10 Year Superannuation Returns

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The front page of the Australian Financial Review today (Friday 23rd July) suggests that ‘Balanced’ Funds “have failed to keep pace with investments such as low-risk bonds and gold over the past decade even after posting double-digit gains in the year to June“.

If you move on to page 51 to read the balance of the story, you find that the average (‘median’) super fund has earned 4.6%pa over those 10 years.

4.6%??!!!!, i hear you shout. Yes, 4.6%.

You would have earned 6.4% in fixed income ‘bonds’ and 7.0% in Australian shares. International shares would have shown a return of minus 2.1%pa. You have to ponder that one for a minute or two… That is 2.1% DOWN each and every year for 10 years. Therefore, if you had a higher exposure to global shares (especially in the early part of the decade) and little or no exposure to bonds then you are likely to be close to zero when measuring your 10 year return. 

Cash apparently returned 5.5% pa over the 10 year period. In other words, you would have been better off leaving your money in a (very) high yielding cash account for those 10 years and not bothering with asset allocation, diversification, portfolio efficiency, searching for Alpha, protecting positions, global positioning or any other clever-sounding financial activities. You should have just parked the money in cash and left it there.

If that sounds strange then it’s time to turn off the television at night because the messages from mainstream media are distorting your view of the world. We are in the midst of a generational global shift in conditions. At this point in time, it would be unreasonable to expect anything other than the results above.

It may seem very difficult to digest these kind of numbers as we are continuously told by media of one kind or another that you can make huge pots of money by buying this or selling that. The large changes in valuations over the past 3 years have resulted in a small number of people doing particularly well (i’ll suggest that this is predominantly fluke) and a very large number of people looking over the fence at them and assuming that such returns are available to everyone.

As an example of this, i would point to the current proliferation of ‘trading’ advertisements and articles on tv and in magazines and papers. This happens every time the broad markets bounce after a large fall. It happened in 1994, in 2004 and it’s happening now. The large fall brings about huge discounts to ‘inherent’ value and so companies, properties and businesses can be bought for far less than was the case previously, and sometimes for what are borderline ridiculous prices. As markets recover, and shell-shocked investors realise that the sky is NOT going to fall on their heads, prices return to more ‘normal’ levels and a ‘business-as-usual’ environment gradually rebuilds itself. Those who bought at cheap prices during the falls find that they have done incredibly well. This leads other people to get a bit excited and enter markets in search of similar returns. Those that have done well feel that they have found El Dorado and they start to invest as if such returns are readily available.

It should always be remembered that one or two or three or even 10 good ‘trades’ doesn’t endow you with a crown as a clever investor. A ‘clever’ investor will see that there will be times where the buying is good and there will be times where it is not. The trick is to be able to make money across different market conditions and over an extended period. This is an incredibly difficult thing to do. That is why good fund managers are as highly paid as they are. It is a mix of art and science that is very difficult to master.

Enough background, let’s get to the point of this post…

It is in times such as these that investors will be lured by the siren-song of ‘high returns’ and ‘market-beating performance’. It is times such as these that the institutional marketing machines will move into high gear, selling short term performance and trying to gain a competitive advantage by focussing on narrow points of difference.

Here’s a piece of free advice – DON’T LET YOURSELF BE FOOLED. Not one individual on this planet is able to offer you guaranteed market outperformance without a cost that is likely to exceed any outperformance gained by a comfortable margin.

Here is an example to help put this into perspective. The Australian Financial Review article alludes to it but it doesn’t really put meat on the bones of the issue. The key point being made is that you would have done better to be in a relatively conservative area of bonds rather than the traditional ‘growth’ areas of property and shares. You now need to ask yourself, “why is this?”

We will ponder a picture of the United States 30 year bond rate of return over the past decade or so. (i’m using the US figures as it is easier to obtain a 30 year rate history).

Interest rates for United States 30 year bonds

What does this actually mean?

It means that a 30 year bond that you bought in 1990 would have paid you a consistent annual income of around 8.5% for the last 20 years, and you would have the certainty of knowing that you will continue to earn 8.5% for the remaining 10 years of its term.

