Share on Facebook Share on Twitter Share on Reddit + - Tackle risk for super returns By Chris Becker in Special Reports, Superannuationat 8:48 am on November 16, 2011 | 27 comments Login to access MacroBusiness Members special reports. If you are not a member, sign up here. Please fill in the following form to login Username: Password: or Please fill in the following form to subscribe * Username * Email * Password Share on Facebook Share on Twitter Share on Reddit + - YOU MAY ALSO BE INTERESTED INLobbyists puke as compulsory superannuation in cross-hairsEarlier this year, the Productivity CommissionCoalition neuters retirement income reviewEarlier this year, the Productivity CommissionLabor's superannution flunkies demolished againLast week, Labor's policy thinktank, the McKellSuper life insurance reforms pass SenateThe Productivity Commission's landmark 500-plus Comments VirusMEMBER November 16, 2011 at 9:06 am I am an amateur investor (not sure you can call someone with 5k as an investor! :-)) Empire Investing website account is suspended! I was just getting a bit worried that you might have closed-shop? 🙂 The Prince November 16, 2011 at 10:21 am Hi Virus. I’m experiencing a delay in switching hosts on our website is all – should be back up in running in a day or two (this is what happens when you let a Mac guy play with computers) I’ll email our subscribers shortly – there’s been no change at Empire, we continue to outperform the market and provide absolute returns to our shareholders. VirusMEMBER November 16, 2011 at 9:08 am Oh, thanks btw for sharing your knowledge, it is quite informative for a financial-naive person like me 🙂 Jack November 16, 2011 at 9:28 am I find one of the biggest issues is for fund managers to be always fighting the last war. I once spoke to a fellow that manged westpac’s balanced fund for a bout 20 years. They spent the 80’s getting into Japan and up to benchmark, and got to where they wanted to be in 1989 and then spent the 90’s getting out of Japan. Also the fact that the balanced funds used to be 50% growth assets an 50% defensive but along the way particularly in during the great moderation that definition was warped. Janet November 16, 2011 at 9:48 am Cool! “…“speculative assets” and must not comprise more than 10% of your total portfolio…Typical examples include …real estate speculation (especially if negatively geared)”.I’ll bet in general it’s more likely to be >50% in spec real estate for many of our property ‘investor’ friends. And herein lies the seed of real disater for them. mentasm November 16, 2011 at 9:55 am Thanks for the great article. I’ve been waiting for this for ages. I’m so glad I’ve finally done pretty much what you are describing here. I took some heavy losses while my super was in the ‘Balanced’ option with my fund during the GFC. I hate that the fund managers are so flamboyant with the retirement money of the fund members. Capital security really should be the most important focus of their efforts, especially for a ‘balanced’ option. Ideally only the High Risk, High Return options should take a large hit through something like the GFC. I think I’ll be remaining on my safe options for a while to come. I can’t predict whats coming to the global economy over the next few years, but the outlook isn’t great from what I can see and understand. Alex Heyworth November 16, 2011 at 9:56 am Prince, I’ve always treated my indexed Commonwealth superannuation pension as being the equivalent of the investment part of my portfolio, given that it is guaranteed to (approximately) maintain the real value of payments. I assume, given your inclusion of annuities in that category above, that you would approve. However, annuities in general are in a slightly different category than other investments, in that they usually have no residual value. Their value to the recipient is that they can’t run out. The ideal retirement product, really, although very expensive. (How much would you have to pay for a $30k indexed annuity?) dam November 16, 2011 at 10:08 am so far my bonds did better than my shares, talk about risk reward crap. macros November 16, 2011 at 10:38 am Right. So how are those Greek, Irish, Portuguese, Spanish, Italian (and soon to be French) government bonds going? How about 1 year US treasuries? Massive yield of 0.09% right now. It is all relative and nothing is certain. Karan November 16, 2011 at 12:07 pm How about 1 year US treasuries? Massive yield of 0.09% right now. If this is your super, why are you in 1 year T-bills? Get a 10 or 20 year TIPS and you’ll be laughing. And as for the relativity: certainly, but 0.09% positive is far better than -10% you’re getting on the ASX 200 YTD. macros November 16, 2011 at 7:50 pm Karan, I don’t own bonds. My point was that those who are buying in at record low yields for fear of losses in equities/property are setting themselves up for further trouble. 0.09% positive better than -10%? Over what time period? 0.09% has only one way to go in terms of bond prices. Those seeking higher yields look for longer duration for a tiny bit more income. Bond markets can crash, just like equity markets. Dan November 16, 2011 at 10:39 am Great article prince. Thanks. Look forward to the next one. The equations were complex enough, but I always thought the theories in my Quant Finance classes at uni were a little thin on substance. That appears to be where it has all fallen apart… macros November 16, 2011 at 10:59 am Prince, I understand where you are coming from and in a normal world I would agree. You said: ““Investment” assets must have all of the following attributes, or they will fall into the “speculative” asset category: High or complete certainty of original capital return Known and calculated payoff in yield/earnings Zero or very low leverage preferably Provide at minimum same yield as government