The ABCs of choosing a superfund (Part 1)
It was over a delicious Melbournian brunch with a group of girlfriends one fine afternoon that I realised how many of us need help with choosing a superfund. Whilst it seems like an excruciatingly boring topic, it can make a big difference to you later on in life. With a plethora of products out there, ads constantly shoved in your face, how do you know which superfunds are just flashy advertising, and which ones will actually deliver on their promise? As someone working in this space, I thought I'd impart some of my thoughts. I've started with two simple and quick things that you can check (more on performance and fees in Part 2) :
1. What kind of superfund is it? There are two broad camps of superfunds, 1) Industry superfunds, and 2) Retail superfunds (aka master trusts or corporate master trusts). Broadly speaking, industry superfunds are set up for the benefit of their members (and in fact the establishment of the compulsory superannuation scheme was born from the industry super movement back in the 1980s). Retail superfunds on the other hand, are set up with a profit motive, they have shareholders to deliver to at the end of the day. So how do you know which ones an industry superfund? Easy, the fund will advertise itself as "an industry superfund" and show the logo:
2. Target Return. All superfunds offering a typical "Balanced My Super" Option (this is the default option that most people will go into, and is usually the most diversified option ) will have a CPI based target. This usually ranges from CPI + 3% to CPI + 4%. (There may be some outside this range but its rare, and I would be slightly suss if it fell too much outside this range). The CPI component just promises you a return above inflation, the plus part is what you are focused on. As a young investor, it's a no brainer that you probably want to go for a higher "plus" part, because you can afford to take on more risk. But whatever the target return is being advertised, you need to consider this in the context of what the underlying investment is, specifically, how much risk is being taken.
A typical "Balanced My Super" fund, this will have a mix of "growth assets" - think Equities (shares), Private Equity, Hedge Funds and other risky but higher returning assets, and "defensive assets" - think Fixed Income, Cash and other boring but so called 'safe haven assets' (I will go into more detail about why not all fixed income is as safe as you think in a later blog). Assets like Property and Infrastructure are a mix, it depends if its core or development or opportunistic property/infrastructure. The key is that the higher the allocation of growth assets, the more risk is being taken. So if two Options have the same percentage of growth assets (i.e both are taking on the same amount of risk), but one has a much higher return than the other, than logically you would go for the Option with a higher return (hence the phrase "risk adjusted returns").
Typically, a "Balanced My Super" fund will have between 60-70% in growth assets, and will have a Strategic Asset Allocation resembling the below chart (note this is a guide only, each Option will have a range):
Of course, this is not perfect, as the definition of a "growth asset" and "defensive asset" is not strictly clear. There are obscure asset classes such as "alternative debt", or just "alternatives" which can be a mix of growth/defensive assets (more on this in a later blog). And just because two funds have the same amount of Equities, doesn't mean that the level of risk is the same (think speculative mining stocks vs blue chip stocks).
So how does one know how risky their Option is, apart from looking at the Strategic Asset Allocation and working out how much is invested in growth assets? Luckily the regulators have (tried to) make it easier for consumers, and APRA has published guidelines on risk which superfunds have to disclose. In other words there is a standardised risk measure that consumers can use to compare the level of risk across all Options. ARPA defines risk as the estimated number of negative annual returns over any 20 year period, and has set 7 risk bands as follows:
So as a high level guide to how much risk a particular Option is, check the Risk Band. Typically, Balanced My Super Options fall within Risk Band 5 to 6. As mentioned above, a Balanced My Super Options will have a target return of around CPI + 3% to CPI + 4%.
The only Options that should fall within Risk Band 7 are single sector Options that have no (or little) diversification across asset classes (e.g. Shares Options) or High Growth Options that take on an extremely high level of risk. For these Options, you would expect that their return targets are also higher to compensate for the additional risk. e.g. For a Shares Option, something like CPI + 4.5% or more.
What is interesting, is that there are some products that take on a high level of risk but yet target a low return. For example, Spaceship (a popular one among millennials as it is focused on sexy Technology stocks) has over 90% allocated to growth assets (based on their PDS), yet has a target return of only CPI + 2.5%. The 90% allocation to growth assets is understandable, the product is targeting a relatively young demographic, and the idea is that as young investors, you can ride out the market volatility (so if there was another Dot-com bubble, hopefully as a young investor you can hold through the cycle and capture the recovery). But if that is the case, why is the return target so low? I couldn't actually find which risk band it was in, but I suspect it would be 6 or 7, based on the fact that there is only around 10% in defensive assets.