Let’s say you paid $100,000 for that bond back in 1990. That means you have earned $8,500 a year for 20 years. If you wanted to buy an $8,500 income from a bond today, you will have to have enough money to buy a bond (that is currently offering 4%) big enough to get you that $8,500. Very roughly speaking, at 4%, you would need to spend $212,500 to earn the equivalent of the income your original $100,000 is paying you! If you decided you wanted to sell your bond, chances are that someone will pay you much more than $100,000 for it!

This is why bonds have done so well over the past 20 years. Now ask yourself what the chances are for interest rates to halve again from the current levels – because that is what would have to happen for a similar performance to be repeated.

From this you can see that the chances of a repeat performance are not particularly high. Interest rates are currently being kept at artificially low levels, in a bid to stabilise economies and rebuild confidence in global banking. However, the money that governments (especially the US and UK) have borrowed to achieve this end will eventually have to be repaid and at that time the competition for available funds will most likely lead to a substantial increase in interest rates.

In the AFR article, MLC’s investment spokesperson suggests that sovereign (ie, country) debt is likely to show a nil return over the next 7 years, and this makes sense when you think about the impact rising interest rates would have on the value of any bonds purchased at current interest rates.

And so we move to the other investment mentioned in the article – GOLD. Fascinating, sparkly stuff is gold. Global production is falling and many investors are looking to gold as a ‘safe haven’ from the potential of high inflation brought about by the US and UK printing money.  The 10 year return from gold is shown as 11.7% pa. Let’s look at just what that does over 10 years…

10 Year US$ Gold chart from www.kitco.com

Oh, My, Goodness…! That was clearly a very good place to be. Why don’t super funds place more money into gold?

The key to interpreting all returns for superannuation funds is to understand that you do not measure performance over fixed periods when trying to work out what to do into the future. If you did, and if you look at the last 10 years then you will place all of your money into gold, bonds, cash or a mixture of these. You would definitely avoid global shares and property. And the chances are that you would be unlikely to meet the average fund return over the next 10 years. Why? Because of a principle known as ‘reversion to the mean’.

What is ‘reversion to the mean’? In this case, it is the idea that returns have an ‘average’ that is displayed over time and across different economic cycles and different parts of each cycle. When the return deviates too far from that ‘mean’ (or average) then there is likely to be a large event to bring that return back to average. In an ideal world, such changes would happen gradually but in the real world that is simply not the case. It is more likely that the longer and further returns move from the mean then the shorter and sharper the correction back to the long term return.

Let’s consider the result of everyone’s favourite – property. Commercial, retail and industrial property had flourished over the last few decades, as interest rates continually fell and the relative attractiveness of a steady, inflation-linked rental income rose and rose. This reached a point in around 2006/07 when the 20 year returns of property exceeded those of the broader sharemarket. That’s fine, you say. No it isn’t, i say. Property is a lumpy, expensive asset that requires continual additions of capital to retain its value. Therefore, it is illogical that it would outperform productive assets (ie, people actively working to produce goods and make money),  which are most visibly reflected in the valuations given to sharemarket listed businesses. In broad terms, the outperformance of property over the broader sharemarket equated to around 1.5% a year. So when the Global Financial Crisis erupted property was reassessed in a credit-constrained environment and the premium over the broader market was wiped away in an incredibly short time. So when the broader market fell 50% (which the sharemarket did at one stage) then the property market fell by around 80%..! So for many, many years investors received very good returns on their property. For late investors they purchased at prices that had ‘excess’ built up over many years, resulting in far more risk than was visible to anyone peeking in. Property is now back to reflecting more of the long term characteristics that it would usually present – such as a yield quite a bit higher than the general marketplace and with that yield being dependent predominantly upon rental income.

And so we could go on and on, looking at various areas where ‘bubbles’ have or are forming. The gold price is one potential area (although some commentators are suggesting the gold price could rise to over $2,000 – and that is true, in the same way that the oil price was predicted to rise to nearly $200 a barrel, which it did – only to fall to around $40 a barrel not long after). Another is residential property in Australia and predominantly in Perth. The valuations of residential property have risen by amounts far greater than the broader market for productive assets. This is a bubble in any terms (keep in mind though that a bubble does not necessarily burst quickly… it can simply show a nil return for many years which has an equivalent effect over the long term).

