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As things stand, it’s left up to super funds to decide whether their investments should be classified as growth or defensive. This might seem arcane, and of little interest to the average fund member, but it has real implications when it comes to comparing funds and returns.
How so?
Your super fund’s exposure to growth assets is commonly used as shorthand for risk – the higher the level of growth assets, the higher the risk – although it is a rough approximation at best.
Even so, research groups such as ChantWest and SuperRatings use the information funds give them to put their investment options into categories such as Balanced, Growth and Defensive and rate their performance.
Financial advisers and individual investors then use these ratings to compare funds. The super fund regulator, the Australian Prudential Regulation Authority (APRA) also uses these growth and defensive risk profiles as part of its heatmap analysis to identify poor performers.
Yet there is no standard measure of risk to guide the way super funds classify their investments as growth or defensive. And this makes it near impossible to compare funds on a like-for-like basis.
A standardised approach
To bring some order to this free-for-all, an industry working group has spent over a year developing proposed standards for classifying growth and defensive components of super fund portfolios.
David Bell, who chaired the working group, says the challenge is to manage the competing tensions of providing a more nuanced way of classifying assets while minimising operational complexity for the funds.
“Growth/defensive categorisation is one of those tough projects – it is complex, controversial and everyone has different views,” he says.
You can jump to their proposal below. But first, a little history.
A brief history
Historically, shares were in the growth basket while cash and bonds made up the defensive part of portfolios. That worked well enough up until the mid-1990s.
Since then, super funds have embraced a much broader range of investments and asset classes. These include unlisted property, unlisted infrastructure, private equity, hedge funds, high yield credit, long duration bonds and other forms of alternative debt.
All these new kids on the block have different growth and defensive characteristics. Sometimes, differences emerge within the same asset class.
For example, an investment in a commercial property with a secure tenant has a reliable income stream that could be regarded as defensive. While investment in a development property is a much riskier proposition, albeit with the potential for high growth. Yet both are property investments that once would have been lumped in the growth basket.
The problem
Currently, funds disclose the proportion of growth and defensive assets in their investment options, but not how they derive these figures. So a while back Chant West asked them.
The table below shows the responses of 32 not-for-profit funds (including 24 industry funds) and eight retail funds as at June 2018.
How super funds classify the growth component of non-traditional assets
Growth asset classification for not-for-profits
| Unlisted property | Unlisted infrastructure | Hedge funds | High yield / emerging market debt | Alternative / other debt | |
|---|---|---|---|---|---|
| 100% growth | 15 | 14 | 6 | 3 | 3 |
| 51–100% growth | 3 | 4 | 3 | 1 | 2 |
| 50% growth | 11 | 13 | 3 | 5 | 8 |
| 1–49% growth | 2 | 1 | 1 | 0 | 2 |
| 0% growth | 1 | 0 | 3 | 7 | 6 |
Growth asset classification for not-for-profits
| Unlisted property | Unlisted infrastructure | Hedge funds | High yield / emerging market debt | Alternative / other debt | |
|---|---|---|---|---|---|
| 100% growth | 6 | 5 | 0 | 3 | 0 |
| 51–100% growth | 1 | 1 | 1 | 0 | 0 |
| 50% growth | 1 | 1 | 1 | 1 | 1 |
| 1–49% growth | 0 | 0 | 0 | 0 | 1 |
| 0% growth | 0 | 1 | 2 | 2 | 2 |
Source: Chant West
Not all funds held assets in all sectors; and some did not provide a growth/defensive split for hedge funds and debt assets, which could fall either way depending on individual risk characteristics.
Even so, as you can see from the table, close to half the not-for-profit funds classed unlisted property and infrastructure as all growth (the traditional approach to these assets), and about 40% treated them as 50/50 growth/defensive.
Some funds break down the growth and defensive components of each asset, often by taking the expected capital growth as the growth component and income as the defensive component. But this is also a broad-brush approach, given that income and growth can both be variable, depending on the nature of the asset and market conditions.
By comparison, around 75% of retail funds classified unlisted property and infrastructure as all growth.
The classification of hedge funds and debt assets was more mixed by both groups of funds due to the wide range of risks within these asset classes.
The responses highlighted the inconsistent approach across and between fund sectors.
