A scenarios-based approach and deeper understanding of risk is needed by super funds if they are to ‘future proof’ their portfolios, delegates at AIST’s (Australian Institute of Superannuation Trustees) Thought Leadership luncheon heard.
“It’s really understanding each sector in your portfolio, working out why you are holding each sector and really stick to those decisions,” said Stephen Howard, head of fixed interest at Vanguard.
He added once the allocation was decided, super funds needed to resist the temptation to tinker with growth and defensive assets, as with so much uncertainty in the world ramping up growth assets in the expectation of getting higher returns could have a large impact if downside events started to play out.
“Now’s the time, more than any time in recent history, to be careful about that decision and maintain those structures,” Howard said.
Nick Bishop, head of fixed income at Aberdeen Asset Management*, also cautioned against relying on a central modal case, recommending instead that super funds should use a risk-adjusted approach that considers upside/downside scenarios.
“Because in some instances it’s not the central case that will hurt you, it’s some of those downside risks which may be unlikely and sitting at the tail, but if they do occur they might massively distort your outcome,” Bishop said.
“The other point is to be very careful about extrapolating from old models that are using historical inputs, as they are awfully less likely to occur in the future. You need to be doing asset allocation on a future-forward basis rather than looking in the rear-view mirror.”
Dividends hurting long-term investing
Bishop also highlighted that investors’ reliance on the “gravy train” of dividends could be damaging to the long-term growth of the economy, as the money was not being invested to increase the capacity of companies.
“The idea that a company might say, “We’ve got good news and bad news. The bad news is that I won’t be paying you a dividend for five years or so, but in 20 or 30 years we are going to be in a great position to be paying you more.” Investors are not willing to stomach that. They’d rather see the dividend train come in. And yet, that is stealing future growth and future capacity in the economy to deliver it today.”
Olivia Engel, managing director and head of active quantitative equity for Asia Pacific at State Street, picked up this argument adding it was an anchoring on the past.
“We are used to having the dividends and we can’t see any other possible way it should be,” Engel said.
“It is weird, because as equity investors you are giving your capital to companies to go and build things for the future. To invest to build new plants, open new divisions and find new things to do with the money, and give it back to you later in the form of good profits. But now you give some money to the company and they give you some back [as a dividend].”
On the subject of future proofing, she added super funds needed to understand the equity concentration risk of their portfolio in a low-growth environment, because of volatility and lack of growth.
“And definitely on a five to ten year view I am not convinced by these negative bonds,” Engel said. “I would be asking if I could rearrange the fixed income allocation so that I don’t have to buy any negative yielding bonds.”
*This story was corrected on 19/07/16 to attribute the quotes to Nick Bishop, head of fixed income at Aberdeen Asset Management.