Good morning, everybody, and welcome both in room and online to Challenger's 2021 Investor Day, which has become an integral part of our Investor Relations program. So welcome. Today's program is broken into 2 sessions with a quick break in between. For those of you online, we'll do our best to keep on schedule, and you'll receive a notification at the break when we're about to start again. There is also the ability to ask questions online, and so we're here to help.
So please send through any questions you've got, or if you've got any technical difficulties, just let Mark or I know, and we'll help you out. For those of you in the room, just a matter of housekeeping, please flick your mobile phone onto silent. Today's presentation will be followed by a Q and A session. I'll now hand over Richard to get us underway. Thanks.
Next slide, Stu. Thanks, Stu. Good morning, everyone, and welcome today. Whether you're joining us here in the room or online, it's great to have you here. And I'd say it's certainly great to be able to do one of these again.
The team and I are really looking forward to having the opportunity to share with you today an update on our business and on our plans for the future. I guess we're doubly glad to be able to do this given that it's been 2 years since we've been able to host an Investor Day. Now I guess those 2 years have been quite an part of quite an eventful period for Challenger. The disruption to our retail distribution channel on the back of the Financial Services Royal Commission has been an important factor, as has the impact of COVID-nineteen on the group's balance sheet. The company has emerged well and strongly from these challenges in a strong position and has proven its resilience.
We remain very strongly capitalized. Our strategy to diversify Life's revenue flows is working, and our best in class funds management business continues to be a standout with solid foundations for the next phase of growth. Our acquisition of the My Life My Finance Bank is an important part of this next phase. More broadly, our expanded product offering and distribution channels have increased our customer reach, and we're well positioned to benefit from the stabilization we're seeing in the retail financial advice market and from partnering opportunities with institutions. We're committed to helping our customers create financial security for a better retirement, and the opportunities we see ahead to achieve this are exciting.
I'm optimistic about Challenger's future. With that in mind, I wanted to start by sharing with you our refreshed corporate strategy. The strategy builds on the foundations of the core strategic pillars we've had in place for a number of years now, making it stronger and more relevant for the future as we look to further expand our offerings for retirees, including more directly and initially through our acquisition of the bank. Providing our customers for financial security for a better retirement remains as our strategic core as our purpose, and we serve this purpose with both guaranteed income products, such as lifetime annuities and term deposits, as well as funds management products that help our customers accumulate savings into retirement. We've added an explicit vision statement for each of our core stakeholder groups, for our customers, shareholders, employees and the community to clarify what we're aiming for into the future.
Reflecting on our commitment to build a more customer centric business, the customer vision is ambitious: to provide 1 in 5 Australian retirees with improved financial outcomes as a consumer of Challengers products by 2,030. We want to provide middle income Australians with confidence in retirement. These are the people who've worked hard to save for their retirement and deserve to enjoy this period with the confidence that their money will not only last, but will underwrite their dignity in retirement no matter how long they live. The scale of our ambition here is both bold and it's achievable.
At the
end of the decade, our goal is that Challenger will be synonymous with a secure retirement and that 20% of our retiree households will be using Challenger product to help provide them with the secure retirement that they deserve. I believe this is absolutely achievable, and the strategy we've evolved will move us forward towards this vision. At the same time, we're also focused on the impact we have on other stakeholders and have a clear vision for ensuring that we continue to make a positive contribution across all domains. For the community, we'll champion financial security for retirement by providing financial help and education, advocating for constructive public policies and by leading by example with responsible business practices. For our employees, we'll bring together a diverse group of top talent inspired by our purpose, strong culture and capabilities to deliver shared success.
And for our shareholders, we'll build resilient long term shareholder value, leveraging the capabilities of the group to achieve compelling returns. These vision statements are ambitious and will be achieved through the execution of 4 strategic priorities. We'll broaden the way customers can access our products across multiple channels. We'll expand the range of products and services we offer to support a better retirement. We'll leverage the combined capabilities of the group, and we'll continue to strengthen the resilience and sustainability of our business.
I'll share a little more on how we're going to deliver on these priorities in the near term after we hear from the rest of the team. Our strategy provides a clear, coherent and unifying statement of who we are, where we're going and how we're going to get there. It leverages our unique mix of capabilities that we bring together from Funds Management, Life and the Bank. And this slide illustrates how we'll be able to build a compelling proposition for customers as they plan for and live out their retirements. As the clear leader in retirement income, Challenger has a real opportunity to play a more meaningful role in the lives of our customers.
As people work for and save for retirement, we can support them in building their wealth through our Funds Management business. This business offers high alpha capabilities across all asset classes, including equities, alternatives, real assets and fixed income. Nick will provide an opportunity on how we bring best in class managers to our clients to help them to build their retirement savings. Once completed, the acquisition of My Life, My Finance will provide us with a scalable digital banking platform, the opportunity to provide guaranteed term deposits and the capability to develop more innovative solutions. Our Head of Banking Transition, Michael Vardenager, will share more on this later.
In retirement, as part of a balanced portfolio, our annuity products provide retirees with certainty as they age through guaranteed income and support for aged care costs. You'll hear more from this from Angela, including a deep dive into our evolving institutional offering. We continue to invest in and build on our strong track record of product innovation and development. Whether it be directly or through our partnerships, we'll bring retirement outcomes to Middle Australians. These are people who've worked hard all their lives to save for retirement, and we see ourselves playing a bigger role in helping them achieve the financial security that we see they've earned.
Recent years have been challenging, but we've emerged in a strong financial position, and we're well placed to capture the growth from the long term structural tailwinds that continue to drive our business forward. Our world class superannuation system continues to mature as it benefits from a range of lasting underlying drivers that will see it maintain its strong growth trajectory for many years to come. And Challenger is uniquely positioned in this market, and both of our businesses enjoy market leading positions. We're the number one provider of guaranteed retirement income streams in Australia, and we're recognized by our customers for the peace of mind and the great service that we deliver them. Our Funds Management business is the fastest growing active funds manager in the country and its 3rd largest.
It's a standout performer among its peers, and it has many avenues of ongoing organic growth. The regulatory environment continues to be supportive for both our Life and Funds Management businesses. They both benefit from a rising superannuation contribution rate, and the Retirement Income Review released at the end of last year highlighted the need for better retirement solutions. The Retirement Income Covenant, which will require that Superfunds have strategies specific to the needs of their members in retirement, will also progress and is progressing with the government confirming its recent commitment that the covenant will be legislated to commence by 1 July 2022. While the distribution in the financial advice market has stabilized, the industry continues to evolve, and we're well placed to benefit from the diversification strategy that we've implemented over the last couple of years.
With the contributions from our Japanese partnership, strong growth in our institutional channel and stabilization of the retail advice market, we're well positioned to capture growth from the long term structural tailwinds that continue to drive our business forward. The strategic acquisition of My Life, My Finance will further broaden our business and accelerate our efforts to build direct relationships with our customers. This will support our strategy to ultimately be available to support our customers through whichever channels they prefer, be that their financial adviser, their super fund or directly. Through the evolving market conditions that presented themselves before, during and after the COVID-nineteen crisis, we've operated in a consistent fashion with our strong risk culture. And we've done this while maintaining our long standing relative value approach to investing.
