Commonwealth Superannuation Corporation Annual Report 2017–18

2. Our Performance

Managing and investing our funds

Table 2. CSC’s investment performance: criterion and results

How do our performance results help our members?

By consistently achieving our investment performance criteria summarised above, CSC increases the probability that the average CSC accumulation member in retirement will have reached the ASFA’s (Australian Superannuation Fund Association) ‘comfortable retirement standard’ of income for Australian retirees.

We invest for a comfortable level of retirement income

We know that if our members are to use their superannuation savings to generate this comfortable level of retirement income, their super balance must grow to an appropriate amount over their working life—appropriate meaning that their final super balance can 1) generate this comfortable level of annual income in retirement, and 2) not run out prematurely.

For members to grow an appropriate amount of super savings over their working life, four factors are important to consider as they can all help improve retirement outcomes. These include the member’s current super balance; the amount of their contributions over their working life; the number of years until they retire; and the investment returns their super fund can generate on their behalf.

Our net investment returns target

We target net investment returns of 3.5% per annum above inflation for members in our Default accumulation options.

This is CSC’s target rate of return because it is the real savings growth rate that we estimate can achieve an appropriate amount of superannuation savings for the average CSC accumulation member at retirement, as determined by age, current superannuation balance, amount of superannuation contributions, and likely retirement age.

Our investment strategy

To consistently achieve our target rate of investment return for our members, CSC’s investment strategy has a keen focus on avoiding loss. This focus increases the probability that our members will achieve financial adequacy in retirement. Compared to other superannuation funds, we generally deliver greater preservation of member capital through periods of negative returns, while still capturing most of the gains when markets are rising strongly.

In practice, this means that we are continuously assessing whether investment returns, net of costs and tax, are sufficient to compensate for evolving risks. Where the returns available to prudent risk-taking are limited, our members’ investment portfolio will run at a lower investment-risk level than we would expect to target, on average, over the long term. This contributes to a higher, more consistent probability of achieving a cumulative return for our members that is very competitive.

Competitive and consistent returns for our members

Our investment strategy aims to achieve a cumulative return for our members which is:

• competitive as measured against other superannuation funds, and
• consistent as measured, over the long term, by smaller negative returns when investment markets fall, but still-competitive capture of positive returns when investment markets are performing strongly.

Our investment performance to 30 June 2018

In 2017–18, CSC achieved its real return targets for Default options for the seventh consecutive financial year. All other CSC investment options exceeded their return target over their investment horizons to 30 June 2018.

Factors contributing to our performance included:

Global monetary policy that has been ‘accommodative’: Nearly all asset classes have contributed positively to returns, as they have continued to be supported by low interest rates across most of the developed world. This monetary policy support has supported economic growth, employment and general asset price inflation.

Actions taken by CSC to limit our potential for capital loss: Examples of this include:

• Reducing our reliance on government bonds to protect capital. Instead, we have preferred other defensive assets which are less vulnerable to, or indeed positively correlated with, a period of gradually rising interest rates as the global business cycle matures. Government bond prices typically fall when monetary policy support unwinds.
• Diversifying our portfolio’s dependence on equity risk into other sources of real return (i.e. returns above those necessary to keep pace with inflation). These included finding opportunities in data infrastructure, other private-enterprise assets, and active strategies designed to be less reliant on the direction of equity markets.
• Using protection strategies only to mitigate identifiable event risks in members’ portfolios, rather than using them continuously. This enables us to reduce the costs involved, which are akin to paying an insurance premium.

Our investment governance model supports our capacity to take investment decisions in real time, rather than subject to the constraints of the Board meeting cycle; identifies and manages risks pro-actively, before they can materially impact our members’ portfolios; and ensures full transparency and accountability in all investment decisions.

Our investment governance framework means that CSC implements its investment decisions through:

• A structured and transparent set of delegations: this ensures the right decisions can be taken, at the right time, by those best skilled and therefore accountable to take them.
• A robust set of specialised, external agents: that compliment CSC’s internal resources and reduce our operational risks.
• An agile, stable and skilled internal investment team that is focused on ensuring CSC’s comparative advantages are used to our members’ best interests; are empowered to continuously innovate to maintain our global best-practice credentials; and remains mindful of the implications for risk taking that flow from a continuously evolving, global market.

To learn more about CSC’s investment approach and strategy, see 5. Our Investments.

The global investment outlook

CSC is alert to the consensus view that real returns (i.e. returns above inflation) are likely to be much lower, on average, in future because the pace of asset reflation will slow as interest rates rise from their historically low levels and valuations become increasingly less supportive. However, we are also mindful that developed-market central banks are intensely focused on trying to ensure that their transition away from extreme monetary policy settings is gradual and undisruptive of economic growth.

Their capacity to execute this has the potential to return financial markets to a more normal operating environment, where interest rates are once again above the inflation rate (i.e. real interest rates are positive).

Our observations of current global market conditions include:

• The process of monetary policy withdrawal in the developed world is being led by the United States, albeit at a very gradual pace.
• Economic growth around the world is improving but remains low by historical standards and is unsynchronised.
• Global debt levels are persistently high.
• The impact of technology on productivity and labour demand is uncertain.
• Trade tensions are adding to the sense of global vulnerability.

There are many considerations for investors that arise from these conditions. Some of these include:

• The maturity of the US business cycle compared to other regions: with the most recent differentiating factor being an expansion of fiscal policy to further support growth and employment.
• China’s continued rotation towards domestic sources of growth: China has so far been very successful in rebalancing its growth drivers away from a reliance on government-funded infrastructure investments towards private consumption, and on progressing its parallel strategy to develop well-functioning, stable capital markets to support the efficient allocation of financial resources.
• Inflation and interest rate uncertainty: There is genuine uncertainty about whether the drivers of persistently low inflation and interest rates are temporary – because they just result from the impact of a financial crisis in extending the business cycle beyond historical averages – or more persistent – because non-policy-related structural changes have permanently altered the balance between savings and investment (through, for example, technology changes, demographics, and reduced capital-intensity in production). This is a critical factor that will determine how asset market prices evolve.
• Geopolitical event risk: This manifests in risks around Eurozone cohesion (specifically in Italy), tensions in South-East Asia, and global trade wars.