Multi- Asset Group Chief Investment Officer
Getting people engaged with their superannuation is the holy grail for the industry. AMP Capital Multi- Asset Group Chief Investment Officer Sean Henaghan looks at how lifecycle funds can help.
Increasing customer engagement with superannuation – the holy grail for our industry – is a slow process. The road to that holy grail is paved with challenges, not least of all the intangibility of retirement, particularly for younger customers.
What excites me, however, is the role lifecycle funds and MySuper can play in getting us closer to achieving greater customer engagement with superannuation.
Lifecycle funds, otherwise known as target-date or agebased funds, invest in a predetermined way depending on the age of the customer. The asset allocation shifts as the time horizon changes and the customer moves towards retirement. They are particularly popular in the US.
The key thing about lifecycle funds is that performance is not the sole focus. The primary focus is the final outcome: delivering a suitable level of income at retirement. Performance is a key component but not the driving force.
An evolving system
Defined benefit funds were once the mainstay of the superannuation industry. One of the advantages of defined benefit funds was that assumptions were made about the path of assets and liabilities. Every year, the defined benefit fund’s return expectation was reviewed. As a customer, you knew what income you were set to receive at retirement and, therefore, you could plan for it.
Today, defined contribution funds are the norm. But the primary measure for success for defined contribution funds is past performance. Being a backward-looking metric, customers don’t have a future figure they can plan around.
Incidentally, the industry in The Netherlands is doing some interesting work around ‘defined ambition’ funds, which are midway between a defined benefit and defined contribution fund. Both the company and the employee are focused on ensuring an adequate pension in retirement. The employer aims to deliver a certain retirement outcome but the system is sufficiently fluid to allow for the outcome to be lower (or higher) depending on market risk. Either way, the benefit to customers is they have a more certain outcome.
The downside to peer-relative performance
Another prevalent measure of success in our industry today is performance in relative terms i.e. against a peer group or a benchmark. This can provide fiduciaries with important information about the success of manager selection or the management of business risk. However, it provides no information to the customer about whether their retirement strategy is on track. What does it mean to a customer if a fund is a ‘second-quartile performer’? This is partly why engagement is so low.
As an industry, we’re blinkered by performance figures. Of course, it’s critical that a fund performs well over one, three, five and ten years. However, it’s just as important to look forward and consider whether a fund will deliver a suitable level of income at the end of a customer’s working life. This is ultimately what customers are concerned with and so they are much more likely to be engaged with a fund that focuses on this outcome such as a lifecycle fund. Lifecycle funds create a much better platform for customer engagement, which is one of the reasons why AMP chose to use them as part of our MySuper solution.
So what are lifecycle funds?
Lifecycle funds see default members grouped by age into a cohort, the management of which is specifically targeted to reflect the average age of the member in that cohort. The fund manager looking after each cohort aims to optimise customers’ income in retirement and also to increase the certainty of achieving that outcome. In the early years, it’s about maximising return. But as members mature, certainty of outcome becomes more important.
The way the portfolio is managed is critical. It’s fair to say a traditional 70/30 balanced fund will, on average, produce a larger balance than a lifecycle fund. Though it is only when the customer is aged in his or her late 50s that the return profiles of the two funds cross. However, if the intent is to produce, on average, the highest possible balance at age 65, why not run a high-growth strategy? As most would agree, a high-growth strategy is not appropriate given the significant sequencing risk (the risk share and other growth asset markets will fall substantially just as the customer is nearing retirement thus wiping value from their portfolio).
The intent of the lifecycle fund is to manage the competing objectives of maximising return while minimising sequencing risk. This is best expressed through the metaphor of crossing a river. While a river may, on average, be four foot deep, a quarter of the people crossing the river risk drowning because there are pockets that are seven or eight foot deep. The fact the average depth of the river is four foot is actually irrelevant. Our intention is to get as many people as possible across the river without drowning.
This is why we’ve taken an age-based approach, and why we manage our MySuper lifecycle funds very actively. We haven’t dumbed them down. We’ve picked the investments that make the most sense, discarded those that don’t, and rejected the temptation to de-risk too quickly. It’s been a great process as it’s made us think about things in new and different ways. We canvassed the globe for examples of innovation, thought leadership and best practice. And I think we’ve created a world-class product for customers. Just because certain customers are disengaged and in a default product, doesn’t mean they should be any worse off.
Why communication is critical to customer engagement
But having a great product alone will not get us to the holy grail. Communication is critical. Telling a customer their fund outperformed 50 per cent of superannuation funds in the industry during the last three years provides no meaningful information about whether that customer is closer to a comfortable retirement. Instead, we need to focus on whether the fund is on track to meeting its objective. The objectives of AMP’s lifecycle funds are specifically designed around customers’ retirement needs, so that should be the key success metric and embedded into customer communications.
Our ultimate aim is for our MySuper customer communications to look and feel different to what people are used to. Communications should directly reflect how each age-based cohort is managed. While we expect communications will, initially, be built around the average member in an age cohort, future iterations could focus on individual customers’ specific circumstances (and potentially also include assets outside of super). An expected income in retirement (in today's dollars) is far more relevant than a current lump sum dollar value. This might also serve to dissipate investor concerns about short-term volatility as it helps to remind customers that superannuation is a longterm investment. Notably, there is nothing stopping a typical balanced fund employing customised communication.
Referencing the average customer age, we can also target the tone of the communication and the method of delivery. For example, language, collateral and branding for the 1950s cohort should be very different to that for the 1990s cohort. For the latter, everything might be done virtually! It comes back to having customers’ needs and wants at the centre of the process, and tailoring accordingly. This can only serve to improve customer engagement and interest.
You will see AMP’s lifecycle fund customer communications begin to change later in the year when we start moving existing default customers into MySuper.
Of course, lifecycle funds aren’t the panacea for engagement and the various issues our industry faces. As with anything, there are risks. An aspect of lifecycle funds that can make people nervous is the question of whether there some sort guarantee is implied. The industry must tread carefully here. There are no guarantees with investing, and the lifecycle funds remain at the mercy of market risk. The challenge is to create a process whereby we can talk about this risk openly. We want to talk directly to customers about the action they can take to ensure they meet their goals in retirement, whether that’s increasing their contributions or planning to work a little longer.
At AMP, we’re proud of our MySuper offering and we believe we have created something that is going to improve customers’ retirement outcomes as well as their level of engagement with superannuation.
By demonstrating to customers that we’re delivering a product that really matters and increasing transparency around retirement outcomes, we also have the chance to improve trust in the industry and prove to our customers we’re creating products that are all about them and not about us.
The hope is this will lead to customers participating more actively in their super; for example, moving out of default. The more people we can get interested in how they’re going to fund their retirement, the better. Success is getting customers thinking about their retirement on their own. I think we’ll see more of this in the coming years, thanks in part to MySuper. And that is when we’ll know we’ve reached the holy grail.
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