Angela will take you through our investment portfolio and the returns we're currently generating in more detail shortly. As you can see, our strategy to grow sees us building further on our already strong brand and customer franchise, a franchise built on our purpose of providing financial security for a better retirement. It's essential that we protect this valuable asset to underpin our long term growth and our success. This is also, of course, essential from a shareholder perspective. It's important that we're able to grow in a way that can be more readily accommodate significant market shocks without having to derisk the investment portfolio in the face of such shocks.
To support this, we're enhancing our capital settings, reflecting our commitment to maintain our strong capital position that we've established. Looking back to the end of January 2020, just before the pandemic began, we had a PCA ratio of about 1.45 times. This was at the midpoint of our target range at the time. And as the market sold off, our PCA ratio reached the bottom end of our range, requiring us to take steps to reposition our portfolio, consistent with our risk management framework. Now reflecting on this experience and on our growing customer franchise, we've enhanced our risk settings, and we're now extending our PCA operating range to improve our ability to withstand periods of market volatility.
This will provide a more stable experience for shareholders. We're extending our normal operating range to be 1.3 to 1.7 times our prudential capital amount, which shifts the upper end of the range, which we've previously said, at 1.6 times. Moreover, we'll target to operate at a PCA ratio of around 1.6 times as we've done over the last year. Our new operating range provides us with increased flexibility during periods of market volatility and reduces the risk of having to lock in negative investment experience in response to significant market shocks. This is good for shareholders.
It's consistent with our strategic priority to strengthen the resilience and sustainability of our business and it aligns with our purpose, which is all about financial security. Now naturally, the lower risk profile leads to a lower return, so we've also reviewed our ROE target. In light of the desire to hold more capital, we've made the decision to lower this target. Going forward, our pretax ROE target will be the RBA cash rate plus 12%. This adjustment is the natural outworking of what will be on average higher levels of excess capital with our PCA ratio targeted to be at 1.6 rather than 1.45 being the middle of the previous range.
And it reflects an appropriate risk return trade off. Group ROE target is also consistent with current life ROE and the high ROE in Funds Management, which is more than offsetting the corporate cost base and what will be a subscale bank for a period of time. As we've discussed previously, the ROE for FY 2021 will be lower than this target, reflecting the progressive redeployment of our cash and liquids balances over the year. With this capital now fully deployed, the new ROE target is achievable in the current environment, which of course reflects very narrow credit spreads. And so as conditions normalize, we would expect to be and we do expect to be in a position to outperform this target.
We have robust foundations in place, a clear strategy for growth with the experience, capabilities and commitment of a team in place to deliver. Our executive team has a strong mix of long tenure leaders and newer members, bringing a rich mix of perspectives and skills to take us forward. We're very fortunate to last month have welcomed the newest member of our leadership team, Rachel Grimes, who's in the audience with us today. She's joined as our new Chief Financial Officer. And Rachel brings with us an out brings with her, I should say, an outstanding track record as a leader in her field.
She joined us from Westpac, where she was most recently the 2RC to Westpac's CFO. Importantly, Rachel brings a genuine passion for our purpose, and I'm really delighted and excited to have her as part of the leadership team. We've also made some other significant changes to the team to ensure we're well organized to deliver our strategy and to utilize the strong capabilities from across the group. In November, Chris Plater moved into the newly created role of Chief Executive Operations and Technology, reflecting the importance of these functions as strategic enablers for us. Chris' deep understanding of our business is a real strength here as we seek to drive an increased focus on deep and effective engagement with customers, advisers and with our superannuation fund clients.
Chris has been with Challenger for 18 years, the last four as the Chief Executive and Chief Investment Officer of our Life business. Chris remains as the Chief as the Chair, I should say, of our Investment Committee, of the Life Company's Investment Committee, enabling us to continue to draw upon his deep investment expertise and insight. Complementing this change, we've streamlined our business line structure, combining our Life distribution our Life and Distribution product and marketing teams into 1 business with the focus and capabilities to drive strong commercial outcomes. Angela Murphy took on the role of Chief Executive of this new Integrated Life business in March, having previously led the larger of the 2 teams. Finally, Michael Vardenager has taken on the role in leading the transition project for the bank.
Now this appointment reflects our very strong focus on ensuring efficient and effective integration processes in this regard and our commitment to delivering quickly on our strategic objectives. Michael's been with Challenger for 16 years and previously led our group corporate strategy function as well as being our General Counsel and Company Secretary. Now of course, the executive team is only part of the story, and I'm incredibly proud of the broader team that we have here at Challenger. Our people are our most important asset, and so prioritizing employing well-being during the pandemic was a key part of our response. And this has led to an opportunity to rethink our work practices as we go forward.
From Challenger's perspective, flexible work is here to stay. And I must acknowledge the positivity and commitment from our employees as they've navigated this challenging period and embraced our new hybrid working approach. They've told us that in providing effective flexible work practices is something they value very highly and it supports retention and productivity. I'm sure our approach during the pandemic has been an important part of the results we got from our recent employee engagement survey, which shows that we've maintained a very high overall sustainable engagement score at 85%. And this is 1% higher than our result from 2019, and it's in line with the Willers Towers Watson Global High Performing Norm benchmark.
Challenger's strong risk culture was also reflected in these survey results. Our score for risk culture was 86%, which is 4 points above the global high performing norm and 10 percentage points higher than the Australian national norm. We've consistently performed well in this area, and it tells us that we're doing a good job and being successful in embedding strong risk culture across the business. Our diversity and inclusion outcome was also very pleasing at 94%. This is 12 full percentage points above the high performing norm, and it reflects a strong focus that we've had in this area.
Separately, we're once again recognized as an employer of choice for gender equality in the 2021 WIGIAR Workplace Gender Equality Report. And these two outcomes as well as others reflect, among other things, the significant work that our own employees have done as part of our 4 internal networks focused on diversity and inclusion in areas of gender, sexuality, age and culture respectively. We've also made significant progress on a range of sustainability issues that support our purpose and business strategy more broadly. Last month, we launched a major research report on the employment experiences of older workers, a product of our community partnership with the Peak Body Council of the Ageing or CODA New South Wales, Enabling people to work for longer as they for as long as they wish provides a range of benefits to both individuals and the economy. And it aligns and resonates strongly with our purpose by supporting the financial security of older Australians.
The next phase of this partnership is the development of a program to support employers in this space. And yes, I'm looking forward to Challenger engaging in this program when it's up and running later in the year. ESG is also an important area in our Funds Management business, and we were pleased to receive an A rating in the Principles for Responsible Investment 2020. We're embedding ESG across our Funds Management business and platform, and this positions and our positions on climate change and other really important ESG matters are now available on our website. So hopefully, you can tell from my presentation this morning that I'm really proud of the position that our business is in.
But of course, I've really only touched on an outline in some senses of why this is the case. So I'm pleased to hand over to my colleagues to color things in a little and give you some more detail in key areas. Thanks.
Thank you, Richard, and good morning, everyone. As many of you will know, I've led Life's distribution product and marketing capability for a number of years. As Richard noted, earlier this year, we took the opportunity to bring our distribution capability together with our investment capability into a single division. I feel privileged to be leading the business, and I'm looking forward to sharing some insights with you today and giving you an update on our progress. The initiatives that we've undertaken over the past few years have increased the resilience of our business and created a solid platform from which we can grow.
