Funds must adjust return assumptions to reflect reality

Actuarial research house, Rice Warner, has questioned whether the continuing low interest rate environment has spelled the time for superannuation funds to change their return settings.

In an analysis published by the company this week, the company has asked whether widely used targets for balanced (default) portfolios to exceed the consumer price index (CPI) by three per cent to four per cent a year over a rolling 10-year average are still achievable.

It then asked whether funds should make fundamental changes both to their asset allocations and their investment targets.

According to Rice Warner, the reality confronting many superannuation funds was that they were using performance targets for their MySuper strategies that were set before the global financial crisis (GFC).

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"Yet, since then, central banks have stimulated their economies through quantitative easing, creating enormous liquidity and historically low interest rates. Consequently, the expected investment returns on asset classes and the correlation between classes have changed," the analysis said.

It said all real assets were now priced on the assumption that long-term yields will stay low for extended periods, with yields on infrastructure investments having reduced from above 12 per cent to eight per cent in four years and with some Australian prime CBD property having sold at gross yields below six per cent.

"Over the past four years, leading asset consultants and other investment professionals surveyed annually by Rice Warner have significantly lowered their median expectations for annual returns over the next 10 years in each of the traditional asset classes, namely Australian and international equities, property, fixed interest and cash. The biggest reductions in long-term return expectations since 2012 are, not surprisingly, in fixed interest and cash," the analysis said.

The analysis suggested there were highly practical ways for superannuation funds to meet their asset allocation challenges to keep their real returns as high as possible in a low interest era, given their members' circumstances. Many funds now:

• Better understand and segment their members with the aim of developing asset allocations appropriate to different broad categories of their memberships, their differing needs and differing tolerances to risk.
• Avoid focusing excessively on sequencing risk at the point of retirement when setting asset allocations for older members. Sequencing risk is frequently overstated in product development given retirement is a long-term exercise with retirees requiring sufficient exposure to growth assets.
• Avoid surrendering long-term performance to reduce short-term volatility. The fear of paper losses in any financial year tends to reduce long-term returns.
• Efficiently manage tax to reflect the tax treatment of members in the accumulation and tax-free pension phase to increase real returns.