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.

———

[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).

The post It’s time to include risk measures alongside super fund investment returns appeared first on AdviserVoice.

Lindsay Garnock

Financial advisors are engaged in a battle on behalf of their clients. It is a battle to generate enough income for a comfortable retirement.

That might seem strange given cost of living increases have been subdued over the last decade however, the collapse in the interest available on bank accounts or other “safe” investments, combined with cost increases in key areas like health and utilities, have forced advisors to look for other solutions for stable and sustainable income.

With the current economic environment characterised by low inflation, low growth and low interest rates, investors are looking to better diversify their income streams. For advisors this new reality presents both challenges and opportunities. As their clients look to build retirement income streams, advisors are moving away from low yielding cash and fixed income investments and this has significant consequences for risk management. But the move isn’t only away from defensive assets.

The past 12 months haven’t been so positive for some of Australia’s high income yielding stocks with the local market’s heavy reliance on resources and banks never been more apparent. As a result, the attitude of investors towards global equities has changed over the past 2-3 years as the breadth of opportunities for building income streams from offshore investments is realised.

Advisors are having to educate their clients about the benefits of supplementing their current income stream with global equities. This includes sectors that aren’t broadly available in Australia such as healthcare, utilities and staples. Exchange traded funds (ETFs) that follow income “rules” are one method advisors have been using to access these income opportunities offshore.

These rules are designed to increase portfolio yield while avoiding some common dividend traps. For example, the rules for the SPDR’s S&P Global Dividend Fund (WDIV) require each company to have had stable or consistent dividends over a ten year period. At the same time, stocks that have a yield above 10% are excluded – extreme yields at this level usually occur because of a sudden price collapse rather than strong profits or dividends.

Advisors are still seeing a home bias to local equities due to franking credits but there is definitely a place for global equities in an income portfolio. A global equity portfolio, such as the WDIV ETF, is able to generate surprisingly high yields without resorting to concentrated stock weights. Recent equity yields 5% pa have been achieved while holding 100 stocks – a significant boost on more traditional global equity portfolio yields of 2-3%.

———-

Commentary from a recent webinar ‘The Search for Income: Time for a New Approach’ held by State Street Global Advisors moderated by Michael Furey, Managing Director of Delta Research & Advisory, with guest presenter Lindsay Garnock, Director and Senior Financial Advisor with Boyce Financial Services alongside Jonathan Shead, Head of Portfolio Strategists, State Street Global Advisors Asia Pacific.

The post When it comes to income, the goal posts have changed appeared first on AdviserVoice.