Case Study: Hostplus
Hostplus’ Balanced default option has a strategic asset allocation (actual allocations will vary depending on market conditions) of around 76% growth and 24% defensive. According to its website, the asset breakdown is as follows:
| Asset class | % of portfolio |
| Shares | 50% |
| Property | 13% |
| Infrastructure | 12% |
| Private equity | 8% |
| Credit | 7% |
| Alternatives | 5% |
| Diversified fixed interest | 0% |
| Cash | 5% |
| Growth | 76% |
| Defensive | 24% |
As you can see from the table, if the traditional classification of defensive assets as cash and bonds were used, the portfolio would be 95% growth/5% defensive. Instead, Hostplus apportions growth and defensive components to each of its property, infrastructure, credit and alternative investments.
Hostplus chief investment officer Sam Sicilia says: “If you assume only cash and bonds are defensive, we would be 95:5 and we would get booted out of the (Balanced category of the performance) survey.”
In recent years, Hostplus has been among the top performing Balanced funds based on returns over multiple periods. While he argues they would still perform in the top percentile if they were labelled a High Growth fund, they would not stand out as much as they do now.
Sicilia says this would please critics who say funds like Hostplus game the system by not including unlisted property and infrastructure in their growth allocation. As the Chant West survey mentioned earlier shows, retail funds tend to invest in listed versions of these assets that are included in their growth allocation.
“Using a sporting analogy, you either beat the other teams in the competition or you get them booted out of the comp. Either way you win.”
For this reason, Sicilia believes the standardised classification of growth and defensive assets proposed by the Conexus working group (below) is unlikely to keep his detractors happy.
The proposed solution
As mentioned earlier, on 23 July 2020 a group of industry professionals released a set of standards to guide the way funds categorise the growth and defensive portions of their portfolios. They are calling on industry participants to comment by 28 September.
The group of eight includes representatives of retail and industry super funds as well as Chant West and SuperRatings. It is chaired by David Bell, a former fund manager and super fund chief investment officer who now runs the Conexus Institute.
They propose replacing the traditional method of scoring assets as 100% growth or 100% defensive with a more nuanced scoring system.
While equities (including private equity) would remain 100% growth, and cash and traditional fixed interest would remain 100% growth, other assets are broken down into growth and defensive components in a systematic way, rather than the ad hoc approach that exists now. These other asset sectors include unlisted property and infrastructure, alternative assets and high duration bonds.
Funds would also be able to choose a simple scoring system where funds have less than 15% exposure to a sector, and the option of a more detailed approach for higher exposures.
You can find the detailed proposal here. The table below is an excerpt to illustrate the proposed approach for some of the more problematic asset classes.
Proposed growth/defensive scoring for non-traditional investment sectors
| Asset class / sector | Sub-asset-class / sector | Simple scoring | Detailed scoring |
|---|---|---|---|
| Unlisted property | Risk category 1 | 80% growth | 100% growth |
| Risk category 2 | 80% growth | 60% growth / 40% defensive | |
| Unlisted infrastructure | Risk category 1 | 80% growth | 100% growth |
| Risk category 2 | 80% growth | 60% growth / 40% defensive | |
| Alternatives | Includes emerging markets debt, hedge funds, forestry, agriculture commodities, catastrophe bonds, insurance-linked strategies | 75% growth | Apply risk scaling approach |
| Fixed interest | High duration bonds | 60% growth / 40% defensive | Apply risk scaling approach |
Source: Conexus Institute
Industry response
David Bell strongly encourages the industry to actively participate in the consultation process. “All industry feedback is important. It would be great for an industry of this size to be able to develop collaborative solutions to industry problems.”
Early indications are that the superannuation industry broadly supports the proposal’s intent, if not the detail.
An APRA spokesperson said: “APRA recognises the benefits to all superannuation industry stakeholders, including members, of having a widely accepted, consistent approach to categorising and distinguishing between growth and defensive assets.
“On that basis, APRA supports industry-led efforts in this area and encourages all superannuation trustees and other interested stakeholders to participate in the consultation process.
“APRA is closely following the work of the Industry Working Group and intends to participate in the consultation process.”
In a recent interview with Investment Magazine, head of investments at Statewide Super Con Michalakis said: “It’s important we sit down and have a conversation about what is a growth asset. If we can get a code it will be a good outcome for the industry.”
Hostplus chief investment officer Sam Sicilia welcomes the work done by the Conexus working group but doubts it will solve the problem.
“We intend to lodge a submission but, I know that at the end of the day, the group is trying to solve a problem with a limited tool set. It still uses the words ‘growth’ and ‘defensive’, which is problematic because it ignores diversification,” he says.
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