Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 330

Three key outcomes needed from the Retirement Income Review

The recently announced Retirement Income Review terms of reference detail the three pillars on which Australia’s retirement income system is based – age pensions, compulsory superannuation and voluntary savings. This paper focuses on the second pillar, superannuation.

There are three key outcomes that can be met by the Retirement Income Review:

  1. Further develop the risk adjusted returns disclosure arrangements criteria to assist retirees in understanding the risks inherent in retirement income products.
  2. Encourage the development of a variety of risk management approaches with the objective of improving risk adjusted returns for retirees. 
  3. Develop guidelines for ‘alternative – conservative’ and ‘alternative – growth’ asset classifications, based upon the risk level rating and in particular the product’s ability to address sequencing risk.

1. Risk adjusted returns disclosure

The December 2018 Australian Government Actuary Paper ‘Retirement Income Risk Measure’, discusses a range of standard metrics to help consumers make decisions about the most appropriate retirement income product for their own circumstances.

It is noted that:-

“…behavioural economists commonly point out that individuals are more averse to downside variation than upside variation. Intuitively this would apply to retirement incomes. For this reason, I have chosen to focus on quantifying downside risk and using that to measure the relative ‘income risk’ of various products.”

The Actuary’s advice says on page 6:-

“The proposed presentation for the fact sheet is a scale of one to seven referencing ‘income security’. A high number on the scale would indicate expected income is stable and reliable, higher risk products would equate to a low level of security, so a lower number on the scale ...

The income security measure takes account of inflation, longevity and market risk. For consumers these risks may be of different values. For example, a consumer who is concerned about whether their income varies due to market forces may want to know whether the product protects them from this particular risk.”

The much-discussed 'Comprehensive Iincome Product in Retirement' (CIPR) would provide a complete solution that balances a number of competing objectives. The three key retirement objectives are to maximise income, ensure income is provided for life and provide flexibility to access capital.

The Review provides the opportunity for industry to critically review the Treasury analysis of CIPR and observations on the proposed risk objectives (including any suggestions on how the approach could be improved). This process may enhance the risk metrics ratings products will receive on their ability to address longevity risk, market risk, sequencing risk and inflation risk.

2. Encourage the development of a variety of risk management approaches

There are a variety of investment risk management approaches with the objective to meet the equity income needs of retirees and defend against losses in declining markets.

Typically, the investment generates dividends from a diversified portfolio of Australian shares with an investment risk management overlay that aims to reduce the volatility of returns, in particular defending against losses in declining markets.

A brief summary of the approaches is as follows:

  • Vary asset allocation between stocks and bonds (diversification)
  • Buy underlying asset, write call options (buy-write income funds)
  • Long/short funds (market neutral, 130/30)
  • Buy underlying asset with the ability to sell futures contracts
  • Buy put options and hold cash
  • Buy underlying assets, buy put options (always include a ‘hard’ risk parameter)

These approaches are adopted by Russell Investments, State Street and Gyrostat (amongst others).

By developing clear evaluation criteria, industry will likely continue to develop innovative risk-managed investment approaches. It is likely that through the combination of these approaches, retiree solutions that maximise risk adjusted returns can be developed, with external providers becoming a component part of the retirement product if these are ‘best of class’ addressing a particular component of risk.

3. ‘Alternative – defensive’ and ‘alternative – growth’ classification criteria

For a product to be classified as ‘alternative – defensive’ it must address sequencing risk. Sequencing risk is the risk that the order and timing of investment returns in unfavourable, resulting in less money for retirement. If the benchmark used by a fund has experienced significant drawdowns, it does not address sequencing risk, and would be an ‘alternative – growth’ classification with a lower risk rating.

The marketing literature of many funds attracting retiree investors typically show:

  • Income feature
  • Return feature over specific time periods
  • Relative performance versus selected index over specific time periods

Rarely do they report the maximum capital drawdown since inception. Given that the fund’s objective is to outperform a chosen index, the underlying investment may be exposed to large losses in the event of a major market correction. The protection element is reflected in the fund's maximum capital draw-down.

Many doubt the Review will focus on such definitions, as the super industry has struggled to deliver consistent standards to define growth or defensive assets.

Conclusion

The desirable retirement income product features combine protection, returns and regular income through all stages of the investment cycle, including large market falls. The Retirement Income Review can make positive contributions towards this objective and ultimately meet the policy objective to enable retirees to maintain their standards of living when they retire from the paid workforce or reach the retirement age.

 

Craig Racine is Managing Director of Gyrostat Capital Management. This article is general information and does not consider the circumstances of any investor.

 

RELATED ARTICLES

A defining year for super requires your input

CIPRs are coming and that’s exciting

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates

Strategy

$1 billion and counting: how consultants maximise fees

Despite cutbacks in public service staff, we are spending over a billion dollars a year with five consulting firms. There is little public scrutiny on the value for money. How do consultants decide what to charge?

Investment strategies

Two strong themes and companies that will benefit

There are reasons to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies should benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Financial planning

Reducing the $5,300 upfront cost of financial advice

Many financial advisers have left the industry because it costs more to produce advice than is charged as an up-front fee. Advisers are valued by those who use them while the unadvised don’t see the need to pay.

Strategy

Many people misunderstand what life expectancy means

Life expectancy numbers are often interpreted as the likely maximum age of a person but that is incorrect. Here are three reasons why the odds are in favor of people outliving life expectancy estimates.

Investment strategies

Slowing global trade not the threat investors fear

Investors ask whether global supply chains were stretched too far and too complex, and following COVID, is globalisation dead? New research suggests the impact on investment returns will not be as great as feared.

Investment strategies

Wealth doesn’t equal wisdom for 'sophisticated' investors

'Sophisticated' investors can be offered securities without the usual disclosure requirements given to everyday investors, but far more people now qualify than was ever intended. Many are far from sophisticated.

Investment strategies

Is the golden era for active fund managers ending?

Most active fund managers are the beneficiaries of a confluence of favourable events. As future strong returns look challenging, passive is rising and new investors do their own thing, a golden age may be closing.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.