There are 3 broad areas that I'll cover today. First, I'll provide an update on our sales diversification strategy. Then I'll take a deep dive on our institutional business, looking at the client proposition and what this means for returns for Challenger shareholders. Finally, I'll provide an update on our investment portfolio, including some insights into the economics of new business, which reflects both current market conditions and our pricing. If I reflect back on our last Investor Day in June 2019, the impacts of the Royal Commission were still emerging.
We were moving into a new age pension means testing regime, and we were very reliant on retail financial advice and especially the major banks and advice hubs. At that time, I spoke about our strategies to expand our distribution channels and diversify our sales base, including engaging with more IFAs. I talked about partnering with profit for member funds and building greater customer demand through our brand, education and more direct customer engagement. As anticipated at the time, the following 12 months were tough, But pleasingly, a number of our strategic initiatives are now starting to deliver results. While the retail advice industry, there's been significant adviser turnover and a reduction in overall adviser numbers, I'm pleased to report that we're starting to see a stabilization.
As you can see in the chart on the left, we expect FY 'twenty one retail sales, both term and lifetime, to deliver double digit growth. Some of the initiatives that we've undertaken to improve our traction in the retail advice channel include implementing an end to end digital application process, which was a pain point for advisers. This has led to a circa 70% improvement in turnaround time from quote to application. It's reduced the support that our distribution team need to provide to advisers in originating an annuity, and it's led to a 26% reduction in the number of applications requiring follow-up. We've also expanded our messaging.
In addition to the product and technical benefits of a lifetime annuity, we know there are key points or events when advisers consider an annuity for their clients, and we've built new messaging around these moments. For example, this might be an inheritance, the sale of a business or downsizing. We also know that some advisers position their strategies around portfolio construction, so we've been developing messaging that aligns with this approach also. This means our distribution team can adapt their messaging to better meet the client and or the adviser situation and approach. Following the Royal Commission, many advice licensees reviewed and tightened their processes around ongoing advice relationships.
As a result of these reviews, some of their clients became direct customers of Challenger rather than continuing to be managed through an ongoing relationship an ongoing advice relationship. By July 2019, more than 6,000 customers had become direct challenger customers in this way. Across financial years 'twenty 'twenty one, we had approximately $800,000,000 of maturing annuities with direct customers. While not deliberately embarking on a direct to consumer business, we had a sizable direct customer base by default. We rapidly developed a customer service process to provide these direct customers with information and support around their maturity options.
Through this work, we've gained insight into customer considerations at maturity, and we've successfully retained the majority of direct customer maturing business over the last 2 years. Our forecast reinvestment rate for direct customers in financial year 'twenty one is almost 70%. We've also undertaken initiatives to educate customers directly on financial considerations for retirement to help them be advice ready. After commencing a Facebook pilot in July 2019, we quickly moved to an always on approach in this channel given its success. From a standing start, we've captured over 13,000 customer leads who have opted in to hearing from Challenger around retirement.
Nearly 20,000 consumers have completed our retire with confidence tool that helps retirees understand how long they might live, how long their money might last, what age pension they may be eligible for and what impact an innovative retirement income stream, such as an annuity, might have. We undertook a significant revamp of our online customer portal and commenced a rollout with customers to support them in online engagement with us. The box in the middle of this slide shows some high level results from independent research undertaken by 5th Quadrant. Our net promoter scores and customer satisfaction results stand up extremely well against our peers, particularly given our business is predominantly B2B and that and in that context, customer experience has traditionally been less of a focus for us. While these results reflect the ongoing efforts of our team to provide great service, they also reflect the nature of our products, which deliver certainty and confidence.
As highlighted in the chart on the right, institutional sales have more than doubled since financial year 'nineteen, reflecting the increased focus on institutional partnerships as part of our sales diversification strategy. We've also successfully diversified the client base. Part of this success has been a refresh and relaunch of our Index Plus product, which has allowed us to provide a more attractive client proposition. Given the significant role institutional partnerships is playing for our business, I'll take a deep dive into this shortly. Our important partnership with MS Primary in Japan has also contributed to a more diverse sales mix with our reinsurance of MSP Japanese sales of both Australian and U.
S. Dollar annuities. Overall, our efforts over the last 2 years have helped us adapt to the disruption in the retail advice channel. We've built greater diversity and resilience in our sales. With our brand, thought leadership and retirement capability, we are well positioned to grow.
As I mentioned, a focus on institutional clients has been a key part of our strategy to diversify our sales. As you can see in the charts, our institutional business has been growing strongly with 33% CAGR over the last 5 years. I'm going to provide some more detail on this today so you understand our client offering and the returns shareholders can expect from this growth. The team who have innovated and evolved our institutional offer have done an incredible job over the last couple of years. In addition to the sales growth, we've achieved significant client diversification.
In particular, our AUM across the profit for member fund sector has nearly doubled over the last year, benefiting from new relationships with a range of new clients. Whilst Index Plus has been building for some time, more recently, we are also seeing growth in institutional term annuity business. Term annuities represent sound relative value, and we've been positioning them in the institutional market as a viable alternative to term deposits and short term fixed income instruments. These investments are usually shorter duration, particularly for an initial investment. However, clients typically roll the investment multiple times and sometimes also extend the duration after becoming more familiar with the product and with Challenger.
In this way, the effective average duration of the investments can extend beyond 5 years. This business also allows us to build relationships with key institutional clients. This understanding of and familiarity with our team and our capability is a solid foundation for a broader relationship, including the exploration of retirement solution partnerships as funds prepare for the retirement income covenant. And I'll share a case study shortly that shows how these relationships are evolving. I will now take you through our institutional toolkit and how we are positioning ourselves in the market.
Our offering aims to provide institutional clients with access to the capability that sits within our life business. This includes investment and structuring skills, asset and liability management and our intellectual property and thought leadership, especially around retirement income. Our institutional approach is solutions led. Most of our partners or prospective partners are in the business of developing and managing their own products or solutions. They are product manufacturers.
In this institutional ecosystem, Challenger is an enabler, providing components for our clients' solutions, and this is what lies behind our approach. To meet the needs of sophisticated institutional investors, we must understand and work within their investment strategies and governance frameworks. We want to understand our clients with sufficient depth to know if and how our capability might make a difference for them. We have formalized our institutional offer into 4 broad pillars, 2 of which are investment focused and 2 of which are retirement focused. This solution spectrum is scalable because the capability is built broadly around our balance sheet.
It allows us to engage on a wide range of topics. And with this broad relevance, we avoid being a binary service provider and can develop deepening engagement with our partners. From our experience, our investment oriented solutions, such as beta and income, tend to have shorter lead times, and this complements the much longer lead time characteristics of our retirement solutions. I've touched on our 4 pillars and the ways we engage with the institutional market, But what are the capability components that sit under these pillars? As you can see here, we have numerous product solutions.
Starting from the left, under beta solutions, we have Index Plus. At a high level, this is contractual alpha with 0 fees and represents 2 thirds of our institutional AUM. I'll explore Index Plus in more detail on the following slides, both from a client perspective and from a challenger perspective. Under Income Solutions, we have term annuities, which provide a competitive spread relative to alternative fixed income investments, such as term deposits and high grade corporate bonds. Our institutional clients are increasingly considering term annuities for the purpose of cash flow, whether it be cash flow matching or more simply for yield.
