Franking credits, also known as imputation credits, are a type of tax credit that allows Australian companies to pass on a credit for tax paid at the company level to shareholders.  For an individual investor, the benefit is that these franking credits can be used to reduce income tax paid on dividends received, or may potentially be received as a tax refund.

The benefits extend to large institutional investors like superannuation funds and charities, many of whom are looking to adopt ‘smart beta’ strategies to enhance yield.  “Superannuation funds and many other institutional investors in Australia should be thinking about the difference between introducing a standard yield tilt and a franking-aware yield tilt into their passive Australian equities portfolio,” she said.

Ms. Williams said that Parametric’s focus on showing the value of active tax management across the spectrum of passive, smart beta, systematic alpha and full active portfolios led them to create a simple strategy to demonstrate the potential ways in which the cash-convertible nature of franking credits may assist superannuation funds in their search for yield.

Comparing a smart beta franking-aware strategy to a more typical tax-unaware strategy at a recent industry event Williams commented, “While no strategy can be guaranteed to work, research shows that over the past decade, accumulation-phase superannuation portfolios could have earned significant additional after-tax returns from franking by investing in the franking plus yield smart beta strategy.”

According to Williams, the Parametric analysis suggests there are three basic types of ‘smart beta’ superannuation fund investors:

• A passive investor seeking return enhancements.  A franking-aware smart beta strategy could help generate the additional yield the investor is seeking, but the investor would need to tolerate potentially significant tracking error (or deviations) from a standard market-capitalisation weighted index.
• An active investor dialing down active exposure in order to reduce fees.  Such a strategy could look particularly good to these investors, as they will be accustomed to tracking error against the index.
• An active investor dialing down active exposure to embrace a more passive investment philosophy.  A smart beta strategy of this type may not achieve this type of investor’s desired objective of dialing down active risk, as it comes with many ‘active’ systematic bets.

“Our analysis has additional relevance for larger superannuation funds considering a segregation of their equity portfolios into separate accumulation and pension pools, given the extra importance of yield and franking to pension investors.”

“We presented our research findings for both a 15 percent taxed superannuation accumulation portfolio and a tax-exempt pension portfolio, allowing a large fund to compare the relative value of this type of strategy separately for their accumulation members and pension members.”

“We also measured the results on a risk-adjusted basis to better capture the risk-return trade-offs of adding franking-awareness to a yield strategy. Over the timeframe we analysed, we showed that although the franking credits are not a ‘free lunch’, for both accumulation and pension portfolios, they can be viewed as a good deal, relative to extra risk required to access them.”

Seattle-based Parametric Portfolio Associates LLC is a subsidiary of Eaton Vance Corp. and has 25 years of experience offering tax-managed investment solutions to U.S. retail investors. Since 2012, Parametric has been working with Australian institutional investors to explore ways to trade more effectively and efficiently.

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Craig Keary

With less than six weeks to go until the New Year, AMP Capital is encouraging customers to consider their finances when setting their resolutions for 2015.

AMP Capital Head of Retail and Corporate Business Craig Keary said: “Health and fitness resolutions are popular as are intentions to”save more” or”pay down debt”. While these are all worthy pledges, we”d like to see people set more specific resolutions to grow their wealth during the year.

“Consider a resolution to contribute more to superannuation or commit to undergoing a New Year health check of your finances to ensure your investments are meeting your needs, you”ve got the best rate on your mortgage and you have enough insurance. Challenge your children to develop good saving patterns in 2015 or resolve to invest some time towards better educating yourself about saving and investing.

“Above all, setting a clear goal is critical for the success of any resolution and talking about your goal with others can help ensure you will actually follow through on your promise.”

Here are AMP Capital”s top eight New Year”s resolutions for a wealthy 2015

1. Set goals. The best thing you can do when setting your financial New Year”s resolutions is to start with what you want to achieve by the end of the year. Then adjust your budget or behaviour accordingly in order to meet that goal. For example, your goal may be to go on an overseas trip in a year”s time. Therefore, your action could be to save an extra amount from your budget each week or to make an investment that will give you a level of income during the next 12 months to ensure you have enough money at the end of the period to pay for your holiday.

