How do you create a portfolio that delivers a consistent return of inflation plus 4% with less volatility that a traditional balanced fund? This has been the focus of LUCRF Super’s review of the strategic asset allocation for its member investment choice option.

The Melbourne-based fund, which manages A$3bn ($3.2bn) in assets on behalf of more than 184,000 members, is adding alternatives to help deliver a consistent return of inflation plus 4% with less volatility, compared with equity-centric funds.

Ben Samild, Head of Investment Strategy at LUCRF Super says the fund has been working on an investment option which would be a viable solution for all its members, particularly those who are approaching or already in retirement.

“When super was introduced, it was primarily seen as a compliment to the aged pension, balances were small and the membership often young. In these circumstances a high equity allocation was appropriate.” 

As it happened, the introduction of super in the late 1970s coincided with the bottoming of the equity market and the beginning of a period of strong equity returns and lower than normal volatility. Because of this, Samild notes that “high equity allocations became entrenched” and this trend was “reinforced by the consultant model, which relied on very long-term assumptions, Markowitz models, etc” all of which skewed portfolios towards holding equities.

A fund’s strategic asset allocation should be determined by its objectives: “Is it to maximise wealth? In that case heavy equity allocations can be defended. Is it to provide consistent, reliable income to members in their retirement? In this case, current strategic asset allocations are difficult to defend.”

LUCRF‘s member investment choice offering “still needs to earn a CPI + 4% objective to account for longevity concerns”. The fund will aims to achieve this target- with less volatility when compared to equity-centric funds - by focusing “more on capital preservation, economic diversity and producing returns throughout the economic cycle”.

Recent changes made to the fund’s strategic asset allocation have been in alternative strategies, such as diversified growth funds, rotational credit strategies, hedge funds including managed futures and global macro and low-risk cash plus strategies.

LUCRF is currently in the implementation stage of the recently completed review of its balanced fund’s SAA. Importantly, there was no increase to the balanced fund’s management expense ratio (MER) resulting from the review. Samild explains that a fee neutral outcome was achieved by “allocating our active fee budget toward less efficient markets which have a greater impact on our portfolio’s risk and return profile”.

Samild says the additional allocation to alternative strategies in LUCRF’s member investment choice option will result in “a small increase in MER “but that any increase “will be fairly well contained and the total MER isn’t anticipated to be dramatically different to that of our balanced fund”.

As members generally become more interested in their super as their balance increases or as they approach retirement, Samild feels “this is exactly the time when this kind of (post retirement) product becomes appropriate”. To better educate its members about their retirement needs, Samild points to LUCRF’s investment “in a quality free advice channel for our members” as well as “frequent seminars and workplace visits which are well attended”.