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Lifecycle investment products: room for improvement

David Carruthers, Frontier

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, a new study funds.

Asset consultant Frontier Advisors has reviewed lifecycle investment strategies and argues that those strategies could be better constructed, more flexible and cheaper.

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/return profile of the account is adjusted automatically as fund members approach retirement, with the investment strategy moving from a high growth profile to a more defensive profile.

Frontier says there are several factors with lifecycle strategies that can have an adverse impact on outcomes.

Frontier’s head of member solutions research, David Carruthers, 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 year, 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.

Carruthers says Frontier’s research suggests 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,” he says.

Frontier says 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.

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.

Carruthers says: “Currently, lifecycle is essentially a single factor mass customisation model, with age/time to retirement the key cohort determinant. An exception to this is QSuper, which uses a combination of both age and account balance, so that members over age 40 with lower balances are assigned to marginally higher risk strategies than similarly aged members with higher account balances.

“We view this more nuanced approach as a positive and one that should result in better outcomes.”

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.

On the issue of adapting to the prevailing market environment, Carruthers says: “A clear concern with some existing lifecycle models today is that they shift into defensive investments irrespective of the return outlook – for example, bonds today look expensive. We believe that an enhanced lifecycle model needs to take a dynamic approach to incorporating the prevailing market environment when setting the asset allocation.”

On the issue of fees, the MySuper reforms recognised that defensive assets are typically cheaper to manage than growth assets and set up four price points for lifecycle strategies.

However, Frontier says many of funds charge a single standard fee across all stages of lifecycle investment, regardless of the underlying investment mix.