Taking a Lifecycle Approach to Investment

Lifecycle funds are a newer than average idea in the Australian investment environment, designed to make investing easier.  They provide an investment solution that automatically adjusts the asset allocation of a portfolio for a person depending on variables – the key variable being the age of the person, and therefore the length of time until the funds are accessed.  This is known as the ‘target  date’, and lifecycle funds are also known as target date funds. 

The key value proposition of these funds is that as the portfolio matures, the asset allocation in the fund will be adjusted to become increasingly made up of defensive assets (cash and fixed interest) decreasing the overall volatility of the fund. 

It is well recognised that one of the key elements of portfolio performance is asset allocation.  The question is; does the lifecycle approach to asset allocation offer value for investors?

Two large superannuation managers in the Australian market offer this style of investment strategy, Q Super (the Queensland Government superannuation fund) and Sunsuper.  We will use these products to look at how lifecycle funds work. (Co-incidentally, Q Super and Sunsuper are in the process of merging to form a $200 billion combined superannuation fund.) 

It is important to mention that within Q Super and Sunsuper there are a significant variety of investment approaches available, including members being able to access direct shares and term deposits within their portfolios through Q Super’s self-invest options, with the lifecycle options just being one investment approach offered.

A Quick Look at an Example

Let’s quickly look at an example to further understand how a Lifecycle fund works.  The Q-Super fund, called the Lifetime strategy, adjusts asset allocation based on a person’s age and account balance.  There are 8 different investment strategies, set out in the table below.

The funds invest in a range of assets including the defensive assets of cash and fixed interest and growth assets including shares, infrastructure and real estate. 

To give an example of the asset allocation changes over time, let’s consider the progression for a person who starts with the outlook options, moves to aspire 2, then focus 2 and finishes with sustain 2.  With the outlook fund (up to age 40), they will have 24.1% in defensive assets and 75.9% in growth assets – a fairly traditional asset allocation for an early superannuation investor. 

At the age of 40 we will assume that they have at least $40,000 accumulated and more to the aspire 2 option, which is 35% defensive assets and 65% growth – a reasonable portfolio for a person in this age group if they are a little conservative. 

At age 50 we assume they have enough to move them into the focus 2 portfolio, which is 42.7% defensive and 57.3% growth before, at age 58, we assume they have build more than $300,000 in assets and shift to the sustain 2, which is 73.8% defensive assets and 26.2% growth assets.

Table of Asset Allocation over Time:

* it is noted that a person won’t move directly from the focus 2 account to the sustain 2 account, and will need to spend a little time in the focus 3 or sustain 1 accounts – however for simplicity we have proceeded with the 4 funds.

There is clearly a simplicity about this strategy – over time the fund increases in defensive assets as a person moves closer to retirement. 

That said, I think three important issues need to be considered by a person employing this strategy including the variety of needs a person may have in retirement, the impact of asset allocation changes on performance and the strategic benefits of controlling asset allocation using ongoing portfolio contributions.

The Variety of Needs in Retirement

Let’s consider two different people retiring at age 65 with $500,000.  One has a plan to have a (post-COVID) worldwide cruise and pay off their mortgage.  The other plans to draw on their superannuation at the minimum rate, hoping it will provide an ongoing superannuation pension stream in their 90’s if needed. 

It is likely that the two people in these examples will have two very different asset allocations as they approach retirement. 

The person looking to a cruise/ mortgage repayment might be suited to the sustain 2 asset allocation of 26.2% growth and 73.8% defensive – they want very little volatility in their portfolio as they intend to spend their funds quickly at retirement. 

However, a person hoping that their assets will still be providing a superannuation pension in 30 years’ time is likely to come to the conclusion that they will be better served with a portfolio exposed to more growth assets.

The Impact of Asset Allocation Change on Performance

We have seen an extraordinary period of sharemarket returns over the past 14 months – a significant fall and then a quick recovery. The last thing an investor wants to do is to be ‘selling low’, that is selling growth assets while investment markets are down. 

However, if you are making a change in asset allocation towards a more defensive one at a point in time, you might be doing that.

Q Super manage the change of investment decisions in this way (from their PDS Investment Choice Guide):

‘Every six months (in May and November) we check your age and Lifetime balance, and if needed, move you to another group’

Last May markets were down fairly sharply – if you were moving from one strategy to another you could be effectively reducing your growth asset allocation (selling growth assets), for example by 10% if you moved from the outlook strategy (75.9% growth assets) to the aspire 2 (65% growth assets). 

A move of this nature reduces the portfolio's ability to rebound when asset values rebound.  Even if the fund manager defers the move for a period, there remains a chance that as the portfolio moves toward defensive assets, exposure to recovery is reduced.

Sunsuper uses a more gradual approach to changing asset allocation to a more defensive one, using contributions and monthly transfers to adjust the portfolio balance towards the more defensive ending balance.

The Strategic Benefit of Controlling Asset Allocation using Ongoing Portfolio Contributions

One of the great benefits of superannuation is that during the accumulation phase you have additional contributions that you can choose how to invest.  It provides a great opportunity to ‘nudge’ the asset allocation of a portfolio, without having to sell assets.

As Warren Buffett’s long-time colleague, Charlie Munger, says: “The first rule of compounding is to never interrupt it unnecessarily.” Selling assets effectively interrupts the compounding effect. 

In contrast, using ongoing contributions to take advantage of market downturns, or to move the portfolio to a more defensive asset allocation by increasing investments in cash/fixed interest investments does not impact existing assets.

Conclusion

While the underlying premise of a lifecycle fund makes reasonable sense, that as an investment portfolio matures it might move to a more defensive asset allocation, my sense is that most informed investors will have better results from taking responsibility for their own asset allocation, particularly with the crucial portfolio decisions around the time of retirement.

Disclosure: The author’s wife has her superannuation invested with Q Super.