(May-2003) Volatility strikes again

If only we had known then what we know now. Super Review’s TOP 300 survey reveals that member investment options with a high allocation to international equities performed poorly in the financial year to end June 2002 unless this exposure was balanced by a diversification into appropriate property and cash investments. And options with more conservative, diversified portfolios performed best.

But while there were success stories, 2001-02 generally generated negative returns across all fund types, after a remarkable 15 consecutive years of growth.

The successes were largely contained to those funds which adopted a cautious, and some might say ‘fortunate’, mix of asset allocations which effectively balanced their exposure to international equities. That, at least, would seem to be the case where the Retail Employees Superannuation Trust (REST) is concerned.

REST once again emerged as one of the best performing funds in our TOP 300 survey. According to REST’s CEO, Neil Cochrane, relatively conservative positioning and the better than average performance of portfolio managers were the cornerstones of the fund's performance.

He says the key features of the fund’s performance over the period were:

* a very low weighting to international equity investments compared to other super funds;

* excellent returns from REST’s international equity managers, including Holowesko, which returned 3.8 per cent compared to the benchmark of —23 per cent.

* a high weighting to quality property investments, with solid after-tax returns of around 8 per cent for the year.

* an excellent performance by REST’s Australian equity managers, including Paradice Cooper which returned 30.5 per cent in small cap stocks, and Perpetual, which earned 4.6 per cent compared to the benchmark of -4.5 per cent.

“Returns for all our options this year, and indeed, over the last three years have been strong and consistent,” says Cochrane. “This is because we are a value-based fund and have taken a conservative position where we have a relatively high exposure to direct property and a low international equity exposure.”

Another fund to emerge on the positive side of the ledger as a result of its property holdings was the Rothschild Australia Staff Superannuation Fund. The accumulation fund not only registered a comparatively strong crediting rate of 14.3 per cent from its listed property trust option, but also topped the table with an 11.4 per cent earnings rate from its share options and a solid 3.9 per cent result from its balanced options.

Rothschild’s achievements ran counter to the general pattern for accumulation funds. These proved to be the worst performers in 2001-02, turning in an average crediting rate of —1.46 per cent in the TOP 300 survey compared to —0.82 for hybrid funds and —0.38 for defined benefit funds.

While at the beginning of the last financial year there were emerging signs of declines in international equity markets, nobody could have factored in the impact of the events of September 11, 2001. Indeed, the debate surrounding superannuation in the first half of 2001 was of risk diversification and access to a wider class of investments. This, in turn, persuaded some fund managers to pursue greater exposure to international equities.

This is not to say that share options represented a complete negative for funds, with the Rothschild Australia Staff Superannuation Fund returning members an earnings rate of 11.40 per cent, while the Health Employees Superannuation Trust of Australia (HESTA) also returned a highly satisfactory 6.80 per cent from its share option.

However, these positive earning rates, most of them achieved because of a heavier emphasis on domestic equities combined with some clever long/short positioning, had to be weighed against the heavy negative results (up to -24.30 per cent) from exposure to international equities.

Property was clearly the foundation upon which the best performing funds managed to build positive returns in 2001-02. But according to Frontier Investment Consulting’s Fiona Trafford Walker, funds would have needed to make their property allocations at least four years ago to have been reaping the benefits now.

While property was the saving grace of a number of funds, cash options produced variable results ranging from 5.70 per cent earnings rate at the top of the segment to just 0.96 per cent at the bottom.

The First State Superannuation Fund (NSW) rewarded its members with a 5.7 per cent cash options earnings rate, while the hospitality industry fund, Host Plus, produced a 4.90 per cent return. By comparison, Westscheme’s cash options returned members just 0.96 per cent.

Asset consultants attribute this wide variation to the quality of investments within the asset class, with those funds returning the best earnings rate being those with the least aggressive settings.

Mercer’s Peter Promnitz says the variation in returns from cash options is probably largely due to tactical approaches involving short duration risk and credit risk aimed at boosting returns.

Not surprisingly, the declines in investment returns that have occurred since the middle of 2001 have caused fund managers to reflect upon the circumstances which led to that decline and to ponder whether they justify long-term changes in strategy.

In March, the Association of Superannuation Funds of Australia (ASFA) produced an analysis of events in 2001-02 and concluded in broad terms that, notwithstanding the recent decline in investment values, the existing underlying strategy remains sound.

“Any individual who has direct or indirect exposure to any investment which is not capital guaranteed runs some risk of facing a year in which the value of their investments declines,” the ASFA paper said. “However, history tells us that over the long term, the investment returns from equities and ownership of real estate of various types will exceed that of bank deposits and government bonds, perhaps by four to five per cent per year on average.”

The ASFA analysis seems to be holding good with most fund managers resisting the temptation to significantly alter their strategic asset allocations.

Indeed, InTech Financial Services senior consultant Andrew Korbel warns that those daring to attempt tactical timing shifts will be doing so at their own risk. “Actively deviating from a fund’s strategic asset allocation via tactical timing shifts is like playing with matches, and not an activity likely to generate positive enhancements to returns in the long run,” he says.

While the Super Review Top 300 survey clearly reveals that funds with a property exposure were the place to be, the statistical reality confronting most fund members is that property assets (land and buildings) represents one of the smallest asset allocation classes.

According to data provided by the Australian Prudential Regulation Authority (APRA), property accounted for only 5.5 per cent of total asset allocations in June 2002, compared to equities which accounted for 44.5 per cent.

What’s more, investment in international equities has been steadily growing over the past seven years to now represent 19.4 per cent of total asset allocations.

The performance of funds with a heavier than average property exposure is put into context by an examination of the performance of asset classes over the year to end June, 2002. According to InTech, returns from Australian shares declined by 4.7 per cent, while international shares had declined by 23.5 per cent, and international shares which had been hedged, declined by 19.3 per cent.

By comparison, unlisted property investments increased by 9.4 per cent and listed property investments increased by 14.9 per cent.

Of the funds taking a place in Super Review’s Top 10 listing for crediting rates for the past financial year, seven were property options. By comparison, every fund making it onto the worst 10 list for crediting rates had an exposure to international shares.

It is axiomatic of the circumstances which confronted fund managers through 2001-02 that four funds made it onto both lists, with the decline in values from their international share exposures more than off-setting the returns from their property investments.

A classic example was the Reserve Bank of Australia Officers’Superannuation Fund which registered a positive 16.6 per cent crediting rate from its listed property option but, at the same time, registered a negative 24.3 per cent from its international shares option.

Similarly, Just Super (for journalists and entertainers) notched up a 13.9 per cent crediting rate for its property option only to see that undercut by a negative 22.0 per cent result from its international equities choice.

While the Reserve Bank of Australia Officer’s Superannuation Fund found itself named in the top five performing defined benefits options for the year, another of its options was, at the same time, listed amongst the worst five performing shares options with an earnings rate of minus 24.30 per cent.

Corporate funds once again emerged on top in terms of average return to members, with an average crediting rate of -0.56 compared to the industry funds which returned -1.73 and public sector funds which returned -0.82.

The good performance of these corporate funds is attributed to their more conservative settings, particularly with respect to the quality of their cash options and their generally longer-standing exposure to property.