The previous decade of economic growth in Australia has proved to be a boon for both private sector and Federal Government coffers.
Federal budget surpluses and asset sales resulted in a rapid decline of Government debt, and in 2002, the Government released a discussion paper proposing the abolition of the Commonwealth Government securities market. While ultimately deciding to maintain the securities market, the continued rationalisation has had an important impact on the available investable asset classes for super funds.
Government securities have unique characteristics favourable to super funds, most notably a long time to maturity, liquidity, and relative absence of credit risk. Most default, or “balanced” superannuation investment options, the most popular in Australia, include investments in government securities. Using the ABS Managed Funds Survey for September 2003, we find that direct fund holdings of Long Term Commonwealth Securities peaked in 1995, at just over 9 per cent of fund assets, and declined sharply to the current level of just under 3 per cent in 2003. Government bond holdings by super funds have traditionally been significantly dependent on availability, but similar declines are evident for state government and corporate holdings, despite the rapid growth experienced in corporate bond issues.
An important consideration is that the super figures only refer to direct holdings. Some 60 per cent of super fund assets are invested by other entities.
Not only are super funds holding fewer long term securities, but those that manage their investments are also shifting into other asset classes.
Theory suggests that in the absence of commonwealth securities, semi-government and corporate bonds would be the next available alternative. However, the available evidence suggests that this substitution has not occurred. Instead, there has been a marked decline in holdings of all forms of long-term securities.
The effect of this change in asset allocation on fund members can be significant. While alternate investment classes such as equities or overseas investments may increase returns in the long run, it may be at the expense of short term volatility. Life cycle investing proposes that your exposure to risky assets should decrease proportionately as you age, and such investment options in UK pension funds has proven popular. However, despite an ageing population in Australia, super funds have been increasing their exposure to volatile assets. The recent negative returns of super funds came as a shock to many fund members after a decade of growth, and such returns have the potential to significantly affect the post working living standards of those close to retirement.
Funds heavy in equities or overseas investments, while attractive to young clients with the time frame to regain losses, are unlikely to be attractive to retirees dependent on returns from their superannuation for income. The current trends may leave retirees with an unpalatable choice, either relatively safe, low return cash investments, or the higher returns and risks associated with current pension portfolio allocations.
As a fund matures from the asset accumulation to the asset maintenance phase, trustees will need to be looking for less volatile investments. The decline in holdings and availability of government securities will have a dramatic impact on trustees’ ability to diversify and reduce volatility. With the apparent failure of corporate bonds as a substitute, the question is, will this be possible, or are retirees in for a volatile ride?
— Darren Massey received a 2004 Centre for Applied Economics Research Honours Scholarship, UNSW. Any errors and omissions are the sole responsibility of the author.
