Compare a pear with a pear, not an apple - Zenith

James Damicoucas is an Investment Analyst at Zenith Investment Partners.

Before choosing a super option, James Damicoucas says it's vital for investors to look under the hood and ensure the allocation to growth assets is consistent with their ability and willingness to assume risk

Given the ramp-up in advertising in recent years by Industry Super Funds, retail investors are increasingly (and rightfully so) comparing their performance to that of super options. However, due to limited information, this comparison is not straightforward and is often misleading. Zenith has sought to shed light on the topic and provide investors with the knowledge to appropriately compare the pair.

A lot of the above-mentioned advertising focuses on comparing ‘Balanced’ portfolios. However, what constitutes a Balanced portfolio isn’t standardised. Zenith advocates for a 60 per cent/40 per cent split, in terms of growth and defensive assets.

At a very basic level, growth assets are riskier investments, such as equities, property and certain alternatives. Defensive assets typically include traditional fixed interest and cash.

However, without an industry standard as to what constitutes a growth or defensive asset, differences in categorisation leads to portfolios with the same branding (e.g. Balanced) having divergent levels of embedded risk.

To further complicate things, Industry Super Fund investment portfolios exhibit a low level of transparency. As a result, investors have little clarity as to what they are invested in and where the risks lie.

That said, from what Zenith has observed in a low rate environment, Industry Super Funds have been replacing low yielding fixed income exposures with assets, such as direct property and infrastructure. These assets create a grey area, as they could be classified as being growth, defensive or a combination of each, depending on your view.

Given their size, continued strong inflows of the Superannuation Guarantee Charge (superannuation member contributions) and typically young membership base, Industry Super Funds are able to assume the illiquidity risk associated with such assets.

While Zenith sees the merit in investing in these types of assets, given appropriate vehicles and time horizons, we don’t believe they are an equal risk substitute for traditional fixed income on an overall portfolio risk basis. In our view, based on the return profile, illiquidity risk, the level of gearing, and the experience of unlisted property assets during the GFC, we would argue they are growth assets.

This level of subjectivity when classifying assets has a material impact on the growth/defensive split of portfolios. In Chart 1, we have reclassified the assets as per Zenith’s definition of growth and defensive assets for a subset of Industry Super Funds to demonstrate the deviation from a typical Balanced split of 60 per cent/40 per cent.

An example of this asset allocation is the Australian Super Balanced pre-mixed portfolio that has a 21 per cent allocation to income assets and a 79 per cent allocation to growth assets based on Zenith’s asset class definitions. This is a far cry from a 60 per cent/40 per cent Balanced portfolio and more aligned to a Growth or even High Growth risk profile. This dispersion in asset allocation makes it challenging for investors to compare the absolute performance of Industry Super Funds to that of portfolios with the same risk profile name.

Investors need to keep this in mind when looking at performance league tables. Depending on the table, a Balanced option could have anything from 60 per cent to 80 per cent growth assets, which could be even higher depending on how direct property and infrastructure is classified by the super fund.

In short, the name of the investment option does not mean the underlying asset allocation and therefore, risk level, is the same for all investment options with the same name.

As per Industry Super Fund standards, performance results are disclosed after tax, which will account for tax payable and franking credit rebate. Conversely, many model portfolios will not disclose performance results net of tax.

Unlike Industry Super Funds, model portfolios can be invested in several capacities (e.g. individual, company, trust and so forth), all of which are taxed differently. Therefore, it is not feasible to accurately disclose after tax returns for model portfolios. This is an additional layer of complexity that makes performance comparison even more cumbersome.

In an effort to overcome this dilemma, Zenith has compared a subset of Industry Super Funds with risk profiles termed ‘Balanced’ or the mySuper default option to that of Zenith’s rated ‘MultiAsset - Balanced’ universe and Zenith’s Elite Blends Balanced portfolio.

