Like it or not, investing to grow a retirement nest egg involves taking some risks.
Super funds use a variety of strategies to help reduce the inevitable investment risks they face as they work to deliver good investment returns to their members.
To help you understand how your fund is investing your super savings, here’s a simple explanation of some of the time-honoured approaches it uses and how they work.
How your super fund invests your savings
The best defence against the uncertainty of investment markets is a clear plan.
Every super fund is required by the Australian Prudential Regulation Authority (APRA) to have a clear, long-term investment strategy to help guide the fund and its investment activities.
This strategy is designed to achieve the super fund’s core objective, which is to ensure it has sufficient assets available to pay every fund member’s benefits when they retire.
As part of their investment strategy, super funds establish set allocations for each asset class within a minimum and maximum range (for example, 40–55% in Australian shares). This medium- to long-term strategic asset allocation (SAA) is reviewed annually.
In addition, most super funds set targets based on their view of the future medium-term investment environment (around 5 years) and these are reviewed quarterly.
At any particular time, the super fund’s actual allocation to a particular asset class may be different to its target due to movements in investment markets and cash flows. The fund’s position is regularly monitored by its investment team and rebalanced back towards the target whenever it approaches the minimum or maximum range.
For more about investment risk, read SuperGuide article 9 investment risks and how they can affect your super.
7 investment strategies used by your super fund
1. Balance risk and return
It’s a fundamental principle of investing that the higher the risk, the higher the potential return. Super funds aim to spread their investment risk by investing in a combination of both low and higher risk investments.
Safe investments like term deposits might help avoid risk, but their returns are usually lower, so super funds need to balance these with some higher risk investments. These assets (like shares) involve more risk but have the potential to deliver higher returns. This strategy also helps to smooth the volatile returns delivered by the different asset classes each year.
2. Ride out volatility
Another important investment strategy is avoiding changes to your planned asset allocation in response to a single market event, or predictions of disaster. Most investment markets have regular ups and downs but eventually recover, so swapping between asset classes often means missing out on the upswing.
Super funds avoid this by setting a long-term SAA, which outlines the planned allocation for each asset class. This stops your fund from reacting to every change in market conditions and helps keep the focus on the long-term performance of the particular asset class.
For more information, read SuperGuide article Understanding the dynamics on which your super fund invests.
3. Diversify the assets
The best protection against unpredictable investment markets is diversification. That’s why ‘Don’t put all your eggs in one basket’ remains a key investment rule. Big super funds always spread their investments across a variety of asset classes, including those outside the familiar ones like shares and cash.
By diversifying across and within asset classes, your super fund aims to reduce the impact of volatility within a single asset class. It also means the super fund’s investment returns are not reliant on a single asset class performing well all the time.
For more information, read SuperGuide article Why big super funds diversify and what you can learn from it.
4. Keep costs down
Carefully monitoring investment costs – whether it’s the starting valuation of an asset or the management fees from the investment process – matters a lot in successful investing. The cheaper you can buy an asset, the higher its potential return. When it comes holding an investment, if it costs a lot to own, the potential return is usually lower.
Your super fund aims to improve its investment returns by buying assets when prices are low. It also constantly looks for ways to reduce the fees it pays during the investment process. This can include investing directly, rather than through high cost investment managers or strategies.
For more about investment fees, read SuperGuide article 10 key super fund fees: What are they and why am I paying them?.
5. Use active management
Active investment managers try to outperform their benchmark or index by picking sectors and securities they believe will outperform in the future. They constantly seek out the best investment opportunities both here and overseas.
Although active management can be expensive, it is often the only way to access complex investments or unlisted assets, or an investment manager’s particular style of investing.
Most big super funds use active management for some or all of their investments. They seek to add value by choosing specialised assets or investment styles the fund’s trustees believe have the potential to deliver higher investment returns to your super account.
For more about unlisted and listed assets, read SuperGuide article Super investing: What are listed and unlisted investments?
6. Exploit passive management (or indexing)
Passive management on the other hand, aims to replicate the performance of a particular investment market or sector, rather than trying to outperform it. Indexing is based on the idea that trying to consistently pick which securities will outperform is impossible. Instead, indexing aims to deliver the same investment return as the benchmark – without the high cost of active management.
Your super fund uses indexing to maximise diversification and reduce investment risk in its portfolio. Buying and holding securities for a long period (rather than the regular buying and selling that goes with active management), also lowers investment costs and improves the investment return you receive.
Some super funds blend active and passive investing in a core plus satellite investment approach. This involves investing the core of the super fund’s portfolio in index investments, with the remainder being invested in a series of actively managed satellites that have the potential to deliver higher returns.
For more about indexes, read SuperGuide article Investment indexes: 5 reasons they matter for your super.
7. Regularly rebalance the portfolio
Different asset classes will produce different investment returns over the same time period. This means the actual allocation of assets within a portfolio moves over time. If an asset class performs particularly well, its value may rise above its target range in the fund’s SAA. As a result, the fund’s portfolio may have a higher level of investment risk than intended.
Your super fund regularly rebalances its portfolio to ensure its targets and long-term SAA remain in place. This may involve selling successful assets and replacing them with an asset class that is currently not performing as well. The aim is to reduce the investment risk within the fund’s portfolio and to ensure it is exposed to asset classes that are likely to perform well in the future – not just those that performed well in the past.
For more about investment strategies, read SuperGuide article How to create an SMSF investment strategy (including examples).
Learn more about risk in the following SuperGuide articles:
- How to grow your super: Know your risk profile
- 9 investment risks and how they can affect your super
- 5 ways sequencing risk affects your retirement
- Risk and returns: Getting the balance right
- Risk profiling and your investment choice
- Longevity risk: How deferred annuities can help your savings last as long as you do