2. Talk about your goals. Our experience suggests that people who talk about their goals and resolutions are more likely to achieve them. Share your key resolutions or goals with someone you trust and respect and check in with them regularly throughout the year to let them know how you”re going.

3. Don”t ignore your financial health. Many people resolve to run the rule over their health at the start of each year. Do the same over your finances and undergo a financial health check. Review your spending patterns to see where you can save more money; commit to saving a certain amount each month; if you have a term deposit, look other investments such as corporate bonds that might give you a better return while interest rates are low; conversely, check your mortgage rate to make sure you”re getting the best deal; and review your insurance to be confident you and your family have enough cover in case things go wrong. Consider making an appointment with a financial adviser to really put your finances through their paces.

4. Save more in your superannuation. Don”t just commit to saving more for a rainy day. Commit to contributing a little extra to your superannuation in 2015 so you have more money come rain, hail or shine in the years to come. Through the power of compound interest, adding extra dollars to your superannuation now will mean having so much more to fund your lifestyle when you retire. The New Year is also a good opportunity to review your investment options so that you have the appropriate mix of growth and defensive assets in your portfolio for your stage in life and in line with your goals.

5. Challenge your children. If you have children, endeavour to improve their financial literacy and start them on the path of saving early. Encourage them to set their own financial goals and help them map out a plan to reach them, then reward them when they do. After all, the savvier your kids are about money now, the more it will help you down the track!

6. Invest in yourself and read widely. Financial education is becoming more accessible and investing in yourself, even if it”s just making time to learn more, is one of the best ways to help you achieve your financial goals. There is a lot of valuable information available online (often for free) as well as offline for your benefit. So consider adding a few wealth management websites, blogs and books to your holiday reading.

7. Don”t leave it too late. If you have big long-term goals that require a lot of money, don”t wait a couple of years to start working towards them. For example, if you would like to retire at a certain age, your resolutions should include determining how much you need to contribute to superannuation and then understanding what investment strategy you should have in place. Seeking the assistance of a financial adviser may be appropriate.

8. Have fun! It”s not all about saving money now to only spend it when you”re older. Make sure you include some fun or satisfying short-term goals in the mix to reward your good behaviour and keep you motivated to achieve your longer-term goals.

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Peter Lambert

Local Government Super (LGS) has reaffirmed its strong commitment to responsible and sustainable investing by enhancing its ‘negative screening’ approach to combat the future impact of climate change on its portfolios.

The latest changes to the already comprehensive and well-established LGS negative screen methodology incorporates an additional screen to exclude companies with a material exposure to ‘high carbon sensitive’ activities such as coal and tar sands mining, as well as coal-fired electricity generators. The threshold for this ‘high carbon sensitive’ negative screen has been set at a minimum of one third of company revenue.

According to Peter Lambert, LGS Chief Executive Officer, this decision was driven by the understanding that this sector will be adversely affected from an investment perspective by the likely transition to a lower carbon economy as governments respond to the increasing threat of climate change.

“Climate change is an unarguable scientific reality and one which poses a very real investment risk. Governments around the world have begun to act on climate change, which is having a negative impact on the future outlook for the coal industry. This focus will likely continue as coal companies become increasingly difficult to be relied on as a low-cost energy source,” Mr Lambert said.

“Coal and oil sands are the most carbon intensive forms of energy and most susceptible to carbon regulatory risks. With trends such as competitive pressures in the coal industry, concerns in China over pollution and water, and the introduction of energy and carbon efficiency standards on the utilities sector in the US indicating a shift away from a high carbon to a lower carbon economy, we believe that support for these sectors will decrease as will shareholder value.”

“In moving away from high carbon investments, we are supporting environmental and economic alternatives to investing in these sectors.”