In relation to term deposits, Michael will cover our bank integration later this morning. But when we are ready, we have an institutional market to sell into, and term deposits will complement term annuities. Challenger is also able to assist other insurers by reinsuring components of their fixed term liabilities or longer term liabilities for fixed term periods. All of these investment oriented solutions provide an opportunity for institutional clients to become more familiar with Challenger Life as a counterparty and with our term structures, including annuities. In relation to Retirement Solutions, Retirement Solution Integration is a very big and key focus.
Developing compelling and scalable retirement solutions is a focus for superannuation funds, particularly ahead of the retirement income covenant. And it's a significant focus for us working with them on a bespoke basis to explore retirement product design options, and where relevant to understand how challenger capabilities such as longevity protection, sequencing risk control or contractual returns might be integrated within a fund's broader retirement proposition. Delivering these capabilities as a component or a building block that can be integrated seamlessly into a broader offer is a significant focus as it will enable funds to offer differentiated and superior retirement outcomes for their members. Our retirement solution capability also includes non account based pensions, where superannuation funds in partnership with Challenger can offer their own guaranteed retirement income stream to members. Longevity swaps and lifetime reinsurance are also components of this capability.
We've previously shared our activity in the U. K. Market as a longevity swap provider. In addition to this, we also provide lifetime reinsurance capabilities to other life companies in the domestic market to help them de risk their back books. Finally, our defined benefit solutions span buy ins, buyouts and successor fund transfers.
The breadth of scope of our 4 pillars and the underlying capabilities allow us to normalize the concept of an annuity by expanding the context and the purpose for which they are used, including through integration in product design. So now let us take a look into our Index Plus capability. Index Plus harnesses many of the capabilities of Challenger Life. It's not a new product, but it's a capability that remains fresh as a result of continual improvements. In very simple terms, Index Plus provides clients contractual alpha above a pre agreed benchmark, flexibility in relation to the term and index, the security of a life insurer and A rated counterparty, and all of this with 0 fees.
The current environment for superannuation funds includes an intense focus and pressure on fees and performance. With the APRA heat map and the Your Future, Your Super reforms, this focus and pressure is expected to continue. In this environment, an offer that provides guaranteed alpha with 0 fees is compelling, and this context has been contributing to the ongoing interest in Index Plus. We believe Index Plus is well positioned to continue to benefit from this thematic. So how does the solution work from the client's point of view?
It's an elegant and robust solution. While not a time line, the steps from a client's perspective are shown on the right of this slide. Initially, the client invests into the fund, which invests into eligible assets. Under step 2, Challenger Life receives the returns from the eligible assets and then pays the fund the agreed index plus the contractual excess return. Finally, the fund pays the investor the agreed index return plus the contractual excess return.
Challenger Life effectively swaps the eligible asset returns with the client for an agreed index return plus a margin. As you can see here, the product is flexible and offers a range of indices. Current mandates include equity indices, inflation and CPI, government and treasury and cash. More recently, the shift has been towards equity indices such as MISCE. Importantly, we hedge the underlying index, so we are not taking that risk.
We've seen Index Plus from our clients' point of view, but how and why does the structure work and deliver returns for Challenger? An important part of our diversification strategy has been to evolve and enhance our initial guaranteed index return, or GUR product, which was fixed term. Firstly, we've evolved it into a daily liquid version and now to an enhanced fixed term version. We hedge the returns of the selected index. In effect, we swap the cash rate for BBSW plus or minus a hedge margin for the selected index return.
This means we earn the returns on the eligible assets and we pay a cash rate and an agreed margin. This is very similar to a term annuity where we pay the cash rate plus the margin. The investment returns achieved in the trust depend on the eligible assets and how they are invested. As a result, the margin we pay the client above the pre agreed index also varies based on the eligible assets selected. We have mandates with very high grade government bonds, which do not consume much capital and which generate a moderate basis point return above the agreed index, whereas the enhanced option invests in challenger term annuities and generates a similar capital intensity and cash operating margin as term annuities.
The enhanced option was introduced in June last year and is attracting the most interest from clients. The majority of Index Plus sales this year have been into the enhanced option. From Challenger's perspective, the margin and economics of this option are very similar to the economics on our term annuity business. Importantly, from an ROE perspective, all products meet our ROE target. I mentioned previously that our investment solutions can build the foundation for a broader relationship with our institutional clients.
This is demonstrated in this case study of our 1st profit for member client to buy a term annuity. This is an example of our solutions based approach and the way in which our 4 pillars provide for broad engagement with clients. In this example, the discussion started with Index Plus, but shifted towards a pure interest rate instrument over a managed investment scheme to better fit with the fund's fixed income and cash strategy. The fund opted to invest in a term annuity as a new investment instrument. The relationship has now expanded to include discussions around retirement solutions as they prepare for the retirement income covenant.
Most major super funds are going through similar considerations as they consider options for retirement income that are desirable, scalable and appropriate for their member demographics. I'm going to shift now to the investment side of the business. Since the onset of COVID-nineteen, governments and central banks globally have responded with an unprecedented amount of fiscal and monetary stimulus to help support their economies. Consumer credit performance has shown resilience so far, with recovery in non financial corporate fundamentals well underway, and this is reflected in a significant tightening in credit spreads. The swift actions of global central banks, including launching sizable bond purchase programs and setting up lending facilities, supported market confidence and provided a backstop for credit spreads that recovered much faster than in the aftermath of the GFC.
Australian corporate and financial credit spreads look particularly tight, having retraced COVID-nineteen moves and tightened further. The domestic banking sector has experienced a significant rise in deposit inflows that, combined with the introduction of the term funding facility in March last year, has led to a material shift in the composition of its funding base, with near zero issuance of senior unsecured bonds. By introducing a scarcity factor into the outstanding stock of bank paper, major bank spreads have compressed materially. This in turn has prompted buying of Tier 2 secondurities and materially increased investor risk appetite in many other parts of the Australian corporate bond market. This makes challenging investment markets, but we still see pockets of value for Challenger Life.
While it continues to evolve, there has been a consistency in our investment process and our investment governance over many years. We have an enduring focus on relative value, and risk management sits at the center of our approach. Our asset allocation framework remains constant despite the more challenging investment conditions. As a fundamental principle, we match cash flows to our liabilities and avoid taking any duration mismatch. And finally, we prefer to maintain a strong capital position with ROE discipline.
Now this slide should be familiar to you as Chris Plater has presented it many times. It's our chart showing prospective liquid market risk premiums across our key asset classes of investment grade credit, investment grade ABS, high yield credit, property and listed equities. As a reminder, the light blue bar is Challenger's view of the historical long term averages. The vertical red bar, the historical range and the blue box, the normal trading range. The dark green square is where risk premiums were a year ago.
And finally, the dark blue diamond is where they are today. These asset risk premiums are based on liquid indices and are in addition to the base interest rate, which is subdued. We would expect to outperform these premium in most asset classes using our capability to capture additional returns. So looking at the chart, in May last year, investment grade credit and investment grade ABS risk premia were elevated following the onset of COVID-nineteen. Reflecting significant Central Bank action, we can see these premiums have contracted over the past year and are sitting at or below their long term averages.
