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Accumulation Default Investment Strategy
QSuper Case Study
Rosemary Vilgan – CEO
ICPM Discussion Forum
October 2013
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1. Understanding risks from a member perspective
2. 1st and 2nd generation investment strategy responses
3. QSuper’s response – 3rd generation ALM and supporting
influences
4. Investment process and principles
5. The first cohorts
6. Conclusion
Agenda
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• QSuper’s objective for Default Option was CPI + 4% pa over ten years.
• Little relevance to members
− longer or shorter horizons than 10 years
− risk tolerances change with age and account balance
− accrue an IRR not a time-weighted return
• They will understand an objective to accrue a dollar amount
− Fixed dollar amount (e.g. $500,000)
− “ASFA (Industry Association) Comfortable” income level (e.g.
$40,000 pa).
− Individual replacement rate (e.g. 70% of salary)
• The Trustee will set a specific target for each cohort of default
members
Understanding members’objectives
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Sequence of returns matter
1930-50: 2.0 %/yr
Source: New York Times 01/02/11, “In Investing, It’s When You Start and When You Finish”
Best 20 year return 1948-68: 8.4 %/yr
Worst 20 year return 1961-81: -2.0 %/yr
2nd best 20 years 1979-99: 8.2 %/yr
Expectations are 7% pa real (areas in green) This is rare over 20 years or longer Stable returns over 60 or 70 year periods
0% +3% +7% +10%
Average real annual return for S&P500 (includes dividends and taxes)
Australia is no different! 10 years average real returns since 1980: • minimum of 1.3% (2010) • maximum of 9.2%
(1992)
Outline squares show investment returns after 20 years
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• The Board endorsed the Lifetime Accumulation strategy
• First steps: changed Balanced (Default) Option (objective and
strategy) and withdrawn from surveys
• Subsequent steps:
− Segment default Accumulation members into meaningful cohorts
− Developing investment strategy for each cohort using asset-
liability management (ALM) principles
− Strategies will be managed dynamically into the future as cohorts
and risks change
− A range of complementary non-investment initiatives
• Goal: exercise fiduciary authority to accumulate assets and transition
to maintain retirement income
The path QSuper is following
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• Use age as a starting point. Age is a good proxy for:
− Investment horizons
− Member risk tolerance around adequacy vs. certainty
• But it is imperative to also include other factors:
Account balance Contribution rate
Salary Variable retirement dates (later)
• Make assumptions regarding unknown data
• Establish homogeneous cohorts with reasonably narrow distributions.
Accept and understand the shortcomings of averages.
• Similar in some concepts to a DB Fund measure of solvency.
Segmenting cohorts of default members
Funded status
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Investment theory
• Asset-liability management: well advanced in DB funds – adapt
principles and theory
• Behavioural finance research
• Short and long term volatility is difficult to manage against
• It does not represent true risk to members
• Risks change when transitioned from relative returns to absolute
returns
• Key investment risk factors
− Inflation
− Interest rates
− Economic growth (profits)
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• Forecast assets and liabilities under plausible future scenarios.
• Iterate to the best trade-off of income quantum vs. certainty.
• A fundamental tenet of ALM framework (contrasts with our past default):
− Start from an evaluation of outcomes assuming assets are fully
invested in the risk-free asset; then
− Evaluate outcome of adding risky assets (i.e. add investment risk
only to the extent warranted).
• Monitor the progress to the target over time and manage dynamically:
− Decide how much and when to add risk; which is
− A function of the ALM situation (surplus) and the ex-ante economic
and investment environment.
Setting strategy
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• Invest “to” not “through” retirement.
• Define risk as not achieving the retirement income objective, rather
than volatility of asset returns.
• Respond to changing investment environment and cohort
characteristics. Not a static lifetime glide-path.
• Default members have asymmetric risk preferences.
− Adopt a conservative bias for default members, with opt-out
provision.
− Emphasise short-fall and down-side risk metrics.
• Use the risk-free strategy as an ALM benchmark. Add investment risk
(quantity and timing) when it appears to be rewarding.
Some emerging ALM principles
“When” not “if”
• In 10 years time, would you ignore what you know about your
members?
• Funds will become advice engines; even to default members
• This will invert current business plans
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Investment and Administration platform
Education and marketing
segmentation
Advice
Personal advice
Mass Fund
Driven Advice
Investment and Administration platform
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• Cohort 1 is underway:
− 2,100 default members
− Contacted in February 2013
• Outcomes:
− Very few negative comments
− About 25% elected to opt-out
− New strategy executed in April 2013
• Australian MySuper licensing obtained
− A further 51,000 default members in Cohort 2
− Will be executed in December 2013
• Next six cohorts for younger members in 2014
The First Cohorts
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Membership Profile and Analysis
Cohort No# MembersTotal FUMMed Age
Med Balance
30 40 50 60 70 80
$100,000 $100,000
$50,000 $50,000
$500,000 $500,000
$300,000 $300,000
$250,000 $250,000
Cohort 8177,167
$6,002.2m31
$18,012
Cohort 640,125
$4,573.0m45
$95,636
44 Cohort 7$7,900 83,916
$1,123.3m
Cohort 567,158
$1,882.6m53
$16,729
Cohort 414,710
$2,209.6m53
$140,682
Cohort 12,956
$1,574.3m61
$453,572Cohort 33,304
$1,349.8m54
$345,960
Cohort 251,169
$2,580.4m62
$19,522
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Summary of strategies
Age
$100,000
$50,000 H20
H0
40 50 58
Account B
ala
nce
H80
H40 $300,000
$250,000
H20
H30 H60
H0
• The industry often analyses lifecycle strategies using glidepaths.
• While QSuper Lifetime is not a traditional glidepath product we should
remain aware of how it will be perceived by stakeholders.
• The paths of this for the age/account balance cohort structure:
Glidepaths (stylised)
0
20
40
60
80
100
20 25 30 35 40 45 50 55 60 65 70
% G
row
th A
sse
ts
Age
Low Balance Med Balance High Balance Typical Balanced
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• This is a material change to the way we manage default
accumulation members’ assets.
• Initially applied to cohorts and based on average factors (age and
account balance) and investment expectations.
• Not a perfect solution but we start here and improve over time.
Remains flexible (e.g. to incorporate Australian MySuper rules) and
we will move through cohorts methodically.
• Limited number of initial cohorts allows us to test decision making
process and make administrative adjustments.
• Similar ALM methodology has been used in DB fund since 2006.
Summary and conclusion