Let’s look at the big news here in Australia yesterday – the first phase of the Cooper Review of Australia’s superannuation industry. Yesterday’s release looked really pretty and sounded very smart. But what did it really say?
Well first, let’s be clear what it did NOT say. The list of issues “not pursued” by the inquiry included two big ones: the level of equity asset allocation and portfolio rebalancing. Leaving these issues out of a discussion of super is like leaving out nutrition and exercise out of a diet plan. In other words, it’s no plan at all. We’ll explain why in a moment.
But to understand why equity asset allocation and portfolio rebalancing are so important, you have to understand what the review recommended. We can’t really improve on Alan Kohler’s characterisation of a two-tier system of those who “care” and those who “don’t care.”
Those that “don’t care” would be placed in a “universal” plan, described as “a single diversified investment strategy” with “embedded advice.” It’s a no-frills plan for people who don’t pay attention to their Super. The advantage is very low fees, meaning more money actually goes into Super and less to an adviser.
The disadvantage, of course, is that you get a one size fits all plan. And that plan is based on the idea that ordinary Australians can use the stock market as a retirement machine by mindlessly ploughing in 9-12% of their income into a fund that tracks the market. Does that sound sensible to you?
It does if you think the stock market can pay for your retirement. And the review’s authors seem to think the current system is working well. They write that “Australia’s superannuation system has grown tremendously in size and importance over the past 17 years. On most grounds, it can be regarded as having been a success. In particular, the system has demonstrated substantial resilience in one of the most severe financial market crises of the past century.”
What they fail to note is that for most of the last seventeen years, shares have been in a bull market. There are plenty of other 17-year periods in the last 100 years where shares did NOT go up. If you were investing during those periods, your confidence in the ability of the stock market to provide for everyone’s retirement might be…diminished.
The other recommendation for a “choice” fund preserves the right of retail funds to charge fees based on the quantity and quality of advice. If you choose a produce with more bells and whistles than your employer provides, you’ll have to pay for it. It might give you better performance, but you’ll have to pay for it.
It’s too simple to say this is a case of offering a passive versus active investment strategy. But the main premise – that stocks can provide you with all the retirement income you need – never seems to be challenged or even mentioned in the report. What a serious flaw!
Which brings us back to the issue of asset allocation and rebalancing. As we mentioned in November, the average Aussie super fund has nearly 60% of its asset invested in equities – and growth equities at that! With the current review’s recommendation, many Aussies would be encouraged to become even more passive, presumably in funds that are largely exposed to growth equities.
How exactly this achieves retirement income and security…we’re not sure. We’re pretty sure it guarantees that money will stay in the market. Some of it will go to buy shares which super funds can then loan out to short sellers for income (another issue not taken up by the review). And we imagine some of it will eventually, miraculously, go toward supporting state and Federal bonds (ultra-conservative and ultra-passive. In other words, we can see how this arrangement keeps the industry with money to manage and the government with access to funds, but we can’t really see how it achieves what ought to be the fundamental goal of Super: securing retirement income for the average Australian.
You don’t get any closer to that goal by not addressing the issue of portfolio rebalancing. Portfolios are rebalanced to preserve or revise your original asset allocation decisions. If you fail to rebalance them regularly, you’ll end up with too much of your net worth concentrated in one asset class (usually shares). This exposes you to huge risks.
Granted, all this sounds like hard work. But is your money, isn’t it?
As is, the review essentially encourages a lot of Australians to not care about their money. This means those Aussies will stick their money in the stock market and not think about it at all. They’ll automatically buy shares, supporting stock prices and the superstructure of the financial services industry. But they won’t be any more engaged in their own financial life, or any close to a better financial future.
But maybe a better financial future for ordinary Australians was never the purpose of the Superannuation industry to begin with. And maybe the purpose of this review was to give retail funds continued access to a huge pool of money – without the expectation of doing anything but matching the market return each year.
Not a bad gig is it? More money to manage…fewer (no) expectations.
The second and third parts of the review are not due for awhile. But don’t be surprised if both undermine the ease of setting up your own self-managed super fund (SMSF). Assets in SMSFs doubled between 2005 and 2009 to $332 billion. SMSF assets are now larger than retail fund assets and make up fully 30.9% of Super assets.
That trend has to terrify the industry and the government. It means more Australians are taking more control of their money. The typical SMSF has a larger allocation to cash and a smaller allocation to equities (an even bigger disaster for financial firms whose main business is selling stocks or financial products).
Maybe we’ll be wrong about the government’s motives. But in the meantime, the average super fund still has a disproportionate allocation of assets in growth equities. That would be fine if this were 1982. But it’s not. It’s 2009, and there are heaps of risks out there for your money. Tomorrow, more on what to expect in 2010 and what general asset allocation discussions we had in South Africa last week.
for The Daily Reckoning Australia