“At the same time while the use of renewable energy will increase, it will not be able to meet all the energy needs around the world in a lower carbon future, so alternatives need to be considered. Because of this we have decided to remove the nuclear energy screen from our list of excluded industries, as we believe nuclear energy is increasingly becoming a viable, low carbon emitting energy source globally.”

“Nuclear energy is currently the only proven alternative to fossil fuels that provides baseload power capacity, so outright exclusion of nuclear energy directly conflicts with our view on the importance of reducing our reliance on high carbon energy sources.”

Local Government Super’s ‘negative screening’ approach has been applied and regularly reviewed since its inception in 2000. It is designed to actively screen out investment in tobacco, gambling, armaments and old growth forests, as well as excluding companies with poor management of environment, social and governance (ESG) risks.

Additional recent changes to LGS’ ‘negative screening’ approach include:

• removing the revenue threshold (to a zero threshold) for ‘controversial weapons’ (e.g. land mines and cluster bombs) and tobacco
• clarifying the definition of an excluded activity to that of manufacture and production only.

The changes to LGS’ ‘negative screening’ approach were approved by the LGS Board and are being implemented immediately. The approach is reviewed regularly and updated when required.

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Andrew Bragg

The first report on MySuper performance and fees released by APRA yesterday is a game changer for the way superannuation is reported, the Financial Services Council said.

Andrew Bragg, FSC Director of Policy said: “For the first time, Australians have APRA data which directly compares the fees and performance of MySuper products.”

“As of yesterday, APRA is showing true ‘apple with apple’ comparisons.”

“APRA data shows FSC members’ funds have outperformed industry funds since MySuper started in January 2014.”

FSC members’ funds averaged net returns of 3.4  per cent compared to industry funds at 3.18 per cent since the commencement of MySuper.

“This is evidence that MySuper is delivering both transparent, comparable information and lower fees,” Mr Bragg said.

“This is good news for 70% of working Australians who do not choose a superannuation fund.”

Mr Bragg said:  “Fees can be further reduced if the industry fund-dominated default superannuation market is opened up to competition.”

“MySuper has been a game changer for the default superannuation market.”

“Industry funds are now more expensive and offer lower returns than FSC member funds, but maintain a monopoly on default contributions through the Fair Work Commission process.

“While the FWC process continues, millions of Australians will be missing out on the benefit of lower fees and higher return MySuper products offered by FSC members ,” he said.

“Superannuation is a long term investment. This is why fees and performance are important.”

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Mark Rantall

The 14^th annual Financial Planning Week (FP Week) wrapped up this week, and has revealed that Australians are most concerned about retirement, home loans, superannuation and the best way to invest their hard earned savings.

The results of the campaign, run by the Financial Planning Association of Australia (FPA), have also shown that Australians aged between 20 and 35, are particularly interested in ‘quick fix’ tips to help them get ahead and make the most of any surplus income before they incur long-term debt.

Not surprisingly, people aged 50+ were the most engaged in FP Week, seeking out content that explained how they can prepare for retirement and also maximise retirement income.

Mark Rantall, CEO of the FPA, reflected on the campaign: “The aim of FP Week has always been to show the value of advice and demonstrate to Australians that qualified, professional advice can help secure their financial future and also help with short term goals.

“The financial planning profession has been in the spotlight recently, and education announcements made during FP Week by large financial institutions are another win for consumers because they will ultimately result in better protection and quality of advice. When people go and see a planner, they have a right to trust the person they see.”

One way the FPA seeks to demonstrate the benefits of good advice is through its Ask an Expert forum, Run by the FPA during its annual FP Week and Ask an Expert campaigns, Ask an Expert is a free service that allows people to submit a question about their finances to an FPA member.

“Over 20,000 people viewed our Ask an Expert forum this year, a 100% increase when compared to last year’s campaign, which shows there is a growing appetite and awareness of advice in Australia.