bond Zero risk, or known risk that can be adequately insured” I would argue that these assets do not exist and are pure imagination. The whole risk free asset concept is dead. Government backing it not risk free – at least in real terms. No assets can be adequately insured as counter-party risk exists and is significant – the whole concept that gross positions matter. There are no easy assets today: shares, property, bonds, cash – none of these assets are risk free. It all depends on government intervention – we do not have free markets. Therefore it is my view that all forms of investment today is pure speculation. If you are investing in cash for too long then you are speculating that the interest rate will exceed your loss of purchasing power (big ask). If you are investing in bonds you are speculating that they will a) be repaid in full and/or b) they will maintain purchasing power versus interest rates (again big ask). If you are investing in shares then you are speculating that the companies in which you invest will a) be able to grow, b) be able to maintain purchasing power, c) manage debt burdens and/or d) avoid government interventions. If you are investing in property you are speculating that the total system credit will continue to grow and/or that the real rates of return will maintain purchasing power. I don’t think that any of these decisions are easy. This is why buy and hold is dead. This is why it is required that all asset allocation positions must be managed over the time-frame in which it is deemed that they are appropriate. By time-frame I’m not referring to an individual’s time-frame, I’m referring to the outlook for that asset class. If you are an investor in the US and relying on an income stream to fund retirement. How would you go on <1% bonds? How do you manage higher yielding bond risk – aka MF Global? Essentially one must speculate on a particular outcome and split their bets based on the probability of outcomes. All asset types should be considered (all commodities including gold/agriculture) depending on the risk/reward over the next 6 months, 12 months, 2 years – to be honest, who knows how the world is going to look in 5 years?? I think all investments must be reviewed on a regular basis. On this basis, I think that the typical 'balanced' portfolio does not do the job (essentially they were designed on the back of the bull market starting from the 80s). I think that a true balanced portfolio should have a very diverse and broad asset base – something that is sorely lacking in the super industry. The Prince November 16, 2011 at 11:54 am I agree with the thrust of your argument Macros, in particular the time-frame allocation argument, and splitting your bets (allocation) on a probability of outcomes. That is basically how I trade for a living. Indeed, read my concept of the “amateur” and “professional” investor types – the latter would be able to comprehend your argument, but the former would be, for want of a better word, “sh#t-scared” and thus faces the greatest risk of all. Doing nothing, the second risk is retaining their super in “growth” or “balanced”. Philosophically I agree with you that all investing is really speculating, but its how the average investor in toto approaches this and systematically why we have almost no “investment” assets to choose from, and why the industry “invests” over 70% of our super into clearly speculative (i.e the Oz and Int’l stock markets) endeavours. There is no perfect solution, apart from each of us becoming traders, so I put this solution forward as an advancement of what has gone before. macros November 16, 2011 at 3:23 pm A solid response Prince. I think my emphasis is that regardless of perception, all asset types are speculative right now. The key should be the focus on effective investment strategy and management as opposed to a static asset allocation suited to buy & hold approach through a bull market. JC November 16, 2011 at 3:58 pm Buy and Hold isn’t dead if you’re holding period is 20-40 years. You’re argument about holding timeframes is a good one. However as an individual if you’re investing purely in equities history says it’s safer than cash, bonds or any asset class if you buy and hold for a long period of time, and re-invest dividends, and ideally don’t touch your capital. Many planners are forgetting this when they assign a lazy buy and hold strategy for a client who’s holding period is 10 years…..the whole timeframe could be a bear market and when they need to liquidate they lose money. The real problem atm is correlation. Virtually everything is moving in the same direction and trades are crowded. Alex Heyworth November 16, 2011 at 11:40 am There is one fundamental investment strategy that should underpin everyone’s approach, which I think you have missed. Probably the most basic of all. It is “spend less than your income”. If you only ever spend 80% of your income (from whatever source) you will always have plenty of money and will die rich, regardless of your detailed investment strategy. If you invest in more volatile things like shares, this will benefit you all the more as the 20% of income you reinvest each year will buy more shares when the market is depressed. Of course, that is also the flip side of recent poor super returns as well. If you are currently contributing, your contributions are buying more assets than they were five years ago. The Prince November 16, 2011 at 11:44 am I covered that in my “Master the markets and then yourself” article Alex. This is about allocating your super funds (and can be put to outside super investing with surplus funds). Alex Heyworth November 16, 2011 at 11:50 am So you did. Mea culpa. The Prince November 16, 2011 at 11:56 am I did have my list of articles at the top of the post, but we edited it to the bottom, so you must have missed