We measure the investment risk of our investment options using the super industry’s standard risk measure. The standard risk measure helps you compare investment options between different funds.
How does the standard risk measure show risk?
The standard risk measure describes risk based on how many negative annual returns you can expect over 20 years. It places this risk into one of seven risk labels, ranging from very low to very high.
If the risk is ‘low’, we’d expect one or less years of negative returns over 20 years. If the risk is ‘high’ we’d expect between four and six years of negative returns over any 20 year period, as shown in the table below.
These negative returns can be experienced several years apart or several years in a row within the 20 year period.
How is the risk for each option worked out?
We used Mercer’s Capital Market Simulator to calculate each option’s risk. Mercer is our investment adviser.
What kind of information does the simulator consider?
The simulator considers how returns and volatility are affected by different economic conditions, such as inflation, economic growth and asset prices. The simulator uses predictable information, for example, using past prices to predict future prices and assuming conditions eventually return to normal, but also throws in some random events. To ensure the resulting risk labels are conservative, the simulator also incorporates extremely negative conditions, like those that occurred during the global financial crisis in 2008.
How are the risk labels determined?
The simulator creates 2,000 portfolio returns over 20 years, resulting in 40,000 possible outcomes. It then determines the most common outcome to work out the probability of a negative return in one year. This is then multiplied to find the probability of negative annual returns over 20 years for each investment option, resulting in the risk labels as shown in the table below.
|Investment option ||Estimated number of annual negative returns over any 20 year period as at 1 September 2014* ||Standard risk measure risk band ||Standard risk measure risk label |
|Aggressive ||3.0 ||5 ||Medium to high |
|Growth ||2.4 ||4 ||Medium |
|Balanced ||1.7 ||3 ||Low to medium |
|Stable ||1.4 ||3 ||Low to medium |
|Capital Guarded ||1.3 ||3 ||Low to medium |
|Australian Shares ||4.7 ||6 ||High |
|International Shares ||4.2 ||6 ||High |
|Property ||2.7 ||4 ||Medium |
|Bonds ||1.3 ||3 ||Low to Medium |
|Cash ||0.0 ||0 ||Very low |
|Term Deposit ||0.0 ||0 ||Very low |
* These negative returns can be experienced several years apart or several years in a row within the 20 year period.
Mercer’s Capital Market Simulator meets regulatory guidelines and takes into account active investment management fees. However, it doesn’t consider the impact of administration fees.
What else should I consider when thinking about the risks of my super investments?
The real world is complex and not always rational. This means mathematical theories may not always play out in practice. So while the standard risk measure can help you understand your investment risk, it shouldn’t be the only consideration.
For example, the standard risk measure doesn’t show you:
- how big a negative return will be
- whether you’ll get the returns you’re after
- how fees and taxes will impact your return
- other risks faced by investors, such as market risks, liquidity risk and credit risk.