“As well as encouraging people to use this service, we also ran a consumer blog throughout FP Week that focused on different demographic groups and provided targeted and relevant content for each.

“Based on the visitor traffic to our blog, we can see that the piece about getting ahead in your 20s and 30s was most popular. Often we assume that people that fit into this demographic aren’t actively looking to manage their finances but FP Week has revealed that their appetite for advice isn’t much different from the retirement age group,” Mr Rantall explained.

Nearly 7,000 people viewed the FPA’s Find a Planner directory during FP Week to search for a qualified financial planner in their area.

“For 14 years, the goal of FP Week has been to show Australians the positive impact that qualified advice can have, and also encourage them to seek personal advice of their own. It is encouraging to see Australians using our directory to find a member of our association that can help with their finances.

“We want to thank those members who have contributed to the success of this year’s Financial Planning Week by contributing to the blog and Ask an Expert forum. We represent a community of professionals that is passionate about improving the lives of their clients through qualified financial advice, not only during FP Week, but ongoing,” Mr Rantall said.

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Melissa Fuller

Leading consultants to the financial services and superannuation sector Rice Warner has outlined the scale of the retirement incomes bulge facing Australia’s ageing population, its policymakers, superannuation funds and product manufacturers.

The next 15 years will see more Australians leaving or winding down from the workforce than entering it. On Rice Warner analysis, Australia’s ageing nation will comprise two million men and 2.3 million women in retirement drawing a pension from their superannuation savings by 2029.

This represents a shift to around 40 per cent (or $1.3 trillion – in 2014 dollars) of Australia’s retirement savings assets being converted to some form of retirement income stream. Currently that number sits at 30 per cent (or $492 billion of total superannuation assets) in today’s dollars.

At a personal level, many retirees will not have adequate savings for their retirement. Rice Warner’s latest Retirement Savings Gap research, commissioned by the Financial Services Council, measured (at 30 June 2013) a $727 billion savings gap. This is $67,000 per person less than the amount required for an ‘adequate’ retirement, which would pay retirees up to their life expectancy (more than 20 years).

Compounding this issue is longevity risk: half of Australia’s retirees will live well beyond their life expectancy age.

“It’s great we are all living longer, but the fact is too many retirees will simply run out of money and be forced back on the Age Pension,” said Rice Warner CEO Michael Rice, who has led Rice Warner’s many contributions to the Abbott government’s Financial System Inquiry (FSI), chaired by Mr David Murray.

The FSI’s recent interim report specifically mentions the issue of retirement savings policy, calling for solutions to the problem. “The picture of Australia’s retirement demographic ‘bulge’ is not new. But new ways are needed to address the underlying problems of adequacy, funding and product design – even the fundamental need to deliver people more choice, greater dignity and a better standard of living in retirement,” Mr Rice
said.

“The problem represents a looming challenge requiring a comprehensive range of solutions from industry and government. Our own investigations show today there is not one Australian superannuation fund provider that has in place the right default retirement incomes package to meet the wave of retirees preparing to shift their super into pensions,” he said.

The Rice Warner Retirement Incomes Solution

Mr Rice said the current default option of the superannuation industry is to treat retirement income as handing over a lump sum payment to members when they retire.

“Superannuation fund members are currently given no default option for managing this lump sum. We believe there are better ways to approach this, and have devised what we think is the first comprehensive solution,” Mr Rice said.

Melissa Fuller, deputy CEO, Rice Warner and a leading advocate for the unique retirement savings needs of women in Australia, said the great anomaly is that Australia has a world class retirement savings system but “lags when it comes to an effective and comprehensive retirement incomes system.”

Ms Fuller said the Rice Warner Retirement Incomes Solution, which effectively takes into account the needs of members through the various phases of retirement, provides a comprehensive alternative.

“Rice Warner believes the essential solution is to separate the money needed for any lump sum at retirement and to invest the balance long-term to provide inflation and longevity protection,” Ms Fuller said.

