Evolve lifecycle strategies to improve retirement outcomes for super fund members, says Parametric

Raewyn Williams

Lifecycle investing is becoming an increasingly valuable option for superannuation funds aiming to construct a long-term default asset allocation strategy for their members.

Research by the global specialist implementation manager Parametric shows that about 37% of total MySuper assets and 31 of the registered 111 MySuper products offer lifecycle investing. Although these assets and products sit predominantly in retail superannuation funds, there is growing interest among industry and corporate funds.

Tom Lee, Parametric Managing Director (Investment Strategy and Research) and Raewyn Williams Managing Director (Research, Australia) say lifecycle strategies operate on the uncontroversial premise that with increasing age, fund members have a lower appetite for risky assets in their portfolios.

“So, the fund gradually de-risks members’ portfolio. What starts as a reasonably high-risk portfolio (high allocation to growth assets like equities) ends up as a low-risk portfolio (high allocation to defensive assets like cash and fixed income) as the mix of assets becomes more defensive assets over time.”

“Differences in lifecycle approaches reflect nuances such as when the de-risking starts, how often it occurs and how graduated the asset allocation shifts are, but the essential principle of using age, or more precisely earnings lifecycle as a proxy for risk appetite, is the same.”

Lee and Williams argue that lifecycle strategies can be a powerful tool for many funds – and they can be sharpened further, especially regarding the use of asset classes. Their new research paper, “Defensive Equity: A Sharper Tool for your Lifecycle Toolkit”, contends that adding a defensive equity strategy to mitigate the “rather harsh” leap from equities to fixed income could deliver better absolute and risk-adjusted returns to retired members, including a higher income stream in retirement. [The defensive equity strategy Parametric uses in this analysis reduces volatility in a super fund’s equity portfolio while accessing a substitute source of income to replenish account balances.]

“These benefits are delivered while continuing to significantly de-risk the portfolio through time, with liquidity and transparency preserved in the portfolio.”
“Funds that add this sharper tool to their lifecycle portfolio take a crucial step toward genuinely addressing retirees’ ‘triangle of needs’ identified in the Financial Systems Inquiry —income, risk management and flexibility.”

The research compares a “classic” lifecycle portfolio that goes from 80% growth assets to 80% defensive assets over a 30-year period to a portfolio that also begins with 80% growth assets but substitutes a defensive equity strategy for some bonds. The research stress-tested the results to explore best and worst case scenarios and as well as the expected mean (most likely) outcomes across a range of portfolio attributes. The outcomes were modelled before fees but net of transaction costs.

“We explored two hypothetical lifecycle strategies for super fund members and our modelling led us to believe that, pre-fees, the portfolio using a defensive equity strategy could deliver higher total returns each year on average to members, indicated by an expected mean return of 6.72% annually to members, which is around 1% more than the classic lifecycle strategy expected mean return of 5.71%.”

“Using a defensive equity strategy in a lifecycle approach also produced an expected 18% higher annual income, based on our simulations, which is noteworthy given last week’s reaffirmation by the Government in the Federal Budget that new ‘CIPR’ retirement products must meet members’ income needs.”

Strikingly, Parametric’s research also showed the lifecycle portfolio using a defensive equity strategy to have not only better income and growth characteristics, but also better risk characteristics, measured by volatility and maximum drawdown.