The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Friday, November 13, 2009

Updated: Calls for super funds to cut equities exposures

Ahhh, finally (nb: this extends the post below). I have previously written at length about the risks associated with over-investing in the equities casio (ie, the incredible 15-20% pa volatility as borne out graphically in the 1987 crash, the 1997-98 Asian Crisis and LTCM bailout, the 2001 Tech Wreck, and now the 2007-09 GFC), and the reservations we have about many super fund asset-allocation strategies that give them ridiculously high 50-60% weights to Australian and international shares (both of which are highly correlated).

The key take-away is that these decisions expose members to unnecessary risks, which is why immediately post the GFC the average default super fund had delivered negative returns over the prior three years, and had underperformed cash over the previous half decade. And for many members, timing does matter.

Framed differently, super funds could deliver their members similar return outcomes with substantially lower risks if they got their asset-allocations right (or, more technically put, their asset-allocation decisions tracked more closely to the mean-variance efficient weights that are outputted when optimising the last 30 years worth of cross-asset-class data).

As I noted here, a recent OECD study validated this critique, which also appears to be shared by the Future Fund, by highlighting just how out-of-whack Australian asset-allocations are vis-a-vis other pension fund benchmarks around the world.

With this in mind, it was gratifying to see one of the most respected minds in the industry, Ken Marshmann of JANA Investment Advisers, which is also a leading super fund advisor, point out precisely these hazards in a recent speech.

According to the Financial Standard, "JANA's longtime investment expert, Ken Marshman, predicts there's a 25 per cent chance that equities as an asset class will deliver low to zero returns over the next 20 years - a grim reality that should spur trustees to start lowering the risk in their existing portfolios today."

Another leading journal, Super Review, added:
"Superannuation trustees need to reduce their reliance on equities to deliver returns if they want to reduce their risk exposure, according to JANA Investment Advisers' head of investment outcomes, Ken Marshman...The financial crisis had proven that investment portfolios were taking on a lot more investment risk in equity than they thought, and part of the cause was the tendency of super trustees to introduce risk into asset classes that were meant to increase diversity, Marshman said. “It was unlikely that we will want to, or can, reduce our risk levels that much. And in the context of that, I think our responsibility is therefore to lighten our reliance on equities within portfolios to deliver our returns,” he said. The industry needed to turn to tried and tested methods such as fixed interest and more non-market based strategies to deliver returns to investors, he said."
As I have pointed out on countless occasions now to, frankly speaking, our commercial detriment (given that many vested interests find it confronting when folks like us speak out), the chief casualties of Australian super funds' love affair with shares have been fixed income investments (bonds, bills, corporate debt, RMBS, CMBS and government debt), which have around one third to half the risk of equities but yield attractive raw returns. That is, they smash all forms of equities--including private equity and hedge funds--on a risk-adjusted basis.

Here it is sobering to note that over the last 30 years international shares has underperformed government debt with much higher risk.