“The account-based pension is converted to a distributing trust so members can derive income from stable fund earnings (and any tax refund from franking credits). Meanwhile, the capital would be projected to grow steadily in real terms. The risk of market volatility impacting the underlying assets is also reduced as the member is not spending his or her capital.

“We’ve received keen interest from some leading superannuation funds about implementing the Rice Warner Retirement Incomes Solution,” she said.

“Our thinking is based on many years of data and insight in this sector, and draws upon numerous submissions, research reports and intellectual property invested by our firm on behalf of clients and various government and independent inquiries held during that time,” she said.

‘We look forward to continuing our contribution to the debate in Australia, particularly as these issues become ever more prevalent in the future planning for the national interest.”

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Over the past few years, more thought has been given to retirement income strategies, but the market is still relatively immature in terms of solutions available. Now, Australia’s ageing population and increasing life expectancies are bringing the post-retirement market to the forefront.

Click here to read the full report from PIMCO.

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Wade Matterson

With a growing trend both globally and in Australia around low volatility, managed volatility, and portfolio risk management strategies, it is imperative that advisors and research consultants explore each strategy to uncover how different risks are being addressed. Identifying those techniques that are robust and able to address both diversifiable and systematic risks is likely to provide better overall results for investors and fund members.

Traditionally, portfolio construction and diversification across asset classes has been the major focus of risk management for the asset management industry. However, as the global financial crisis (GFC) highlighted, diversification alone cannot provide adequate protection in highly stressed markets. During the GFC, balanced and conservative portfolios experienced significant drawdowns, with some falling by more than 25%. This acutely highlighted the Risk Tolerance Paradox faced by investors approaching and entering retirement: Risk levels expected by investors over the long term are rarely the same as the risk levels they experience over shorter periods.

Historically, the industry’s preferred approach to overcoming portfolio volatility and large portfolio losses has been to stay invested, ride out the storm, average down, keep investing, and eventually growth will return and damage to the portfolio will be repaired. While this still holds true for the young, who have substantial time left before retirement, it may not be practical or realistic for those near retirement or already retired. As demonstrated during the depths of the GFC, many fund members acted against these principles and realised losses at the worst possible time.

The other traditional answer for those near or in retirement has been to de-risk the portfolio by reducing exposures to growth assets — an approach which has been reflected in the increased adoption of life cycle strategies. However, as retirees live longer and interest rates remain at historically low levels, life cycle or annuity solutions may lock in low levels of income or create a higher likelihood of exhausting savings early in retirement. Given current global market conditions and increases in average life expectancies, the answer will most probably include an element of continued exposure to growth, albeit with some explicit ‘managed risk’ or ‘managed volatility’ approach.

Wade Matterson of Milliman Australia stated: ‘With large demographic shifts well underway in the developed world, including Australia, investment strategies focused upon retirement are starting to resonate with local industry and retail funds. The growing issues of balancing longevity risk with the risk of permanent capital loss have continued to grow in importance for most of our clients.

‘Following several years of preoccupation with FOFA and MySuper, we have begun to see a strong increase in demand for retirement solutions that address key issues around risk management and retirement.

‘Our work with Plato Investment Management, who recently launched a Managed Risk Income Fund and Maritime Super, highlights the momentum that is building in the industry and the increased appetite to create solutions which address some of these issues.’

In a new Risk Tolerance Paradox paper published by Milliman, we explore the main reason for this paradox, and introduce a risk management strategy that seeks to solve the problem.

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John Brogden

The selection process by the Fair Work Commission (FWC) for default superannuation funds under Modern Awards will cost superannuation fund members a staggering $400 million if it is allowed to proceed.

Laws put in place by the previous Federal Government require the FWC to assess all MySuper products that apply to receive default contributions and then replace every single fund in every Modern Award.  As early as 1 January 2015, each Modern Award must have from two to 15 default MySuper products.