The risk premia for high yield corporate credit is above where it was a year ago. This might seem counterintuitive, but the risk premia shown here reflects the net return after expected defaults, which we based on an external index. While credit spreads were elevated in 2020, so were expected defaults. Property risk premia are above average. However, this analysis is based on broad market indices and is therefore not a reflection of our more defensive book.
This slide covers both an update on our current portfolio and our asset allocation for the year ahead. The asset allocation will be relatively steady year on year with a very slight increase to debt and cash from property. With risk premia in investment grade options below where they were a year ago, we see relative value remaining in sub investment grade asset backed credit, private debt and syndicated leverage loan markets, and we'll be shifting some of our exposure out of investment grade corporate credit into these sectors. The property portfolio continues to be a source of high quality long term cash flows. More than 60% of our office portfolio rental income is from government entities, and over 60% of contracted leases have fixed or inflation linked rental increases, making for an excellent source of cash flows to match our longer term promises to customers.
Whilst the rent relief period has ended, COVID-nineteen has impacted our forward looking leasing assumptions. The targeted allocation to alternatives, equity and infrastructure is expected to remain relatively stable. Alternative investments provide uncorrelated returns and are an important source of diversification for the balance sheet, including providing liquidity in market downturns. In this slide, we've also provided a guide to the average capital intensity of each key asset category. An observation here is the capital intensity for the alternatives, equity and infrastructure portfolio has increased materially, up from 30% to 38%.
The capital requirements include a stress test for equities that is calculated based on shocks to the trailing ASX 200 dividend yield. The method results in a larger impact when yields are low and a smaller impact when yields are high. It's designed to reduce the procyclical nature of the asset risk charge by increasing the charge following a rise in equity prices and reducing it following market falls. The decline in dividend yields over 2020 has therefore resulted in a higher equity asset risk charge, although this effect is not necessarily expected to persist over the longer term. I'd now like to spend some time looking at the economics we're generating on new business.
The table provides a simple way of illustrating the returns we expect to generate for new business. Reading the table from left to right, in the first column, we have our asset allocation strategy for new business, which is in line with our June estimate. In the 2nd column, our total return expectations by asset class. This represents the total return we expect to make on each asset class. Next, we expect in aggregate to write new business at around 90 basis points over the prevailing cash rate.
This reflects current pricing, which is down approximately 30 basis points from the start of the year. At current levels, this translates into a total funding cost of about 1% per annum. Next, the capital requirement based on current average capital intensities across the portfolio as we provided in the previous slide and a PCA ratio of 1.6 times, our preferred operating level as Richard outlined earlier. Based on these enhanced capital settings, we expect new business to require total capital of around 20%. When we combine all this, we get a normalized return on asset capital of 11.6% at a portfolio level.
Challenger Life has additional Tier 1 and Tier 2 instruments, which are effective sources of capital and currently represent 33 percent of the total capital base. Allowing for this, the portfolio is generating a return on CET1 capital of 15.3% before expenses or 11.8% after including life's expense base. If I consider how this picture has changed since the Investor Day in 2019, there are a few key changes to highlight. First, the cash rate has declined from 150 basis points to 10 basis points, leading to a decrease in ROE of around 1.4%. 2nd, we've increased our target PCA from 1.45 times to 1.6 times, which reduces our risk along with our ROE returns.
The actual impact can be calculated from this table. 3rd, we're facing more challenging investment markets, particularly lower fixed income credit spreads that I referred to earlier. These have had a negative impact on ROE, but have been partially offset by pricing initiatives undertaken across the year. Finally, as I mentioned, we're also seeing higher capital intensity on equities, as I described. Of course, rates and returns will vary.
Returns improve as the business scales. But this gives you an important insight into where we're writing business presently and reflects the current investment conditions and pricing. As you can see from the front book economics slide, we expect fixed income returns of approximately 2.2%, which is above broader market expectations for fixed income. And so I thought I would provide some detail around how we generate the fixed income returns we do. Some people have questioned whether we generate these returns by taking additional risk.
However, our regulatory standards and internal capital models require that the level of capital held reflects the underlying risk taken. When we take additional risk, we hold commensurately higher capital. The numerator might increase, but so does the denominator. We can only achieve a higher ROE through our investments to the extent that we identify and extract a superior risk adjusted return. This is one of the reasons we have such a strong focus on relative value.
As outlined in the 3 pillars at the bottom right of this slide, our fixed income capability includes investment capability and resource in the Challenger Life business, an independent and highly experienced credit risk team that reports up through our Chief Risk Officer and the significant investment capability that sits in Challenger's Funds Management Business or SIPAM. It is a capability that is in demand in the broader market. The nature of our business means we know our liability profile. We've previously highlighted how with long dated liabilities, we can make long term investments and extract any liquidity premium in doing so. Credit and illiquidity premium contribute to our returns across our fixed income portfolio, and so there's overlap with the additional boxes at the top of this slide.
The purpose of these additional boxes is to highlight both additional sources of return and our capability to originate and source investments where we can extract credit and liquidity premia. The 3 particular areas of capability that I'm focusing on today are private lending, securitization and liquids. Challenger Life leverages SIPAM's capability in private lending. 2 important keys to success in private lending are scale and experience. Scale allows you to access deals directly rather than through intermediaries, driving better terms and economics.
Experience means that you see more deals than your peers. And with long standing relationships, you don't need to do a deal to see the next one. If I put some color on the scale and experience of our SIPAM platform, the platform has lent over $10,000,000,000 across corporate, real estate and securitized markets, covering Challenger Life and external clients. In the past 5 years, SIPAM has reviewed over 700 opportunities to a value of $34,000,000,000 and has completed 2 12 deals with a value of $6,600,000,000 I think that's important because it shows you what is taken and what is left. We are the only active institutional private lender with pre GFC experience in Australian private lending markets and have been continuously active for over 16 years, with an annualized loss rate on private lending of less than 5 basis points, including the GFC, and have delivered an IRR of 7.7% on originations since the GFC.
In securitization, getting a solid understanding of the credit risk you're assuming can be difficult. Again, our team's scale, capability and experience comes into its own. We conduct robust due diligence on opportunities, including site visits with individual file reviews to establish the nature and the quality of the underlying credit. We get granular reporting that allows us to appropriately monitor experience over time. Because of our scale and long standing relationships, we'll receive appropriate priority in oversubscribed issues.
This is a solid capability for Challenger. It's one that's grown on the back of our balance sheet over time. There's a premium that comes with the insight and rigor that we can apply, and we leverage that to ensure our balance sheet continues to deliver strong returns. Finally, our liquid strategies. Liquidity is a really key consideration for our balance sheet management and something that is core to our focus.
For a number of years, we've also been able to apply investment strategies that enable us to generate additional yields while facilitating our liquidity. We use these strategies over time as market opportunities appear and disappear, and we continue to evolve and explore these short term investment strategies as the market changes and evolves. In summary, we apply a strong investment process and governance framework. We know our competitive advantage, and we're disciplined in applying it. Our involvement across public and private markets provides unique insights and unique opportunities.
