VARIABILITY, not 90% of returns. More recently, our colleague Michael Furey at Delta Research and Advisory tested the level of risk contribution equities provided to various multi-asset funds – for balanced it was indeed greater than 90% (click on link to his findings here).

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