Anyway, that's enough for a first post. I hope this was somewhat useful (more on performance and fees in Part 2). That's it for very high level overview of how to choose a superfund! Remember individual circumstances will determine what is suitable for you as this is only a guide of what to look out for and is not in any way financial advice. Please conduct your own research and consult your financial planner. Happy researching!
Feel free to drop me a line on what you would like to read more about. Comments/feedback more than welcome!
1. What kind of superfund is it? There are two broad camps of superfunds, 1) Industry superfunds, and 2) Retail superfunds (aka master trusts or corporate master trusts). Broadly speaking, industry superfunds are set up for the benefit of their members (and in fact the establishment of the compulsory superannuation scheme was born from the industry super movement back in the 1980s). Retail superfunds on the other hand, are set up with a profit motive, they have shareholders to deliver to at the end of the day. So how do you know which ones an industry superfund? Easy, the fund will advertise itself as "an industry superfund" and show the logo:
2. Target Return. All superfunds offering a typical "Balanced My Super" Option (this is the default option that most people will go into, and is usually the most diversified option ) will have a CPI based target. This usually ranges from CPI + 3% to CPI + 4%. (There may be some outside this range but its rare, and I would be slightly suss if it fell too much outside this range). The CPI component just promises you a return above inflation, the plus part is what you are focused on. As a young investor, it's a no brainer that you probably want to go for a higher "plus" part, because you can afford to take on more risk. But whatever the target return is being advertised, you need to consider this in the context of what the underlying investment is, specifically, how much risk is being taken.
A typical "Balanced My Super" fund, this will have a mix of "growth assets" - think Equities (shares), Private Equity, Hedge Funds and other risky but higher returning assets, and "defensive assets" - think Fixed Income, Cash and other boring but so called 'safe haven assets' (I will go into more detail about why not all fixed income is as safe as you think in a later blog). Assets like Property and Infrastructure are a mix, it depends if its core or development or opportunistic property/infrastructure. The key is that the higher the allocation of growth assets, the more risk is being taken. So if two Options have the same percentage of growth assets (i.e both are taking on the same amount of risk), but one has a much higher return than the other, than logically you would go for the Option with a higher return (hence the phrase "risk adjusted returns").
Of course, this is not perfect, as the definition of a "growth asset" and "defensive asset" is not strictly clear. There are obscure asset classes such as "alternative debt", or just "alternatives" which can be a mix of growth/defensive assets (more on this in a later blog). And just because two funds have the same amount of Equities, doesn't mean that the level of risk is the same (think speculative mining stocks vs blue chip stocks).
So how does one know how risky their Option is, apart from looking at the Strategic Asset Allocation and working out how much is invested in growth assets? Luckily the regulators have (tried to) make it easier for consumers, and APRA has published guidelines on risk which superfunds have to disclose. In other words there is a standardised risk measure that consumers can use to compare the level of risk across all Options. ARPA defines risk as the estimated number of negative annual returns over any 20 year period, and has set 7 risk bands as follows:
So as a high level guide to how much risk a particular Option is, check the Risk Band. Typically, Balanced My Super Options fall within Risk Band 5 to 6. As mentioned above, a Balanced My Super Options will have a target return of around CPI + 3% to CPI + 4%.
The only Options that should fall within Risk Band 7 are single sector Options that have no (or little) diversification across asset classes (e.g. Shares Options) or High Growth Options that take on an extremely high level of risk. For these Options, you would expect that their return targets are also higher to compensate for the additional risk. e.g. For a Shares Option, something like CPI + 4.5% or more.
What is interesting, is that there are some products that take on a high level of risk but yet target a low return. For example, Spaceship (a popular one among millennials as it is focused on sexy Technology stocks) has over 90% allocated to growth assets (based on their PDS), yet has a target return of only CPI + 2.5%. The 90% allocation to growth assets is understandable, the product is targeting a relatively young demographic, and the idea is that as young investors, you can ride out the market volatility (so if there was another Dot-com bubble, hopefully as a young investor you can hold through the cycle and capture the recovery). But if that is the case, why is the return target so low? I couldn't actually find which risk band it was in, but I suspect it would be 6 or 7, based on the fact that there is only around 10% in defensive assets.
Anyway, that's enough for a first post. I hope this was somewhat useful (more on performance and fees in Part 2). That's it for very high level overview of how to choose a superfund! Remember individual circumstances will determine what is suitable for you as this is only a guide of what to look out for and is not in any way financial advice. Please conduct your own research and consult your financial planner. Happy researching!
Feel free to drop me a line on what you would like to read more about. Comments/feedback more than welcome!
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