Vanguard's Super Offering: Lifecycle Investing

Vanguard, one of the largest investment managers in the world, last week unveiled a superannuation product specifically tailored to the Australian market. While many Vanguard managed funds and exchange traded funds are already used in superannuation portfolios, this is the first time they have developed a specific superannuation product.

The history of Vanguard is intricately tied to the development of index funds — low-cost investment alternatives that hold all of the assets in a market or index. It is unsurprising, then, that one of the benefits of the new offering emphasised by Vanguard is its low cost, 0.58 per cent pa, well below the cost of the average commercial superannuation fund.

An element of the fund that is arguably more interesting is the ability to choose the Lifecycle investing option. Lifecycle investing refers to an investment strategy where your asset allocation adjusts over time, moving toward a more defensive asset allocation as you get older and rely more on your investments to replace your income. The following diagram from Vanguard shows the mix of growth and defensive assets in a portfolio over time.

For those interested in seeing the asset allocation of the fund adjust based on age, the following link includes a sliding age option where you can change the age and watch how the asset allocation of the fund adjusts: Lifecycle | Vanguard's Default MySuper Product | Vanguard Super.

The following table sets out the annual adjustments as the fund starts to move from the starting 90 per cent growth, 10 per cent defensive mix to build more defensive assets, as an example of how the lifecycle strategy works over time.

Home Country Bias

By age 64 the fund shows a 50 per cent growth and 50 per cent defensive asset allocation. The asset allocation (from the Vanguard website) is set out below:

Looking at the asset allocation of professional fund managers often provides interesting insights for retail investors and their portfolios. Two elements spring to mind from this Vanguard asset allocation — home country bias and the use of hedging in the international element of the portfolio.

The Vanguard portfolio has 20 per cent of the portfolio invested in Australian shares and 26.5 per cent invested in international shares (international shares, international shares hedged and emerging markets). Very few Australian investors who make their own asset allocation decisions hold a greater share of international stocks than Australian shares. The Vanguard allocation might be a useful reminder to consider whether the portfolios we are responsible for have enough international exposure. The use of international shares in both currency unhedged and hedged reminds us of the power of different sources of diversification in a portfolio, rather than just choosing between one or the other.

Those portfolio observations aside, the more interesting question might be whether lifecycle investing as a strategy is worth considering.

To Lifecycle or Not to Lifecycle?

Lifecycle investing allows an intuitively satisfying approach to having a hands-off investment strategy – allowing your investment asset allocation to adjust over time as your investment horizon changes. Indeed, when you combine this asset-allocation approach with low-cost index investing, you have a very simple, low-cost, well-diversified way of investing.

For most people it provides a simple, hands-off way of organising their superannuation. However, it is not without drawbacks.

A key element in a lifecycle fund is that it largely assumes that people of the same age have similar investment ambitions. This might not always be the case.

Consider two people at age 60, Steven and Chloe. Both intend to retire at age 62. Steven is planning to withdraw all of his superannuation, pay off the balance of his mortgage and travel the world for three years. Chloe is focussed on leaving a significant balance of assets for her grandchildren and is happy to accept volatility in her portfolio in exchange for a higher expected return over time.

In these two scenarios it would probably be prudent for Steven to have almost all his assets invested in cash, because if the share market falls by 50 per cent, as it has done at times in Australia, he would not have time for his superannuation to recover, negatively impacting his ability to pay down his portfolio and travel.

Chloe, on the other hand, may well be comfortable with the majority of her assets invested in growth assets, being prepared to live with the discomfort of potentially higher volatility in exchange for meeting her financial objective of maximising her superannuation balance to pass on to her grandchildren.

That said, putting aside situations like Steven and Chloe, which tend to be at the more extreme of financial objectives for people approaching retirement, a lifecycle approach does potentially provide a simple and effective superannuation solution.

Compare a lifecycle approach to people who use a balanced superannuation fund with a 66 per cent growth allocation all their life. They probably missed out on returns when they were young because it is too conservative for a 25-year-old with 35 years to retirement, and possibly more volatile in retirement than ideal. So, in that case, a lifecycle fund makes sense.

Not All or Nothing

Much like the decision as to whether to have your international shares in a currency hedged or unhedged form, the decision about which superannuation strategy to use does not have to be all or nothing – holding a part of your superannuation assets in a lifecycle strategy while investing other assets with a more individualised approach might make sense.

This counters another criticism of lifecycle investing, that it may not have strategies in place to profit from extreme market movements, like the almost 50 per cent drop in the market during the GFC. Someone who has also built up some cash for strategic purchases can make extra asset purchases during a downturn, as their lifecycle fund would be making purchases to rebalance the growth assets in the portfolio.

Conclusion

For some time we have been promised increased competition in the superannuation alternatives available and Vanguard entering the superannuation market is another example of that. Their relatively low-cost fund, with the opportunity to choose a lifecycle fund as the investment approach, is an interesting addition in the increasing variety of superannuation funds that investors have access to.