Australian Superannuation Investment Conference, Sept 5th 2013

Bev Durston, Edgehaven Pty Ltd

A tale of two pensions: UK & Australia

• Background and experience• Overview of pensions: UK & Australia• Compare & contrast• DB ideas for DC pension funds• Investment observations• Next generation pensions• Summary

A tale of two pensions: UK & Australia

• Pensions experience in Australia, Singapore & UK

• Head of Portfolio Risk, Global Portfolio Manager, Deputy CIO

• 2008 to 2013: • BA Pensions: Head of Alternative Assets;• DC Trustee for BA Pensions

• Edgehaven Pty Ltd (Royal Mail Pension Plan)

Background and Experience

• Heavy DB influence but now switching focus to DC

• Cutting back on DB promises, closing schemes to future accrual

• Industry dominated by DB assets

• Initiation of “compulsory” DC to broaden the scope of pensions investing

• Australia 20 years ago?

Overview of pensions: UK

Overview of pensions: UK

Overview of pensions: UK

• Heavy focus on accumulation: aim only to produce a pot of money at retirement

• Balances not (yet) big enough for meaningful incomes in retirement

• Longevity risk: Members face a very real risk of running out of money in old age

• Increasing age care costs with no policy (insurance) solution in place

• Members can take 100% cash at retirement

Overview of pensions: Australia

Pension Policy Framework:

Item Australia UK

DC Super contributions Compulsory, 9% Auto enrolled to 8%, opt outTaxation in accumulation Taxed but advantaged Tax freeAt retirement Up to 100% cash Max 25% cashGovt (Age) pension Mean tested Non means testedIncome stream in retirement N/a Forced annuitisation

Compare & contrast

A key difference: No member choice of scheme in the UK Bespoke member analysis: Trustees focus on their

member characteristics and devise policy according to their needs;

No league tables produced which rank returns; No “peer group risk”; No “one size fits all” investment default policy in DC;

Compare & contrast

1. Switch to an income focus in retirement

DB ideas for DC pension funds

1. Switch to an income focus in retirement;

2. Benchmarking: Define your income objective as an inflation linked bond

Gap Analysis: “Glide path” plan to move towards it

DB ideas for DC pension funds

1. Switch to an income focus in retirement

2. Benchmarking: Define your income objective as an inflation linked bond

Gap Analysis: “Glide path” plan to move towards it

3. Manage longevity risk: Build tools to transfer longevity risk Consider annuitisation: Ideally “staged” but possibly

forced

DB ideas for DC pension funds

DC Default investment policy:

“One size fits all” investment is a poor proxy for risk return appetite across time.

• Why is a 25 year old invested identically to a 59 year old?• Do they have the same risk appetite as one approaches a

retirement decision point?

Consider Target date (or Lifecycle) investing

Investment observations

Investment observations

Source Mercer Consulting

DC investment breadth

Why is this different from DB?DC members seem “second class citizens”

Over reliance on equity risk rather than diversified growth

Investment observations

Investment observationsCapital allocation DOES NOT EQUAL risk

Source: Blackrock

Investment observations

Source: Mercer Consulting

Using diversified growth strategies and tapering risk before retirement offers less extreme outcomes than 100% equities:

Investment strategy 100% Equities 50/50 DGF 100% DGF+ Equities

Median income replacement ratio: 70% 72% 69%Downside 1 in 10 chance: 33% 42% 44%Min income replacement ratio: 20% 28% 35%Max income replacement ratio: 220% 150% 125%

(Assuming 40 year investing of 14% contributions and 5 year lifestyle policy)

DC investment breadth

Why is this different from DB?DC members seem “second class citizens”

Inappropriate focus on liquidity rather than on risk

Investment observations

Investment observations

Return %

Equities

Property

Bonds

Cash

Risk %

Using only a risk and return lens this investment strategy look diversified…..

Investment observations

Return %

Equities

Property

Bonds

Cash

Risk %

Using risk and return only it looks diversified…..

More LiquidEquities

Cash Bonds Listed Property

Medium Liquidity

Less Liquid

Property

Risk %But this strategy becomes one dimensional using a liquidity lens

Investment observations

A one dimensional strategy on liquidity misses out on diversifying, less liquid opportunities

More LiquidEquities

Cash Bonds Listed Property

Medium Liquidity

Less Liquid

Property

Risk %

More LiquidEquities

Cash Bonds Listed Property

Medium LiquidityHigh YieldFrontier marketsEmerging mkt debtConvertibles Loans Absolute returnDistressed debt InfrastructureDirect lending

Less Liquid

Property

Risk %

Private Debt

Private Equity

• Recognition that the individual is ill equipped to manage the many risks of DC: The European ideal: risk sharing between employer

and employee

UK considering “Defined Ambition” and “DB minus”

Consider a guaranteed minimum outcome for DC

Next generation pension schemes

• Similar origins for UK and Australian schemes• Australia now moving to focus on the decumulation phase• Ideas from DB may be useful for DC• Investment strategy has evolved beyond one size fits all• Policy changes may be needed• Next generation pensions will be different again…..

Summary

If you do what you’ve always done, you’ll get what you’ve always got. (Henry Ford)

Summary

If you do what you’ve always done, you’ll get what you’ve always got. (Henry Ford) For Australian Super Schemes:“Static is the new risk”

Summary

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