Our independent credit risk team ensures risk and return are properly calibrated. Our fixed income track record includes benign credit loss experience compared to both normalized assumptions and compared to market. With our long and strong track record, we are confident in our ability to consistently achieve good risk adjusted returns. So to wrap up, we've built increased diversity and resilience in our sales with an emerging direct customer base, stabilized retail channel, a growing institutional client base and an important ongoing partnership with MSP. We are well positioned to continue to grow with the growing retiree market.
We expect our high level asset allocation to remain relatively unchanged in the coming year, with some adjustments at a more granular level to take advantage of relative value opportunities. Through our significant investment capability and discipline, we are driving value from every component of our balance sheet. With a number of changes, including more conservative capital settings that provide greater shareholder protection from market downturns, the front book continues to provide solid returns on equity. Thank you.
Thank you, Anj, and good morning, everyone. I'd like to now turn to the Funds Management business and provide you an update. Whilst, as Anj made comment, it's undoubtedly true that there's great uncertainty regarding whether it be the economic outlook or markets, we've been very pleased by the resilience of our Funds Management business over this time, how it operated through the aftermath of the 2020 market meltdown and the subsequent market recovery. By way of introduction, I joined Challenger at the back end of 2015, taking over leadership for Fidante Partners in Australia in 2016 and then in my current role, taking leadership at the CIP Asset Management or SIPAM Business through 2019. Active Funds Management is heavily dependent on human capital, and that is certainly true of our business.
Today's Funds Management performance is an outworking of the execution of our strategy over a number of years, and I'd like to firstly make a strong acknowledgment of the people in the business, both Vedante and Sippan as well as our boutique partners, all of whom are critical to our success. Over the course of the presentation, I want to give you some perspectives about how we are thinking about the strategy for Vedanta Partners and Siban and how both have strong growth pathways if we keep executing on that strategy. In 2021, what I'm pleased to report is the quality of the execution against what we laid out in prior years. Today, I will talk about broadening of our investment management capability, leveraging our current distribution strength as well as building out new pathways for growth, both here domestically and in select overseas markets. As a business, we have a team and momentum to deliver against that strategy to build a truly world class multi boutique platform in Ferdante Partners and leading specialist investment manager in CIP Asset Management.
At its core, we deliver high quality specialist investment management, seeking to partner with our clients to provide an outstanding investment experience and therein building our reputation as a trusted industry leader. Let me start with Fedante Partners. The multi boutique platform of Fedante is all about balancing the needs of being both big and small at the same time, which translates as a focus on investment management and scale in everything else. Our managers' track records are powerful evidence of the benefits of focus, and our scale ensures we deliver institutional grade support in all other facets, including the sales outcomes that we're enjoying today. The last year has seen a lot of progress being made in Ferdante.
An important part of our business is working with our boutiques on long term business planning and succession management, which can include the recycling of equity. This year, we worked with Ardagh to acquire additional equity in their business, taking our stake to sub 50%, just sub 50%. The transaction will see a portion of the equity recycled through the Ardagh business, which will ensure alignment of key investment personnel and long term stability. However, Vedante will concurrently maintain a high stake in this high growth business. I would also call out the extensive work undertaken, as Richard noted, around ESG.
Later, I'll discuss a key investment management partnership in this space. However, as important has been the work our teams have done with our boutiques to ensure they have robust institutional grade ESG capability embedded. There is a real passion in the business about doing ESG right, which will be to the benefit of investors as well as employees and shareholders. The last 2 years has seen us evolve our model in Vedante to seek out global best in class partnerships, in addition to the more classic team lift out and build. I'll provide some more details on our partnerships as I go through the presentation.
Over the long term, success of managing a multi boutique platform is about building sustainable scale, including diversification by boutique, which is a balance between mature stage managers and the earlier stage incubation managers. This year, we've made significant progress ensuring we have future resilience in the Ferdante business. Turning to CIP Asset Management or SIPAM. SIPAM is our specialist in house investment and solutions capability, which includes our real estate, fixed income and solutions teams. As Angela just spoke of, SIPAM plays the central role for the Life Company as well as being a highly regarded investment manager for 3rd parties.
As you may know, Challenger was as including what Angela said, Challenger is the largest fixed income manager, and SIPAM fixed income is a very important part of our success. The platform for growth for our fixed income capability is significant and something, again, I will touch on in more detail later. In our real estate team, we've been pleased with the performance of our business, which operates both here and in Japan. Whilst domestically, the focus has been on managing through the impacts of COVID on our portfolio, I'm pleased to announce that our Japanese real estate business has recently won its 1st third party mandate to manage Japanese real estate, which is a very exciting development. In funds management, we always recognize that the earliest wins are often the most important as a basis for future growth potential.
Finally, in SIPAM, it's worth me noting the significant progress we've made this year commercializing our Investment Solutions capability. Investment Solutions is a team of highly talented markets people formed over the last 4 to 5 years, which are able to partner with leading institutions, including in the profit for member sector to deliver implementation, protection and other bespoke capabilities. As Australian institutions build more internal investment capability, this team can add value to these clients meeting ever complex needs. Let me now discuss distribution. We have invested into and evolved our capability here significantly over the last 3 years.
The stability and quality of resource we have in our team today is strong and a core reason for the success we are seeing domestically, which was recognized by Zenith naming Ferdante Partners Distributor of the Year. We continue to see significant opportunity for us in Australia. However, we also recognize the need to diversify globally. As we selectively move offshore, we're focusing on markets where we can meet 3 preconditions of having the right product with the right market structure and the right sales capability. We believe we've identified that in Singapore.
And this month, our new office opens there, adding to our existing presence in London and Tokyo. Success here will see us continuing to diversify by manager, client segment and geography. On that front, we successfully launched a new UCITS Fund for our DEA, which is currently being distributed in the U. K. And select European markets and will be the product platform for Southeast Asia.
Our investment capability and distribution capability are enabled by an institutional grade platform. This next year, we'll see Funds Management make a number of investments to improve client technology. The investments will enable Ferdante, in particular, to provide customers with better ways to access our funds online and via exchange in the form of ETFs. As the business grows globally, the platform is also needing to develop new skills and capability. This last year has seen us launch new fund structures overseas as well as supporting new institutional offshore clients.
Success on the platform is being able to deliver our investment funds and capability in as efficient a means as possible and in the form that clients want. And this year will see us continue that investment. We're currently one of the fastest growing active managers and multi boutique platforms in Australia. And through this last period, we crossed the symbolically significant $100,000,000,000 of funds under management. And I'd like to note that we have grown our retail assets substantially this year, and we'll add close to $4,000,000,000 in Retail Fund in 2021.
As noted on the chart, our growth in fixed income has been a standout. Whereas with our equity flows, we get the benefit of the market over time, the growth in fixed income is a raw flow story. An area of focus for Ferdante and SIPAM has been the development of defensive income up to higher income capabilities, and this should continue to support our leading growth in this segment. We see the role of world class differentiated income capability as a strategic strength of the business. Today in the market, we have 9 differentiated strategies across our managers that target this defensive income, cash plus 2, to higher income, cash plus 8 category.
