While it might seem obvious that taking higher risks to earn higher returns works in investors’ favour over the long term, some studies have suggested that this standard investment theory does not always hold true.
Banita Bissoondoyal-Bheenick, a senior lecturer and the Department of Banking and Finance at Monash Business School, says the high risk, high return theory works when it comes to investing in equity markets but has not always held true in studies and superannuation and pension markets.
“Studies of the US and UK pension market have given different results, suggesting that investors do not always get a higher return by taking higher risks” Bissoondoyal-Bheenick says.
To get a picture of the Australian superannuation market, she reviewed the returns of 862 funds over 27 years using Morningstar data. The funds were a mix of aggressive (with more than 80 per cent invested in growth assets), growth (60 to 80 per cent growth assets), balanced (40 to 60 per cent growth) and moderate portfolios (up to 40 per cent growth).
“According to the OECD, Australia has a high allocation to growth assets compared with other markets. Overall, portfolios have an average of more than 50 per cent in shares. So it is important to see if that risk is worth taking,” she says.
“High growth allocations introduce volatility into portfolios. We saw that during the financial crisis, when aggressive portfolios declined 18 per cent between 2007 and 2009.”
What she found was that monthly mean returns were highest for aggressive and growth portfolios, lower for balanced portfolios and lower still for moderate portfolios.
“If you go for aggressive or growth you will be better off over the long term, especially if you are young.”
Bissoondoyal-Bheenick also looked the pattern of mean reversion for portfolios with different asset allocations (mean reversion is the tendency of a fund to return to the mean rate of return after periods of volatility).
She found that aggressive and growth funds revert to their mean returns at a higher rate than moderate or balanced funds. This means that investors on aggressive and growth portfolios will experience a return to more normal performance after periods of high risk more quickly than investors in other types of funds.
“Higher risk, higher returns holds true in the Australian superannuation market,” Bissondoyal-Bheenick says.