Is this deviating too far away from the issue of 10 year performance figures for superannuation funds? No. Measuring performance of your superannuation fund is a challenging business and you can rest assured that many supposed ‘experts’ in this field show very little understanding of the true nature of investment returns.

You will see arguments for or against the so-called ‘Industry Funds’ or Retail funds or other groups. Please listen to such claims but keep an open mind. The reporting of returns is a poorly understood process and it is highly unlikely that you would be given enough data on which to form a valid judgement.

For example, ponder this situation…

The super funds, the super industry, the government bodies, regulators and analysts all show superannuation returns on a point-to-point basis. In other words, from one day in time to another day one year/2 years/five/10 years to the day from that point. That becomes the basis on which very large assumptions are made, opinions are formed and decisions are taken. Does this make sense?

NO. Absolutely not. How many people do you know have made a single superannuation contribution that they have left in place for 10 years with no further additions or changes? It is so rare that you can say it does not happen.

A far better measure would be to report the super fund returns for various types of investors – for example, what is the return if you invested every month for 10 years? How about once a year? These figures are far more relevant but i challenge you to find them – anywhere. As an advisor, it takes me a great deal of time to get this kind of information together. How long will it take you?

So next time you read about the long term returns of super funds, pause for just a moment and give consideration to some of the points raised in this note – it might help to bring a little bit of understanding to the highly questionable figures that are being published of late.

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  2 comments for “10 Year Superannuation Returns

  1. dungfungus
    July 27, 2011 at 7:59 am

    I am one of the few that has had my super in cash since 1987 when I lost half of it while it was in a “growth” account. After that I sat down and reviewed the meaning of superannuation and decided it was about preservation and not performance. The sole purpose of superannuation is to have it intact when retirement happens. Most of the babyboomers on the cusp of retirement that I know have lost between 50% and 100% of their super in the past few years by chasing the share market. This is a major social calamity yet to unfold. Currently, Australian banks are offering around 6% for Term Deposits (the highest returns in the developed world). This makes “point to point” reporting an exact science and the high input of daily management is not required so retirement can be enjoyed as it should. With respect, only a fool would have their superannuation in the volatile share or bond markets at this time. I doubt if you will post this but some things have to be said.

  2. July 27, 2011 at 9:38 am

    Hi Dick. Thanks for taking the time to comment.

    You are quite correct in stating that cash makes point-to-point reporting an exact science and in highlighting the difficulties in reporting anything other than cash. While i agree with the idea of superannuation being to preserve capital, i disagree with your inference that holding cash is the only way to obtain that. Preserving capital should be measured as an after inflation benchmark, and with appropriate time scaling. If this is done then there are more ways than one to achieve the same end.

    Unfortunately, fund managers are driven by short term marketing imperatives, and regulators don’t understand the difference between data and information, so the material available to the average person for making decisions is fundamentally flawed. In such an environment, holding funds in cash makes sense. Your own position may completely justify a cash investment and if so then i applaud your efforts – few people will achieve their financial outcomes by remaining entirely in cash and if you are one of them then very well done! However, many folk will not get ahead in the way that they want under that scenario, and they will look to alternatives. This is where the problems of available information comes in. With the GFC there has been a shortening of time frames for the average person. Even so-called expert commentators are now making commentary that is so heavily focussed on last nights’ news that there is no encouragement for the average person to ignore the noise and focus on their long term aims.

    I vividly remember the 1987 sharemarket crash, as i was Customer Service manager for a one of the larger superannaution providers. The building next door housed a large company that had offered its super fund members investment choice, and a lot of them moved from the default option into the sharemarket option (returns had been 50% plus in the preceeding period), right in time to see their value fall by more than 50% with the crash. A lot of those folk called in for help during that time. For those who sought advice and for who it was appropriate to retain exposure to market linked investments, there has been a strong recovery in value and are still ahead – even with the 2008 GFC.

    As a by-the-by, maybe you could join my soapbox and argue with everyone you meet to suggest that the default super option for everyone who does not make an election, is cash? It would then be up to every individual to seek advice or do their own research to establish exactly what exposure to non-cash areas they need, and how much they are comfortable with. Unfortunately, you and i will be in the minority, as the vast bulk of interests in the financial world want to control where a persons’ money is invested.

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