Risk and returns: Getting the balance right

For younger members with low super balances, the biggest risk is not taking enough risk. By choosing riskier assets they stand a better chance of building wealth in the long run. But even a risk-taking Millennial may be spooked by the impact of a big market correction on their savings.

And that’s the Catch-22 of super. Rappell says members want high returns, but they also want consistent returns. “Unfortunately, higher returns often mean taking on more risk, which means returns will be less consistent,” he says.

The risk/return trade-off

Where super and investing is concerned, risk is generally defined as volatility, or the degree to which returns fluctuate over time.

While super funds regularly report their performance based on net returns, it’s not easy to tell how much risk you’re taking on for the rewards on offer.

Certainly, the investment option provides a clue. High growth options signify higher risk, conservative options are lower risk and balanced options are somewhere in between.

But there is a way to rank funds by their risk-adjusted returns, even funds with the same risk category.

If you would like to know more about how the risk-adjusted return is calculated, see SuperGuide’s explainer, What is the Sharpe ratio and why is it important for your super? If you want to cut to the chase, read on.

Top 10 funds for risk-adjusted returns

SuperRatings has provided SuperGuide with tables of the top 10 funds in their Balanced and Conservative Balanced categories, ranked by their risk-adjusted returns over the last 7 years.

The results may surprise you…

Table 1: Top 10 Balanced funds ranked by risk and return (7 years to 30 June 2019)

#Risk/return ranking determined by Sharpe ratio

*Returns are net of investment fees, tax and implicit asset-based administration fees

**Interim return

Source: SuperRatings

As you can see, the risk-adjusted rankings don’t necessarily line up with the fund’s returns.

Rappell explains the discrepancy: “QSuper’s return of 9.5% a year over the past 7 years is slightly below the average of 10.1% across the Top 10 ranking funds, but it has the best return to risk ratio of its peers, meaning it delivered the best return given the level of risk involved.” “Funds such as CareSuper and HostPlus were able to deliver higher returns, but for a slightly higher level of risk.”

By way of comparison, SuperRatings has also provided a table of the top 10 Balanced funds ranked by performance alone.

Table 2: Top 10 Balanced funds ranked by returns (7 years to 30 Jun 2019)

*Returns are net of investment fees, tax and implicit asset-based administration fees

Source: SuperRatings

What pops out is that Australia’s biggest fund, AustralianSuper, and one of the most-highly awarded, UniSuper are ranked 2 and 3 respectively for their returns. Yet neither appears on the Top 10 ranked by risk and return.

So, what’s going on?

According to Rappell, AustralianSuper ranks highly for performance over 7 years but it was a more volatile ride along the way. He suggests this is because it has more of a bias towards growth in its share portfolio.

One of the things that helps smooth returns from year to year is unlisted assets such as infrastructure and direct property. Industry funds typically have a higher weighting to unlisted assets than retail funds, which helped them ride out the volatility during and immediately after the Global Financial Crisis (GFC).

However, Rappell says UniSuper has less unlisted assets than some industry funds. This is because its members are older than average, so it needs more free cash flow to pay out retirement benefits. And it’s easier to cash out listed assets than, say, a port facility or shopping centre.

This is not to say that UniSuper and AustralianSuper are not excellent funds. It just means that members are taking on slightly more risk to achieve higher returns. While year to year performance may fluctuate, the ability to provide solid returns over the long term has served their members well.

You may also have noticed that QSuper, which tops the risk-adjusted rankings, is absent from the top 10 ranked by returns, which is the price members pay for a smoother ride and a good night’s sleep.

Meanwhile, HostPlus and Cbus make it into the top 4 of both the risk-adjusted and returns rankings. In other words, they have achieved high returns with a smooth glide path across 7 years.

Now let’s look at the top 10 risk-adjusted returns for the conservative investment options where many pre-retirees and retirees invest their super. Many thanks to SuperRatings for providing this table.

Table 3: Top 10 Conservative Balanced pension funds ranked by risk and return (over 7 years to 30 June 2019)

#Risk/return ranking determined by Sharpe ratio

*Returns are net of investment fees, tax and implicit asset-based administration fees

**AP stands for account-based pension

Source: SuperRatings

Once again, while CareSuper holds the honours for the top ranked fund by risk and return it’s not the top-ranked fund by returns alone.

Also, the top 10 returns range from 8.4% to 10.1% which is below the range of 9.4% to 11.1% for the top 10 balanced funds. This is what you would expect given the lower risk profile of conservative options.

Nevertheless, given that inflation over the period was running at close to 2% these conservative options have performed remarkably well for their members. They have grown members’ savings and provided consistent returns along with peace of mind.