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."

Wednesday, April 4, 2012

Henry, Murray, Cooper and Tanner belatedly back my asset-allocation arguments

I've argued all these asset-allocation points for years in countless Business Spectator columns since 2009. They weren't popular at the time--in fact, they were hard to get published. In January 2009 I wrote over a long, two-part series (containing detailed analysis on the subject here and here):

Australian super funds – which have had every opportunity to diversify their investments across a multiplicity of possible asset-classes – have delivered their members strikingly poor performance over the last one, two and three years.

Yet the 40 per cent plus losses registered by the median super fund’s most important investment holding over the last year or so – listed equities (which consumes about 50 per cent of all super fund capital) – would have been inconceivable in the minds of most pundits prior to the advent of the global financial crisis.

What is even more surprising is how much equities market risk Australian super funds assume. And this exposure is greater than you may think since many so-called 'alternative' asset-classes, such as hedge funds and private equity, are – contrary to their purportedly 'uncorrelated' labels – highly correlated with equity returns. Indeed, it is hard to understand how private equity and many (predominantly long) hedge fund strategies are categorised as distinct investment classes given that the assets that underlie them are largely the same...

The conclusions deriving from this long-term [portfolio optimisation] analysis are interesting: the equilibrium allocation made to Australian equities is between 3.6 per cent and 14.9 per cent...Similarly risky LPTs are afforded just a 3.4 per cent to 4.4 per cent weight. By far the most valuable sources of long-term super fund returns are 10-year government bonds, cash and residential property...

Indeed, it appears that fixed income investments have been especially unrepresented in our super funds’ asset-allocation decisions judging from the latest portfolio weight data that I previously provided.

Applying standard mean-variance analysis to data from the major asset-classes over the last circa three decades one cannot help but arrive at the following conclusion: Australian super fund members deserve an explanation as to why they are being exposed to high levels of potentially avoidable risk, which has only been further highlighted during the recent capital market cataclysm. At the very least, greater transparency is required as to precisely how funds are making their strategic asset-allocation decisions.

I was lambasted for recommending that super funds boost their exposures to Aussie government bonds and cash. Few people appreciate that last year long-term Aussie government bonds gave investors a total return of around 30% (I am now more bullish on equities given the RBA's policy stance).

I was also critical of the Cooper Review for not properly engaging with by far the biggest problem in Australia's superannuation system (ie, asset-allocation). It is nevertheless good to see the likes of Henry, Murray, Cooper and Tanner belatedly endorsing these criticisms today. It would have been perhaps more helpful had Henry done so while he was Treasury Secretary, and it is obviously convenient to suddenly wade into this debate now he sits on the board of a bank that is reliant on the debt capital markets.

It is funny how these ideas take so long to become fashionable, and almost always way after the event (the same could be said of increasing the use of 'shared equity', as opposed to debt, finance in the housing market, which is something that the Bank of England is pushing years too late).

The Australian covers Tanner's remarks on asset-allocation today:

"On any measure, your typical Australian superannuation fund is massively overweight equities. We are 1 to 2 per cent of the world and I'm not aware of any of our super funds that have 1 to 2 per cent invested in Australia" Mr Tanner said.

Mr Tanner said arguments for exposure to equities based on long-term returns were unhelpful and meant nothing to the individual investor who is on the wrong side of a bear market for equities.

"Minimising the extent to which individuals are really going to suffer badly, as some did during the global financial crisis, that is the important dimension. Maximising returns is important, but it is not the only question here, and that to me has been one of the disturbing flavours of this discussion."