New research by Rafe Consulting for the Financial Services Council shows the superannuation arrangements of at least 2.25 million working Australians and 100,000 employers will be thrown into turmoil if the Fair Work Commission is allowed to complete its review of default superannuation terms in awards.

It is the first research to analyse the systemic risks that superannuation members and employers face if the FWC process is not reformed.

Rafe estimates this will cost consumers and employers a massive $400 million due to duplication of fees, insurance premiums and employer search costs.

He says within two years fund members would be $150 out of pocket due to the cost of duplication of fees and premiums. Additional costs which will have no benefits for consumers. Costs which undermine years of reform aimed at stripping unnecessary expense from superannuation.

John Brogden, CEO of the FSC said: “The default superannuation system needs to be reformed as a matter of urgency.”

“The consequences of not making reform are far-reaching,” he said.

“These unnecessary costs to employers and employees may be incurred as early as 1 January 2015 unless the Government acts to reform the process before the FWC review is completed.”

The Financial System Inquiry interim report released last week made a point of commenting on this issue. It observed that “the selection of default funds in awards largely reflects precedent and is not subject to a competitive process.”

In the broader context, the Murray Review focused on driving costs lower to increase the adequacy of Australia’s retirement savings.

Chant West data released this week demonstrates that FSC members have outperformed industry funds over the last three and  five years. Opening up the default market to competition will enable more Australians to enjoy the benefits of their outperformance, forcing industry funds to lift their game.

“Superannuation funds that offer competitive products and provide good service to their members have nothing to fear from competition.

Mr Brogden also said: “The closed shop of default superannuation is a risk not just for individuals who will have lower savings in retirement as a result of less competition, but for the Government which will ultimately bare the cost of lower fund balances in retirement through paying more in Age Pensions.”

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Christine Hornery

Financial planner Christine Hornery, CFP, Director of FMS Group says the new higher contributions caps for superannuation which took effect from 1 July 2014, are not high enough for people who spend prolonged periods of time out of the workforce and is calling for the introduction of a ‘catch-up’ concessional (before-tax) contributions cap to help these people accelerate their superannuation balances.

“Many women and some men leave their jobs to raise families, sometimes for a prolonged period of time and therefore may not receive superannuation guarantee contributions for many years,” she says. “Even when they return to work, they cannot have concessional contributions made to their superannuation accounts beyond the new annual $30,000 cap, or $35,000 if they are aged over 49.”

Ms Hornery says a special ‘catch-up’ concessional contributions cap, that allows people who have spent a significant period of time out of the workforce to receive concessional contributions beyond the current caps may help them build bigger superannuation account balances faster.

“If a person takes say 10 years out of the workforce, then for 10 years that person usually has no money going into their superannuation account at all,” she says. “Currently, there is no provision for these people to ‘catch up’ once they return to work. They are caught under the same concessional, and for that matter non-concessional, contribution limits as a person who has spent a lifetime in the workforce.”

Generally speaking, non-concessional contributions are contributions made from after-tax income. “People can make non-concessional contributions to their superannuation up to a new, higher cap of $180,000 per year, however, where these contributions do come from after tax income, they are not as tax effective as when they come from before tax income,” she says. “People starting from so far behind the eight ball need as much favourable tax treatment as possible – which is why they need a higher concessional contributions cap.”

Last month, Ms Hornery highlighted disturbing statistics published in the Association of Superannuation Funds of Australia (ASFA)’s March 2014 update on the level and distribution of retirement savings which reported that more than a third of all women and around 60 per cent of those aged between 65 to 69 say they have no superannuation whatsoever.

“It is appalling that as a country we know this, we know it is an ongoing problem and yet we are doing nothing to address it,” she says. “We need to be putting in place initiatives to encourage women, particularly those who have spent a long time out of the workplace, to place as much as they possibly can in superannuation for retirement and, given the huge burden these people are likely to become on Centrelink when they retire if we don’t, we need to do it now.”

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