Super funds warming up to fixed income allocations: AOFM

Superannuation funds have indicated they have or would increase their allocations to fixed income amid high interest rates and expected global growth slowdown, according to Australia’s debt management agency.

A new report by the Australian Office of Financial Management (AOFM) said the $3.4 trillion sector was an important source of demand for government securities, such as Treasury bonds, Treasury indexed bonds, and Treasury notes.

While funds would likely continue to have a lower allocation to defensive assets, including to government bonds, even a small proportional shift toward fixed income and Australian government securities (AGS) would be “significant”, AOFM said. 

As of December 2022, super industry allocations to fixed income (excluding SMSFs) was at a record high of $237 billion, according to data compiled by the Australian Prudential Regulation Authority (APRA).

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Still, Willis Towers Watson data revealed Australia’s global pension industry, the fourth largest in the world, lagged behind its global peers in terms of fixed income allocations (13 per cent) when compared to the UK (56 per cent), the US (29 per cent), and Canada (25 per cent).

“Australian superannuation is a defined contribution (DC) system rather than a defined benefit (DB) — as a result, the allocation to growth assets such as equities is much higher than global peers,” the report observed.

However, it said the industry’s fixed income allocation was still significant in outright terms.

“The main reason is that as Australia is a [defined contribution] system, members may elect to hold cash as a defensive asset class,” the AOFM report stated.

“Also, funds themselves value liquidity since members can switch funds and investment options, and funds may need to meet redemptions, unlike in [defined benefit] systems where members do not choose asset allocations.

“Lastly funds may require cash to meet margin calls on hedges (held to reduce foreign currency risks).”

It also highlighted the impact of changes to performance benchmark under Your Future, Your Super (YFYS), which included a high proportion of Australian government securities. Current MySuper performance benchmark excluded Treasury indexed bonds (TIBs).

“Following a public consultation of the ‘Your Future, Your Super’ laws, the Government has proposed new benchmarks for fixed income allocations for MySuper products,” the report said.

“The ‘composite’ index is proposed to be the Bloomberg Ausbond Master 0+ Yr Index, which has around a 3 per cent weighting by market value to TIBs. It will also include specific benchmarks for credit and government bonds (excluding TIBs). 

“This would result in modest allocations towards TIBs by super funds, which in a relatively small TIB market, could be impactful for overall investor demand for TIBs.”

The AOFM report also identified Australia’s ageing population as a factor leading to a gradual shift toward more defensive asset allocations, along with the ongoing increase in retirement savings from population growth and higher compulsory savings rates and increased consolidation activity.