Future-proof your super

Is your superannuation account protected against another GFC?
 
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01 .Lessons of history

Protect your super

Did your superannuation go along for the ride when the S&P ASX 200 fell 40% between March 2008 and 2009? There has been some recovery, but super accounts are still well down from the pre-GFC highs of 2007. 

Now, with the Euro zone and US economy both looking shaky, what's left of your super nest egg may once again be out on a limb. 

In this report you'll find information on:

We also interviewed superannuation expert Jeremy Cooper and you'll find his insights here as well.

For more information about Superannuation, see Investing.

Retirees at risk

The times are especially dangerous for people who have recently retired or are about to, according to Jeremy Cooper. CHOICE recently sat down with Cooper, who headed up the 2009-2010 study on behalf of government that became known as the Cooper Review, to talk about what he calls a “fundamental flaw” in the super system.

The problem isn’t hard to identify. Instead of reducing risk during the crucial period five years before and after retirement – which Cooper calls the “retirement risk zone” -  most super accounts remain overly exposed to fickle share markets. 

“If we go over a cliff like we did during the GFC, there’s nothing much people can do,” he says.CH0212_Superannuation-diagram_WEB

The portfolio imbalance across the retirement risk zone – when the investment strategy should be defensive rather than accumulative – is “a piece of unfinished business” that has yet to be addressed by the super industry. 

Cooper argues that having close to 70% of your assets tied to share market movements when you’re looking to retire makes older Australians uniquely vulnerable to financial calamity.

Shaky track record

The super system has not served Australians well lately. According to numbers released in July last year by the Organisation for Economic Co-operation and Development (OECD), Australian super funds were the third-worst performing retirement funds among the more than 30 member countries from 2008 to 2010 – only Portugal and Estonia did worse. 

Global consulting firm Towers Watson also pointed out in July last year that very few Australian super funds significantly reduce exposure to the share markets while shifting from accumulation to the drawdown/pension phase, with the average proportion invested in equities dropping from about 74% to 67%. And it turns out our super funds have the highest exposure to share markets among all OECD countries.

To be fair, keeping accounts in accumulation mode right up to retirement has seemed like a good idea given the overall gains in the markets from the early 1980s up until the arrival of the GFC in late 2007. But Cooper says the thinking has not kept pace with the shifting realities of global economics. 

“The problem is systemic, and the industry’s really caught in the headlights on this one. More than any other country in the world, we have forced risk on our retirees and near-retirees.”

Case in point

Exhibit A for Cooper is one of Australia’s most popular types of post-retirement product, the account-based pension plans into which many super accounts are rolled. Drawdown requirements mean account holders must withdraw a certain amount every year to stay compliant with government rules, but for the past five years in a row Canberra has stepped in to decrease the amount because retirees have been faced with the prospect of selling assets worth a lot less than when they were purchased. According to Cooper, it’s an all-too-familiar phenomenon.

Locking in losses also happens when you switch to a safer portfolio too late. “You’re just cementing your problems if you switch the balance of your account to fixed-interest products once the losses have been realised,” says Cooper. Not only has your account’s earning power been hobbled, but retirees are using up four or five per cent of the account annually, usually without any money coming in. 

“The sort of returns you would need just can’t be realised.” But those in the retirement risk zone don’t have the luxury of waiting it out. With the world economy looking more treacherous than ever, Cooper maintains that baby boomers should look at trading the hope of recovery for the certainty of fixed-income products.

 
 

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The Australian economy held up far better through the GFC than the economies of other developed countries, but at the height of the crisis shareholders in Australia were hurt as badly as shareholders in the US, UK, Japan, Germany and France. 

Lingering GFC hangoverSuperannuation stats

The impact on super accounts during the GFC depended on how exposed they were to the share markets. 

According to an analysis by super industry research firm Chant West, the median loss for what are generally referred to as “balanced” funds – the asset allocation for most default funds – was 17.5% between March 2008 and 2009.

Jeremy Cooper is not alone in sounding a warning. Associate professor Hazel Bateman, who directs the Centre for Pensions and Superannuation at the University of NSW, laid out a convincing case that Australians approaching retirement are sitting ducks for deep and lasting market drop-offs in her late-2009 paperRetirement Incomes in Australia in the Wake of the Global Financial Crisis

She said workers aged between 30 and 40 would need to save as much as two per cent extra every year until retirement to make up for the losses that occurred between 2007 and 2009. 

But these generation Xers have time to increase their incomes and rethink expenses. 

According to Bateman, baby boomers are in a much tighter spot and need to either “increase their contribution rate or delay retirement to make up for their losses”. The needed increase would be substantial. 

“A retirement saver aged 49 before the crisis would need to contribute almost 19% of earnings each year, or more than double the mandatory rate, between the ages of 51 and 60 to catch up. If you were 55 you would need to contribute about 34% of earnings each year between the ages of 57 and 60 to catch up.”

However, at least one major fund manager has warned against reacting after the markets have moved. Australian Super members who switched to more conservative investment options when the S&P ASX 300 hit a 60-year low in March 2009 missed out on the comeback as the markets recovered and rose about 35% by mid-June, according to an analysis by the company. 

But older Australians would have done better had they avoided the loss in the first place.

Storm cloudCooper’s message is that Australians in the retirement risk zone should move more assets into investments that return, say, six per cent a year instead of the eight or nine per cent the share markets can offer when times are good.

Taking action

Playing it safe means reallocating toward fixed-interest products such as bonds or term deposits. But switching may not be easy. “When you’re in a fund you’re more or less beholden to what the fund manager is doing,” Cooper says. He recommends talking to a trusted financial adviser.

Cooper is currently chairman of the retirement income division of Challenger, an investment management firm specialising in “guaranteed return products”. 

The firm ran a marketing campaign late last year promising to future-proof retirement accounts by shifting allocations away from shares in favour of annuities. It mainly targeted self-managed super accounts and retirees, but Cooper says it’s always a good time to protect your assets, especially if share markets appear to be on the brink of meltdown.

Cooper maintains that super fund members of any age can benefit from parking their money in safer havens during risky times, but such a move requires a hands-on approach. At a minimum, review the level of risk in your account and discuss safer options with your fund manager, whether or not you decide it’s time to reduce risk.

Hopes for MySuper

Cooper sees the potential for positive change in the Australian superannuation system with the introduction of new MySuper accounts in July next year. If the default accounts are designed as they should be, he says “you will be automatically de-risked when you reach the retirement risk zone”. 

But the prospect of upheaval in the super industry remains iffy. It’s a gargantuan beast that’s mightily resistant to change, Cooper maintains, and government can’t press any magic buttons. “There’s going to have to be some profound rethinking of a system that’s remained virtually unchanged in its approach to risk since its inception.”

Despite the lessons of the GFC, taking a more conservative investment position at any life stage goes against the grain of conventional wisdom in the super industry, Cooper says. “The whole crowd of professional opinion would be against it.”

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