To form a sense of standardisation, we have compared the five-year annualised return (after investment fees and tax) against the Strategic Asset Allocation to growth assets (reclassified under Zenith’s categorisation of defensive and growth assets).

From Chart 2, it is clear that the average allocation to growth assets for the Industry Super Funds (Balanced) subset is substantially higher than the 35 per cent to 60 per cent range for the Zenith ‘MultiAsset - Balanced’ peer group. This gives context for Industry Super Funds having higher absolute performance results over the medium term, particularly given the positive performance in direct property/infrastructure assets.

To enable a fair comparison, we have included a trend line based on the Zenith Rated universe that represents the anticipated level of five-year annualised return for all allocations to growth assets. Despite their excessive allocation to growth assets, the Industry Super Fund (Balanced) subset average five-year annualised return is in line with the return expectations trend line.

We have also included a subset of Industry Super Funds with risk profiles termed ‘Conservative’, as the allocation to growth assets for these portfolios is more aligned with the ‘Multi-Asset - Balanced' peer group. Similar to the Balanced Industry Super Fund subset, the Conservative subset broadly follows the expected return trend line.

Investors need to be aware that the name of an Industry Super Fund risk profile is often not indicative of the level of embedded risk. In most cases, Industry Super Funds allocate a much higher exposure to growth assets and therefore, their absolute performance is not comparable to portfolios with the same risk profile name or volatility (i.e. they are riskier).

Before choosing a super option, it is vital for investors to look under the hood and ensure the allocation to growth assets is consistent with their ability and willingness to assume risk.

Zenith understands the limitations of the above study, given the level of transparency provided by Industry Super Funds and due to the assumptions required. Nonetheless, we believe it highlights that performance across all super options is broadly consistent over the medium to long-term, and as one would expect, that asset allocation is the main driver of return dispersion.

James Damicoucas is an Investment Analyst at Zenith Investment Partners.

When determining the growth/defensive split of portfolios the following asset classes are deemed defensive assets:

• Cash
• Australian Fixed Income
• Global Fixed Income

The following assets are deemed growth assets:

• Australian Shares
• International Shares
• Property
• Infrastructure
• Alternatives
• Other Assets

All return data is annualised over five years ending 30 June 2019. Returns are net of investment fees and after tax for accumulation portfolios. In order to convert both the Zenith Rated Universe and Zenith Elite Blends portfolios to after tax returns the following assumptions are made:

• Capital gains discount is ignored, and all distributed income is taxed at the accumulation rate.
• Franking credit yield is calculated as follows:
  - Franking credit yield for each financial year is based on ATO estimates that assumes a portfolio consists of the All Ordinaries Index.

• The franking credit yield is multiplied by the portfolio’s Strategic Asset Allocation for Australian Shares as an estimate for exposure to Australian Shares for each financial year.
• The yield is then multiplied by 70 per cent to account for approximately 30 per cent of Australian Shares that are within the micro cap and small cap universe and are unlikely to pay dividends.

Universes

The Zenith Balanced Rated universe consists of all funds in the ‘Multi-Asset - Balanced’ peer group, with an inception long enough to allow for five year annualised returns as at 30 June 2019.

The Industry Super Fund (Balanced) subset consists of the following:

• CBUS Growth (mySuper Default)
• Energy Super Balanced
• Equip Super Balanced
• Hesta Core Pool
• Host Plus Balanced
• LUCRF Super Balanced
• Media Super Balanced
• NGS Super Balanced
• QSuper Balanced
• Rest Balanced
• Sunsuper Balanced
• TWU Super Balanced
• UniSuper Balanced

The Industry Super Fund (Conservative) subset consists of the following:

• Australian Super Conservative Balanced
• CareSuper Conservative Balanced
• Catholic Super Conservative
• Energy Super Stable
• Equip Super Conservative
• Hesta Conservative Pool
• Host Plus Conservative Balanced
• LUCRF Super Conservative
• NGS Super Defensive
• Rest Capital Stable
• Sunsuper Conservative
• UniSuper Conservative