Think the share market volatility doesn’t affect you? Guess again.
With almost 60% of Australian superannuation funds invested in shares, anyone paying compulsory super contributions has something to lose from the current ructions.
University of Sydney superannuation expert Mike Rafferty explains why all of us, young and old, should pay attention to how super funds are managed.
What do you foresee happening to super funds as this turmoil rolls on?
We are in an era of quite serious uncertainty. Anyone who makes predictions is just guessing but what we can say is that volatility is the new normal.
The global financial crisis was a big shock to the super industry. It had been seven or eight years since the last financial crisis but there was a sense that this was a cyclical event and that over time, this will sort itself out and we can get back to business as usual.
That wasn’t, in fact, what happened.
If you look at all the reviews of super and retirement and the tax system that have occurred – the Cooper Review, the Henry tax review – all those reviews seem to share one common assumption: that is, that financial markets are a good way of financing a stable retirement.
I think this current volatility has really started to change people’s minds about that.
What superannuation promised was to be an addition to the age pension. Unfortunately, the more and more stringent means testing of the age pension means that, increasingly superannuation is expected to shoulder more of the retirement financing burden. So the risk here is superannuation becomes less of a top-up as originally promised and more of a trade-off.
This current turmoil could have a much bigger psychological effect on how we think about super than the GFC itself. That’s because it’s now clear this sort of volatility that the GFC began is going to occur potentially for quite a while, and yet real people are having their retirement and working lives impacted by it.
Did Australian super funds learn their lessons during the GFC and diversify enough so they won’t be too badly hit this time?
There was a promise that we could diversify into all sorts of asset markets and that would minimise volatility. But what we now know is that most asset markets seem to be very highly correlated. When there’s a crash in the equity market, it seems to affect the property market and vice versa.
Who should be bearing this risk? In the past, when employers had defined-benefits schemes, they managed it and they took the risk and governments did likewise. We are now asking individuals to become risk managers of something that is quite complex, long term and quite onerous.
There are ways you can reduce risk however and they turn out to be simple.
The financial services sector is fantastic at selling ideas – like the idea that equities is a great investment and you can diversify away equity market risk. But what we need to do is lower the risk.
Bond markets and interest rate products tend to be lower risk. If you think about the returns the industry has achieved over the last 13 or 14 years, it’s about 3%. You could have bought government bonds and sat on them at 4-5% and had almost no risk, or volatility and much lower fees.
There are huge fees generated off share market trading when really what we want is something low risk and low cost. But what governments and we have been sold is that all these different investment products can generate higher returns and you don’t need the boring bond market and fixed interest products, that’s for losers and what we really want are these exciting products.
Well, it turns out what we bought is tickets to a roller coaster ride.
So will this current volatility bring on a change of thinking?
I think if the industry is left to itself, the answer is no. There’s such a strong behavioural incentive to be in the middle of the pack. So something has to happen at the level of government policy.
The irony is that Jeremy Cooper who headed the Cooper review of super, is now working for Challenger Financial Services and is developing annuity products for retirees. That’s where when you get to retirement age you switch all of your investment into these bond-like investments where you are guaranteed a rate of return.
As he has said, what we really want to do is emulate the age pension. So now the age pension is the gold standard. The financial markets were supposed to be doing something far better than the age pension but now their goal is to emulate it.
Do Australians have more to lose than citizens of other countries because so much of our wealth is tied up in super funds vulnerable to stock market fluctuations?
Australia has a peculiar pension fund system. We have one of the most highly exposed pension investment structures to the equity market. Somewhere like 60% or more of the industry is either in domestic share market, in international equities or equity-like assets.
In the past, many defined benefit schemes funded by companies and governments were not allowed to invest in equity markets at all.
We have gone from this system where we expect pension funds to operate conservatively to a system where we have been promising big returns and trying to get them by chasing a lot of money into the stock market.
None of the recent reviews really tackled the problem of equity-market exposure.
I do note that Jeremy Cooper has now been saying he and others now question whether that exposure is actually appropriate for a retirement savings system.
Should there be any kind of policy response?
In a perfect world, there are plenty of things the government could do. But my fear is that the financial services industry has such a powerful grip on both major political parties, a lot of what’s been happening is policy for the finance sector.
There’s this idea that super will be good for Australians but also make Australia a financial services hub. I think we are mixing up industry policy with retirement policy too much.
Is this something that only older people need to worry about?
The concern I have is that most policy and attention is focusing on older workers or people who have retired. Everyone is saying that over the long run, it will all be OK for those younger workers.
But the long run is just a series of short runs and if you think somehow the stock market will come back roaring by 40% or 50% in the long run, then that’s a heroic assumption. Some of these losses are going to permanently scar young people’s retirement plans.
This issue has also big implications for the younger generation who are in the workforce now and who are trying to pay off houses and have kids.
I think the government has a very strong moral obligation. If they are going to take that money compulsorily out of people’s income, at a time when they need it most, they better have a strong justification for that. They also should make superannuation funds and the finance industry that benefits so much from compulsion much more accountable.