Q: I was reading the APRA heatmap report, which rates the performance of MySuper products, and I saw reference to lifecycle products. What are they?
A: Lifecycle strategies have become increasingly popular in recent years and now account for around 35 per cent of all MySuper products in the market. Their appeal is in the fact that the risk and return profile of the account is adjusted automatically as fund members approach retirement, with the investment strategy moving from high growth to growth and then to a more defensive profile, with the aim of protecting assets in retirement.
There are no hard and fast rules for designing a lifecycle strategy and there is significant variation in the products on offer. One common element is that nearly all funds adopt age as the distinguishing factor on which to base changes to the investment strategy.
However, de-risking can start as early as age 40. Exposure to growth assets at the outset can be as high as 100 per cent and as low as 50 per cent. The number of stages in the de-risking process varies greatly.
Lifecycle strategies help deal with the problem created by the lack of engagement of most super fund members. However, as they have become more common in the Australian superannuation market over the past decade, they have been subject to quite a bit of critical examination.
Work done by asset consultant Frontier Advisors a couple of years ago concluded that adopting a lifecycle investment strategy provides some protection from sequencing risk for super fund members approaching retirement, but it can come at the cost of a lower balance in retirement.
Frontier Advisors recommended that lifecycle strategies could be better constructed, more flexible and cheaper. It says there are several factors with lifecycle strategies that can have an adverse impact on outcomes.
Frontier’s report says: “While members benefit from a more aggressive risk/return profile in their early years, when they have the luxury of time to make up losses, account balances at these times are generally quite low. Once lifecycle asset allocations taper to a more protective mix in later years, balances are at their highest and the impact of giving up investment performance is significant.”
Another consideration is that many retirees will draw down on their final balance over 20 or more years and thus the need to de-risk to protect their balance at retirement is less critical, given the very long-term investment horizon through their retirement years.
Frontier says there is room to develop lifecycle products to offer better outcomes by taking a retirement income approach, rather than a focus on the retirement benefit. “Superannuation is designed to provide a retirement income and, as such, members may have an ongoing investment horizon,” it says.
Frontier recommends that lifecycle strategies would be improved by better defining member cohorts, increasing the focus on post-retirement, adapting to the prevailing market environment and keeping costs down.
A greater level of cohort customisation could be achieved by using factors such as nature of job, salary, access to age pension, other assets, risk tolerance, engagement and contribution rate.
One way to shift the focus to post-retirement would be to define outcomes in terms of expected income, rather than expected balance.
A more recent review by Rice Warner comes to similar conclusions. It says the complicating factor in lifecycle investing is that in superannuation there are two investment horizons: the accumulation phase up to the point of retirement; and the retirement phase, when the savings are run down.
Rice Warner says: “A super fund member’s investment horizon is not bounded by their retirement date, although this date is relevant. A member is likely to hold a substantial proportion of their super well into the retirement phase, unless their balance is slow.
“We consider it prudent that funds develop investment strategies which account for the range of investment horizons to which members are likely to be subject, both before and after retirement.
“Adopting a high allocation to growth assets is not inherently a poor strategy, even in cases where members are approaching retirement.
“Designing lifecycle strategies that use further factors in addition to age provide the ability to better tailor a portfolio to provide enhanced outcome to members by adopting a more growth oriented stance while a member has a long investment horizon and shifting to defensive assets when a member’s investment horizon shortens.”