Australian superannuation funds’ love affair with equities is paying off with the super system growing faster than comparable countries over the last 20 years, making annual returns of 12.1 per cent, according to a new report from asset advisors Willis Towers Watson.

But there is an unnoticed risk hidden in the figures, with Australian super fund equity investments being the most concentrated in the world. And these risks have been highlighted by the market gyrations of more than four per cent in recent days.

Over 10 years Australia also tops the charts of the leading seven economies, returning 7.1 per cent. But it is probably the riskiest with 49 per cent of assets in equities.

“Australian pension funds have traditionally accepted greater risk and made higher returns as a result,” WTW investment consultant Paul Newfield told The New Daily.

While the US has similar equity exposure levels to Australia, at 50 per cent, if you look below the surface an alarming statistic emerges.

“Both Australia and the US have about 50 per cent equities in their pension systems, and of that about 50 per cent is in their home equity markets. But the US market is about 40 per cent of world equity markets, while the Australian market is less than three per cent,” Mr Newfield said.

That means 25 per cent of Australian superannuation is massively over-concentrated in local shares. However there are some mitigating factors at work.

“Australian shares have done very well in the last 25 years because we haven’t had a recession. We weren’t badly hit by the 2000 ‘tech wreck’ and after the GFC [global financial crisis] hit we had a resources boom which pushed up the market,” Mr Newfield said.

The imputation system (explained here) giving investors massive tax discounts on dividends also encourages equities exposures, said Alex Dunnin, research chief at Rainmaker.

However WTW is advising funds to reduce this Australian equity overexposure. “We would advise clients to have exposures of around 30 per cent to local shares rather than 50 per cent,” Mr Newfield said.

The high exposure of funds to equities at a time when markets have gyrated wildly may have some investors worried.

“We appreciate that Cbus members may get anxious about share market volatility,” said David Atkin, CEO of industry fund Cbus.

“This is understandable given the sometimes sensational reporting of such events.

“However, we encourage members to consider what their investment time frame is and to seek further advice from their fund before making decisions based on short-term events,” he said. 

The high exposure to equities in Australian superannuation also relates to the structure of the retirement system.

About 87 per cent of Australian superannuation is defined contribution while in America that figure is 60 per cent. In Europe and Japan more than 90 per cent of assets are defined benefit where members are promised a proportion of final salary in pensions.

Defined benefit pensions invest heavily in bonds to ensure they have the cash on hand to meet their pension guarantees, and that cuts returns. Defined contribution funds have grown on average 7.9 per cent annually over 20 years, while defined benefits grew only 4.5 per cent, WTW found.

The combination of the age pension and superannuation in Australia provides relatively cheap retirement incomes. “Our system as a percentage of GDP is very cheap compared to a lot of other countries,” Mr Dunnin said.

“In Europe high age pensions and defined benefit systems have often become unsustainable from a budgetary position and that is a huge challenge for governments.”

Australia’s superannuation system grew from 112 per cent of GDP in 2007 to 138 per cent. Superannuation assets totalled $US1.92 trillion ($A2.35 trillion) in December, WTW found.

*The New Daily is owned by industry super funds