Joanne Knight

January 14, 2009

Super Big Bang

Filed under: economic crisis — joanneknight @ 10:57 pm
Tags: , ,

Written on 18 November 2008

Believing in an ever-expanding economic and financial system is like believing in a perpetual motion machine which will keep going forever. But this idea is central to Australia’s superannuation scheme. The current market reversal is like slamming a car at full throttle into reverse. The financial system and retirement savings have buckled under the strain of the market slalom causing considerable losses to retirees.

With the current economic crisis, returns on superannuation have fallen more than 6 percent. People who have worked all their lives now see their retirement savings disappearing and some are worried about a future of hardship like that experienced by their parents. This is not welfare dependency as some would claim but a system of dependence on extremely unreliable financial markets. It’s like betting your life savings at the race track.

Falls in the share price index of around 14 per cent have battered share value and superannuation. The market slump has carved an estimated 20 per cent from the average savings of self-funded retirees since August last year. For the 2006-7 financial year, the number of retirees receiving pensions increased. Government benefits, primarily the age pension or veterans’ payments, remain the principal source of income for three-quarters of Australians aged 65 and above. Only 10 per cent are able to rely on superannuation. The Hobsons Bay City Council revealed that 80 per cent of its residents aged 65 and above are reliant on the age pension.

The Australian superannuation fund is the largest in Asia and the fourth largest in the world after that of the US, Luxembourg and France. Between 2000 and 2004, superannuation fund assets doubled from US$342 billion to US$635 billion. This figure is expected to top US$1 billion by 2010. If we are to avoid the budget blow out of thousands of baby boomer retirees on the pension, it is crucial that superannuation funds are protected.

The 2002 and 2003 negative industry fund returns of up to minus 17 per cent should have been seen as a warning sign. Our system of superannuation is dependent on a cycle where more mandatory savings entering capital markets cause asset price rises. This asset price bubble, based on speculation and excessive debt, has now burst due to the subprime crisis in the US and the guarantee of adequate retirement income is threatened. The theoretical faith that capital markets serve to create wealth and hence provide in principle the foundations of self-funded retirement has been shown to be fantasy.

Battlers and veterans expecting a comfortable retirement based on super contributions are watching it being eaten up due to bad financial advice. Financial planners and accountants have been unable to resist lucrative commissions offered by retail funds and consistently recommended them, even though, as a class, they are underperforming. The wealthy also benefit more under this system receiving generous government assistance to build up their superannuation savings. This is a real cost to ordinary working people and a real cost to the nation’s total savings pool.

This faith in the capacity of capital markets to deliver perpetual asset growth to fund retirement (the magical powers of compound interest) is attacked in studies into the exposure of ‘multi-sector’ superannuation funds. These funds make up the biggest number of superannuation funds (38% of the total number of funds) with investments in equities, bonds, and properties in domestic and foreign markets. Their portfolios can be highly exposed to the movements of domestic and international equity and bond markets.

Due to poor management skills, superannuation fund returns are most exposed to US equity markets when the markets are down and when returns are lowest, but least exposed when returns are highest. Maybe fund managers lack market timing skills. A successful timing strategy would be to reduce exposure during down market condition and increase exposure during up market condition. Regulation also plays a role with the Australian Prudential Regulation Authority (APRA) suggested asset allocation benchmark of about 50% into equities and 25% in bonds. A greater weighting of equities in fund portfolios means that the funds are more influenced by the equity market than bond market movements.

The myth that private savings would be invested in the capital market and, given effective and prudent management, they would accumulate over time and savings sacrifice now would be working for you, and compound into a tidy retirement package has been exploded. So-called market discipline and efficient management has been exposed as simply a rich few benefiting at the expense of everyone else.

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