This deliberate strategy of delivering high quality income capability meets the opportunities that are presented by current demographic trends and current interest rate settings. With our domestic equity managers, we recognize that we have more limited institutional capability. However, that is not the case for any of our managers in retail, where we continue to prioritize growth, which provides diversification and better margin opportunities. Product development across our existing Ferdante boutiques and CIP asset management has been and will continue to be an important driver of future growth for the business. Pleasingly, there are a number of new strategies from existing managers that are building their track records and reputation and as well new product ideas that are being developed across existing managers.
A point also worth noting is that there remain segments or asset classes where we either do not have investment capability today or where we are earlier in our growth profile. One area, for example, where we see significant future opportunities is global equities, Developed Market and Emerging Markets. Ferrante will shortly announce a new Emerging Markets investment business. Emerging Market Equity is a globally applicable asset class. And whilst we see domestic opportunity, we are as excited by the global potential to grow a franchise.
We have today several high quality global equity options, and our ability to scale these capabilities over the medium term provides us also with significant scope. In Ferdante, we have typically pursued a build approach characterized as the team lift out where we identify investment excellence and commercial potential. However, we recognize that certain asset classes and segments make that approach either less likely to be successful or where investment compromise may be required. This leads me into an area of the Ferrante platform that we have developed over the last 3 years, long term global partnerships. In 2019, we announced our partnership with Ares Management, a business which undoubtedly has become more well known recently in Australia.
Ares is a world leader in global alternatives, has over $200,000,000,000 under management and an investment team of over 500 people. That world class expertise presents as an opportunity to bring Australian investors differentiated and difficult to replicate capability. We have designed and launched 2 new funds together and early signs are extremely encouraging. Together, we own Ares Australia Management. Very recently, we announced our partnership with Impax Asset Management.
Impax is a global leader in ESG and Impax Investing with credentials that well precede the hyperbolic growth in the segment more recently. Impacts has, over 25 years, developed an approach that is globally recognized and market leading. The partnership has seen us bring across the Impact Sustainable Leaders Fund, a global equity strategy that will form the starting point for more capability between ourselves and impacts in the Australia and New Zealand market. Finally, we've entered a partnership agreement with Nomura, Japan's leading investment trust manager. Our agreement here will see us bring 2 of their strategies into the domestic institutional market, and they will similarly work with us to explore opportunities to help export our capability into the Japanese trust market.
These world class investment managers are attracted to the strength of our distribution platform in a highly competitive Australian superannuation market. Let me now focus on SIPAM's fixed income franchise, which manages circa $16,000,000,000 today, across mostly Australian credit and private lending markets and select global. Whilst the business manages significant assets for Challenger Life, as Ang has noted, since 2010, the team have been managing money for local and offshore institutions. The last 4 years has seen substantial progress made in positioning the broader third party success and presenting us with considerable which presents us with considerable potential. As noted on the slides prior, there has been a lot of product development across the fixed income business and none more so than in SIFAM.
Over the last 4 years, the team have worked with institutional and high net wealth partners to seed and launch a series of Australian credit funds across cash plus 3, cash plus 5 and cash plus 8 segments. The development of 3 differentiated strategies has the potential to add significant value to our clients' portfolios and provides an opportunity for us to build a significant franchise. 2021 has been a very good year for the Funds Management business, with 3,000,000,000 approximately or circa 3,000,000,000 of net flows in both the 1st and the second quarters. We did 7,000,000,000 in the March quarter, and we're extremely pleased with the momentum that has continued through this quarter and the pipeline ahead. With our very strong position in the Australian market, we continue to invest into and make every effort to meet the needs of our clients and their customers.
Today, our domestic institutional business has relationships that serve most Australian institutions. And in many cases, we enjoy multiple investment strategy relationships, which have been developed over an extended period of time. Our model with its specialist investment management focus and alignment makes us an excellent partner for meeting institutional client alpha needs. Our growth in retail has been an important and pleasing feature of our business, and we were ranked by Plan for Life as having the top net flows for 2020. We are servicing a record number of Australian advice groups in our retail business, and continuing to broaden and deepen our coverage in the retail channel is a key plank of our strategy.
This is an important this is an opportunity for us to remix our thumb for managers closer to capacity, which is providing margin resilience, which is protecting us from fee compression. Domestically, we'll be launching more ETFs in the coming year. Our 2 fixed income ETFs have provided valuable experience across the broker channel and the self directed investor channel. And we continue to see the efficiency of the ETF structure as highly attractive to clients and their customers. The Australian high net wealth and ultra high net wealth channel is growing quickly, and as and we are well positioned to build out our business in this channel.
We'll be adding more distribution resource to this channel to ensure we service their specific requirements. We're expanding our distribution efforts offshore. And whilst only a small contributor to overall FUM today, we see considerable offshore opportunity in the years ahead. We have a strong pipeline of offshore clients today, and delivering on this is a priority for the business. As mentioned earlier, we're excited to announce we're opening a Singapore office, which will give us access to the burgeoning wealth market, which serves the Southeast Asian region.
As you can see here, our focus is to build out a diversified platform, diversified by asset class, diversified by client segment and diversified by investment manager, though all sharing the common element of a focus on high alpha. Our platform is extremely strong today, and we're one of the fastest growing funds group in the country. Continued execution of our strategy and a focus on meeting our clients' needs gives me confidence that we can continue our growth trajectory. Thank you, and I think I now pass back to Stuart.
Great. Thanks, Nick. We're just going to take a quick 10 minute break. For those of you online, 10:30 will recommence. You'll receive a message just before
we start. Thank you.
Good morning, and welcome from the break, everyone. I know many of the faces in the room, but I thought I might just give a little bit of background on myself to start. As Richard mentioned, I've been a challenger for over 16 years. I spent a decade as General Counsel in the last three leading the group strategy function, and that included the acquisition of My Life, My Finance Bank. I'm now leading the transition integration process.
It's really exciting to be here to be discussing this important strategic development for Challenger. We started work on the potential setup or acquisition of the banking business over 2 years ago. It's been really rewarding to work on the early formulation of the strategy and see that through to the acquisition of MLMF and now working on setting up that business for its future success. Prior to the acquisition of MLMF, we scanned and due diligence a number of different banking opportunities. And in MLMF, we believe we've acquired something unique with a clean, contemporary and scalable digital platform, free from legacy issues, providing Challenger with an accelerated entry into the term deposit market.
The bank will open up new distribution pathways for Challenger, including a functional direct to consumer offering from the outset and the ability to leverage our existing distribution. We'll extend both our product and customer reach and help provide our customers with better retirement outcomes. Strategy will allow Challenger to play to its strengths in lending and fixed income as we look to broaden on the bank's lending portfolio. The returns delivered will become an important contributor to the group achieving its ROE target over time, acknowledging that it will take some time for the bank to scale. The bank strategy is firmly aligned with Challenger's purpose, which is to provide our customers with financial security for a better retirement.
You can think of it as another tool in our toolkit for delivering great retirement outcomes. Now let me explain how the bank contributes to each of the strategic priorities of our corporate strategy, which Richard presented earlier today. First priority being broadening customer access across multiple channels. The bank will open up new distribution channels, in particular, Accelerating Challenges D2C capability. It will also enable access to a wider range of customers, including those in retirement and those approaching retirement.
