Australian superannuation funds are now required to disclose a measurement of risk to fund members, with trustees encouraged to use a standardised measurement backed by regulators and industry peak bodies.
The Standard Risk Measure will provide a rating of a fund’s investment option based on the likely number of negative returns this option is predicted to experience over a 20-year period.
The push to require funds to disclose the risk profile of their investment options comes as part of sweeping reforms to Australia’s superannuation system, which include bolstering the governance standards of funds to bring them in line with the banking and insurance industries.
Two industry organisations, the Association of Superannuation Funds of Australia (ASFA) and the Financial Services Council (FSC) released a standard risk measurement that will be included in funds’ product-disclosure statements.
ASFA claims no other jurisdiction in the world requires funds to disclose a measurement of risk to superannuation members, boasting Australia is leading the world in this type of risk disclosure.
The standard risk measurement was formulated after regulators demanded the industry improve the way it discloses risk to members of Australia’s $1.3-trillion superannuation-fund industry.
The government has agreed to lift the superannuation guarantee from 9 per cent to 12 per cent, but has instigated a series of tough new reforms for the industry.
The increased compulsory contributions are predicted to treble the size of the industry, bringing total assets to more than $3.2 trillion by 2035.
The power of comparison
ASFA says the purpose of the risk measurement will be to provide fund members with a way of comparing investment options both within a fund and across other superannuation funds.
Super funds can use another risk measurement, but must explain to regulators why they have chosen to not adopt the industry standard.
In a statement, ASFA says the move to an industry standard for risk measurement was an important indication to government and regulators that the industry could self-regulate.
“While we know the measure is not perfect, it is an improvement on a complete absence of such information,” ASFA stated.
The standard risk measurement divides investment options into seven risk bands, from very low to very high.
If an investment option is forecast to have six or more negative annual returns over any 20-year period, it falls into the highest band. At the other end of the scale, an investment option predicted to have negative annual returns 0.5 times over the same time period would fall into the lowest band.
For an investment option to be labelled conservative, it must only experience a negative annual return less than twice in a 20-year period.
Conservative bias preferred
The standardised risk measurement is only one component of risk management, with funds required to disclose to regulators risk-management plans.
These should include consideration of the potential size of negative returns and the chance that while returns may be positive, they may be less than what is required to meet the objectives of fund members.
Funds should also consider what risks are associated with a particular investment strategy, such as market, hedging and liquidity risk.
In outlining the methodology for calculating the risk measurement, ASFA warns that underlying assumptions should be structured to reflect a conservative bias. Trustees are permitted to use alpha assumptions but they should also be conservative.
“Trustees should be cautious of using any assumptions that materially reduce the expectation of negative returns,” ASFA and the FSC advise in a guidance paper for trustees.