Just raise the return

Just raise the return

Former Prime Minister Paul Keating was worried about retirees this week. Superannuation isn’t going to work for those over 80. Balances are simply too small.

A lack of savings is apparently not the problem. Nor is the retirement age. Instead, Keating proposed a new national insurance scheme to fix his own policy’s failings.

This begs the age-old question: How many government policies does it take to solve a problem?

Milton Friedman gave us a hint: ‘Governments never learn. Only people learn.

No such thing as a quick fix

The media are taking Keating to task for the shemozzle that Super has become. The Australian’s Judith Sloan wrote this:

‘If you were in any doubt our system of compulsory superannuation is essentially pointless, other than making industry players extremely wealthy, check out the latest suggestion from the father of the scheme, former Prime Minister Paul Keating.’

She goes on to describe Super’s many, many shortcomings.

But don’t worry. Ian Yates, chief executive of the Council on the Ageing, has solved the problem. And not just for Australia. For the entire world. Pension shortfalls will soon be a thing of the past.

The bad news is, this is honestly the dumbest thing I’ve ever read.

Here’s the quote in all its glory in the Guardian:

“Raising the contribution to 12% mainly benefits high-income earners,” he said. “The alternative is to improve the outcome of super funds. For example, increasing the rate of return on funds by 0.5% would bring a significant benefit to lower and middle-income earners.”

There you have it, Australia. All we need to do to rescue our retirements is to increase the rate of return!

It’s that simple.

Why has nobody thought of this before!?

Quick, let’s get onto this one. All we have to do is declare it to be true.

Or maybe it’ll require a law. “Rates of return are now 0.5% more than they were.” The Queen declares it to be so. And the Governor General has signed off on it.

Congratulations, your Super is now adequate.

Problem solved.

The super mismatch

A friend recently made me aware of a topic a little closer to reality.

Consider the mismatch inherent in the Superannuation fund industry.

A Super fund’s individual members each choose an investment option. It might be the default option, or they might want to take on more or less risk.

But the Super fund itself has one investment position – the asset allocation and actual investments it holds.

Yes, things are more complex in practice. But notice the mismatch. The Superannuation investment option you choose does not actually exist as a portfolio in some account somewhere. It’s not segregated.

Instead, the Super fund aggregates the various preferences of its members and invests the assets as a whole. Hopefully, the two are closely related. The “average” Super fund member’s preferences and the Super fund’s investment position are similar. But this need not be so. There could be divergence.

What to expect from here

This leads to a shocking conclusion. The returns on your Super, presuming you’re not using an SMSF, are arbitrarily declared by the Super fund. They are not real nor linked to actual assets and their return. They can’t be, because the real investment position of the fund does not match each member perfectly.

Say the typical Super fund invests more in stocks than its “average” member does. When stocks go up, members get higher returns than they might have expected. When stocks go down, members get lower returns than they might have expected.

Do you see the disjoint? The divergence between what’s really going on and the mirage your Super fund creates in your account?

The next question is how the returns are allocated. If I tell my Super fund I want to go 100% cash, are my returns still affected by the performance of the Super fund’s wider portfolio? From what I can tell, it is!

Throw some demographics into the problem and things get really interesting.

Over time, investors are supposed to become more risk-averse. They transfer out of equities and into bonds.

Where will this leave the Super industry as baby boomers retire? Will Super funds’ actual portfolios follow the rotation out of stocks and into bonds? Or will they allow the gap between their obligations to members and their actual investment position to rise?

Remember, bonds theoretically return less than stocks. If Super funds mirror their members, expected returns will fall. The problem of not enough Super will get worse.

Until next time,

Nick Hubble Signature

Nick Hubble,
For The Daily Reckoning Australia