Investment in fixed interest: A conversation we have to have

Last month the Association of Superannuation Funds of Australia (ASFA) brought together the superannuation industry and many external stakeholders to discuss the role of fixed interest investments in superannuation portfolios. While newspapers rightly paid attention to the comments by former Secretary to the Treasury Ken Henry that there is a need for super funds to consider their overall allocation to equities, the forum also featured former US Vice President Al Gore voicing his concerns about the structure of the financial services industry and a panel of experts that debated the merits and challenges of creating a deep and liquid corporate bond market.

It is important to understand that the discussion on the role of fixed interest investment in superannuation portfolios is not about the relative attractiveness of bond investments today. As some commentators at the forum pointed out, bond markets have had a strong recent performance history and may have peaked. Now may, or may not, be the time to increase exposure to bonds. This is however not the question. What the industry is debating is the long-term structure of superannuation portfolios and the appropriate place of fixed interest investments, given the changed investment landscape and ageing demographics.

Australian default superannuation funds do have high allocation to growth assets. The argument in favour of this is that if you are a long-term investor, which superannuation fund members are, you have a long period of time where you can ride out short-term fluctuations. Growth assets such as equities and property do historically outperform bonds.

But, as Ken Henry points out, one of the issues that superannuation fund members face is sequence risk; that is, the timing of when an individual enters and leaves work. Fluctuations in markets in the short term can significantly impact the balance of a superannuation fund member. The impact of a significant capital market event on a superannuation account balance is very different depending on whether you are 16 or 60. This is one of the reasons ASFA pushed for ‘lifestyle’ portfolios to be allowed in a MySuper offering.

However, ASFA does not advocate (and never has) a ‘directed approach’ to investments. In fact, ASFA was born 50 years ago to rally against the then Government’s 30:20 rule.

The issue that we now face as a nation is that many of our 4.5 million baby boomers will make decisions to retire over the next decade. We should expect that the ageing of Australia’s population will lead to increased demand for fixed interest investments through retirement income products. It is also possible that superannuation fund trustees will increase their allocation to domestic and international fixed interest investments as a part of their asset allocation strategies.

Trustees must make a call on the balance of long-term investing and liquidity needs. One of the reasons super funds invest in bonds overseas is to access a liquid market and be able to quickly sell an asset at a fair market price. One of the principles of Australia’s superannuation system is portability, which allows individual super fund members to move to a fund of their own choice. Choice of fund has many benefits but one of the costs is that superannuation funds need to ensure they are able to manage their liquidity in such a way that if members ask to transfer out of the fund, they are able to do so quickly.

The super industry is very mindful of the important role the super pool of assets must make in the Australian economy. Corporate bonds and debt markets have a key role to play here and the industry believes it to be extremely important that steps are taken to determine what, if anything, can be done to develop the market here. We agree that issuers should not need to travel to the US to raise debt and super funds should have the option of not incurring transaction costs and hedging currency risk.

The industry has a role in ensuring that it is able to invest in a broad cross-section of assets. The role of super in fixed interest is part of the wider conversation on how we ensure that the super pool drives the economy, sustainable long-term returns and adequate retirement incomes. This must be an open dialogue with industry outsiders and must also cover infrastructure investment, the makeup of the ASX and the role of environment, social and governance issues in long-term performance. The only way we can ensure dialogue is fruitful is to have conversations with the wider community and move both the community and commentators away from short-term benchmarking and to longer term value performance.