it. I’ve been building up to this area, explaining the background to get here. I’m also exploring ways of making the MB archive easier to navigate. By Dog, there are some splendid articles from our bloggers buried deep in the archive, lots of educational based ones too. Hopefully we can clear this up a bit more on the MB 2.0 rollout (probably Jan to Mar next year). Tassie TomMEMBER November 16, 2011 at 12:44 pm Very, very good point. A few years ago people (some of which I knew and was envious of) were buying a house with a 99% loan, refinancing when its value had risen, and buying an investment property with their newfound deposit. Rent would pay for part of it, and the rest could be largely negative-geared, plus the value of both properties were rising. It appeared that by being “smart” one could circumvent the principle of needing to spend less than one earns to put some equity to your name. Not so many people talk about that strategy these days. On your final point – my contributions are buying more assets now that markets are depressed – good news for me (aged 33), bad news for my Mother who is retiring end of next year and still has money in a “balanced” fund because she doesn’t understand all this stuff. No point changing it now though – damage has been done. Velociraptor November 16, 2011 at 11:57 am Thats a great post. I’m going to print it and share with some colleagues who are getting crucified in their equity oriented super. JacksonMEMBER November 16, 2011 at 1:54 pm Prince, thanks for this. Did my own set of investigations on this, and came to a surprisingly similar conclusion – you need to, in all circumstances, never go backwards. This means a majority allocation in cash/fixed interest (ie > 70%). Once you’ve got this bedded down, you need exposure to the upside, so the remainder in what are classically ‘equities’. From my work on this (a massive set of Monte Carlo simulations for a range of scenarios ….. when I should have been doing the gardening), about a 70:30 split came out as the best for my circumstances (>20 years to retirement). I was already sleeping much better at night, thanks for the validation! macros November 16, 2011 at 3:38 pm Sorry Jackson, but I have to disagree with what you have said. Cash/fixed interest depends upon the timing and whether you are receiving a positive rate of interest after the loss of purchasing power. If it is negative then you are in trouble – the general aim of central banks is to gradually tax savers through a targeted rate of ‘inflation’. Also Monte Carlo simulations are almost irrelevant. The simulations are heavily reliant on assumptions which will probably turn out to be wrong. Averages, variances, probabilities do not solve the problem of achieving a solid rate of return over a given time period – this can only be done with an effective investment strategy or based on luck. I don’t like Monte Carlo in application to investment returns as it is like flipping a coin and doesn’t mean a lot in my view. With regards to equities, it completely depends on the investment strategy. You can do well in equities even in difficult times, but most investors don’t. The reason why this is the case is that most funds generally have index based returns. Index returns are fine in bull markets but are terrible the rest of the time. The crux of what I’m trying to say is that a X:X split is not a permanent solution. One split might be appropriate for this year, the opposite may be appropriate the following year, but there is no ‘magic’ number per se. So there are no easy solutions (I guess this is the norm?). The investing public in Australia (effectively everyone via Super) need to be much better educated and be prepared to adapt. The problem that I can see is that most people find it too hard and will invariably go with the ‘easiest’ or ‘safest’ solution. JacksonMEMBER November 16, 2011 at 4:44 pm Macros, all fair enough comments. Agree that set/forget at X:X is nuts, and I won’t be doing it. I wll be assessing it constantly, but the basic outcome was similar to the Prince’s. Any simulation (Monte Carloe or otherwise) is only as good as the assumptions behind it, the person doing the work, and what they use it for. It’s just a tool, if anyone believes in it without question then good luck to them. The whole reason I did it myself was I didn’t believe the genuine garbage being fed to me from elsewhere. No easy solutions? Absolutely. I made the mistake of believing paid professionals with lots of experience, and all that happened was my super went nowhere for 5 years. I just happened to get angry enough to do something about it! Regarding the education of people, I think we need to start with every accountant and financial adviser out there first, before worrying about everyone else. They have the potential to wreak far more havoc. macros November 16, 2011 at 7:53 pm Jackson, “Regarding the education of people, I think we need to start with every accountant and financial adviser out there first, before worrying about everyone else. They have the potential to wreak far more havoc.” Couldn’t agree more. Many professionals don’t seem to know a lot more than the average investor. Perhaps false confidence makes them even worse. monsieurbarso November 16, 2011 at 8:31 pm Many fund managers probably are stuck in a paradigm they can’t get out of, but I would be interested to see how your proposed allocation approach would have fared for say, the 15 years to 2007. I suspect institutional money managers with balanced fund mandates taking a similar approach would have faced massive pressure on their business from those running with allocations heavily weighted to equities, unlisted assets and absolute return (speculative) strategies. They would be looking like heroes today to be sure, but they still had a business to run for those other 15 years.