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Most growth funds (which are the default funds for the great majority of members) express their risk objective in terms of the frequency of a negative return. This is a fairly simple one for consumers to understand, because it translates as: “What’s the chance of my money going backwards?” Typically, this is expressed along the lines that members should expect a negative return once in every five years, on average. Note the words ‘on average’, because it’s important for members to understand that negative years don’t come along with predictable regularity.

Return objectives are commonly expressed as a margin above inflation. Typically, this would be to outperform the Consumer Price Index by at least 3.5% per annum (after tax and investment fees) over rolling five year periods.

With the 2010 calendar year results in, we can now look back over a fairly lengthy period covering at least two complete investment cycles to see how the funds have done. Chart 1 shows the year by year performance for the median growth fund going back 18 years. That covers each complete calendar year since the introduction of compulsory super in Australia. The first point to note is that there have been three negative years out of the 18, the first being the result of the bond market crash of 1994, the second the ‘tech wreck’ and the third the GFC and its aftermath. So the risk objective of one every five years on average has been achieved. Yet if you put that to the average fund member they might be surprised. That is because two of those negative experiences have occurred in the past nine years and so loom large in their memories – especially the dreadful experience of 2008.

The message for funds, therefore, is to keep on stressing the long term and backing that up with graphics such as Chart 1. Pictures tell the story so much better than words can ever do.

Source: Chant West
Note: Performance is shown net of investment fees and tax. It does not include administration fees or adviser commissions.

To illustrate how funds have performed against their return objectives, Chart 2 shows the rolling five year returns for the median fund against the CPI +3.5% target.

This chart shows that for the majority of this extended period the median fund has achieved its return objective and, for much of that time, has done so by a substantial margin. Again, the average member looking at a picture like this would probably draw the conclusion that: “Yes, there have been some down times, but for most of the time we’ve been well ahead of target.”

Source: Chant West
Note: Performance is shown net of investment fees and tax. It does not include administration fees or adviser commissions.

So far we have commented on the industry as a whole, represented by the median results from our growth fund universe. Not all funds are equal, however, and some have produced even better outcomes for their members. To illustrate this, Chart 3 plots the upper quartile of our growth fund universe as well as the median.

The chart shows that the upper quartile fund has spent even less time below the CPI +3.5% target, and even when it has tracked below that target it has not been by much. More importantly, perhaps, the upper quartile fund has averaged 0.7% pa more than the median over the full period. That is a significant margin, especially when compounded over a working lifetime, so there is a strong incentive for members to seek out a fund that is likely to perform at or about this level.

Source: Chant West
Note: Performance is shown net of investment fees and tax. It does not include administration fees or adviser commissions.

Of course the same funds don’t appear in the upper quartile all the time, but for some time there has been a group that has dominated the upper reaches of our performance surveys, and these are predominantly industry funds. Chart 4 shows the Top 10 funds over the past 10 years.

Source: Chant West
Note: Performance is shown net of investment fees and tax. It does not include administration fees or adviser commissions.

In our research and analysis, we have regularly commented that industry funds as a group have outperformed master trusts fairly consistently over the past decade.

Indeed, over the 10 years to December 2010, industry funds have outperformed by an average of 1.3% pa, returning 6.0% pa against 4.7% pa for master trusts. That 1.3% pa is a substantial difference. While the gap may narrow in years to come, even half that amount would make a substantial difference to the eventual nest egg of the average member. That is why it is so important for members, with the help of qualified advisers, to be able to compare funds and decide if the fund they are in is the best one for them.

We have attributed industry funds’ success partly to their more active asset allocation decisions, but more so to their willingness to invest in unlisted and alternative assets. While we don’t have long-term data for these alternative asset sectors, we can now look back at how they have performed over the past five years.

This is what we have done in the table below, which compares the performance of conventional asset sectors and the most common alternative sectors over 1, 3 and 5 years. We have used market indices for all sectors other than for private equity and unlisted infrastructure. For those categories, we have used the returns of a major fund in our survey that are representative of those sectors.

The past five years have been challenging, to say the least, and the median fund has returned just 3.0% pa over that period. The 5 year column in the table shows why, because the conventional growth sectors of listed shares and property have performed very weakly over that period.

No surprises there, but what may surprise some readers is the strong performance of the unlisted and alternative sectors – that is, strong in an absolute as well as a relative sense. Unlisted property and infrastructure have both returned in excess of 7% pa, while private equity at 5.8% pa and hedge funds at 6.4% pa have beaten the listed market’s 4.4% pa.

In our most recent asset allocation survey, we found that industry funds allocated 19% on average to unlisted property, infrastructure and private equity against just 3% for master trusts. They also had higher allocations to hedge fund strategies, although not to the same degree. Clearly, these higher allocations to the better-performed sectors have had a lot to do with the overall outperformance of industry funds.

Australia’s super system has recently become the fourth largest in the world with assets of $1.3 trillion, nearly 5% of the global pensions pool. Australian superannuation is strong, it is safe, it is efficient (but could be more so) and, most importantly, it has delivered good results for its members over the long term. Of course it can be improved, but it is still something worth shouting about.