Next is expanding the range of financial products and services for a better retirement. Initially, this will be via a term deposit offering with broader tenants. CDs are familiar product set among Australian retirees and those approaching retirement, and they form a significant part of their wealth allocation. The term deposit market is significant at around $1,000,000,000,000 And over time, the bank will provide further product innovation opportunities, always linked to Challenger's purpose. The next priority is leveraging the combined capabilities of the group.
The bank will create synergies across the group by leveraging Challengers' leading retirement brand, strong focus on risk management. And finally, it's about strengthening the resilience and sustainability of Challenger. The bank will diversify Challenger's product offering. It will reduce reliance on the financial advice channel, and it will reduce the earnings and capital volatility of the group. As many of you know, the bank uses an historical cost, accounting and capital framework as opposed to the fair value framework of the life company, which requires the life company to market its assets and liabilities.
So for
a bank of the size of MLMF, it is unique to find a platform which is so efficient and scalable. Cathic Super acquired MLMF in 2016. Its intention was to provide a full suite of financial services to its superannuation members. In order to scale the business, Cathic Super realized it needed to invest in the business and implement a new core banking system. So over the past few years, the bank has embarked on a digital transformation program, implementing the cloud based software as a service version of Temenos TRANZACT.
Now this is a leading banking system, contemporary and with a direct to customer capability. Chris will elaborate on that further this morning. We were very impressed with how the MLMF executive team delivered this transformation within budget and on time. Given Catholic Super's focus on making its merger with Equipped Super a success, they decided to sell MLMF and focus on their core superannuation offering. MLMF is a small and efficient bank with only £133,000,000 of savings and deposits and £110,000,000 of loans, mainly residential mortgages.
The loan book is well seasoned and has very conservative leverage ratios. Its customers are right in Challenger's sweet spot with an average age of about 60 years. We are fortunate to be acquiring the business at this time, and we will be delivered a platform capable of supporting considerable growth. The transaction is progressing well. As you know, the acquisition of MLMF is subject to APRA approval under the Financial Sector Share Holdings Act.
Now 2021 has been a pretty busy year for APRA with lots of activity in the banking sector. So while it's taking us a bit longer than we expected, we're now targeting completion by July. And while we're yet to complete, we've made good progress in forming distribution partnerships and setting up the business for success under Challengers ownership. This includes scoping the necessary technology requirements to support a multichannel distribution strategy. The MLMF team is scheduled to move into our Melbourne offices early in the financial year, and we've been working closely with them on the integration.
We've made good progress in building the capability of the bank, particularly in the areas of lending, risk and compliance. To support Challenger's ambitious growth strategy, we will look to increase the size of the team and capability across both Sydney and Melbourne. The bank will transition to the Challenger brand, leveraging our market leadership position in retirement incomes, ensuring it is strongly aligned to our purpose. We are operating within budget with integration costs tracking to our original estimate of about $8,000,000 The distribution strategy of the bank will be focused around building early momentum and scale via multiple channels, including an operational direct to consumer capability. To accelerate speed to market, we will commence marketing under the MLMF brand and look to transition to the Challenger brand during financial year 'twenty 2.
We will prioritize those channels where we can leverage existing capability of the bank or build efficient distribution quickly. Over time, we will gain further customer insights to better meet their needs and to build greater customer loyalty. Our product offering will also evolve over time. Initially, we will retain the existing term deposit product offering with 1 month through to 2 year tenors. However, we'll look to broaden out the tenors to 5 years and beyond over time and bring more compelling offers to our customers.
I will now step you through the evolution of our distribution for each of these channels. Commencing with direct. The bank already has straight through processing capability today. In the initial phases, direct distribution will be attracted by comparator sites such as Canstar and Mozo. Once a customer clicks through a link on a comparator site, they are taken into the bank's native system.
These customers become direct customers of the bank and part of Challenger's ecosystem where we can get to know them better. Over time, we'll look to evolve the direct offering using these customer insights to broaden the ways in which we interact directly and meet their needs. Next is intermediated. Our intermediated distribution strategy will initially focus on retail brokers. These are online marketplaces which advisors, high net worths and self managed super funds can log into to access competitive TD offerings.
Examples are Australian Money Market, CashWorks and the term deposit shop. These brokers effectively do the customer KYC and AML checks, and they aggregate daily payments on behalf of customers to a series of different banks on their platforms. There are a number of different operational models ranging from delivery of aggregated customer data in CSV files through to open API solutions. We are currently exploring an open API solution with a major broker. We have implemented a similar solution with another bank, which also uses the Temenos TRANZACT system.
This will be a highly efficient distribution platform. Over time, we will also look to explore distribution through financial advice platforms, utilizing our existing relationships and highly regarded distribution capability and support services. Next, institutional. There is a capability to raise institutional money from wholesale brokers such as Curve Securities, who can raise shorter term money from other ADIs and small institutions like councils. Much of the institutional distribution will be preserved for the existing clients of Challenger, comprising super funds, life companies and multi asset managers.
Challenger has already had significant reverse inquiry from our clients. We have a pipeline of interested institutions. The Aetna lending strategy for the bank will be important to delivering returns to our shareholders. Our strategy will be centered around broadening the lending capability and embedding a strong risk management approach. The bank's balance sheet will be comprised solely of lending and other fixed income assets.
The bank will seek to maximize ROE by looking for relative value opportunities. Underpinning this will be the strong capital and risk management practices that are in grade and Challengers business. We expect capital outcomes for the TD business to be broadly similar to the term annuity business after factoring in asset mix, duration and so on. In relation to liquidity, there are well documented behaviors of deposit holders in terms of rolling over their term deposits. Term deposit business is sticky.
Term deposits can often be rolled over 3 or more times. The bank will retain its existing retail lending capability, continuing to grow its residential mortgages, utilizing their current resources. The bank will diversify its forms of lending into corporate lending, commercial real estate and asset backed securities. These are all markets that Challengers is very familiar with and currently operates in. SME and asset finance will also be an important contributor to returns.
Challengers' existing SME lending capability will be folded into the bank. This will include accounts receivables finance and other forms of specialized finance. To close, the acquisition of MLMF is a highly strategic acquisition and a significant step in helping Challenger fulfill its corporate strategy. It provides the opportunity to significantly extend our customer and product offering. Adding a digital domestic banking capability to sit alongside the Life and Funds Management operations will also further broaden ways in which we provide financial security for a better retirement.
It will open up new distribution channels. In particular, it will accelerate Challenges' direct to consumer offering. MLMF provides a contemporary and scalable platform free from legacy, enabling speed to market and a platform for growth. We will continue to invest in its distribution and product offering. And whilst it will take some time, we are confident the bank's highly efficient digital offering, coupled with broad lending capability, will deliver significant growth and compelling returns for shareholders over time.
I'll now hand over to Chris.
Good morning, all. Thanks for your time this morning.
It's great
to be here today as Chief Executive of Operations and Technology. I have a deep understanding sorry, I should say that's a role I took late last year as an opportunity to broaden my contribution to our business' success. Having spent the last 4 years leading our Life business, I have a deep understanding of all the elements that need to come together for us to deliver for our customers. In fact, one of my final actions as CEO of the Life business was to document our core investment beliefs. These are the beliefs that underpin our investment decisions.
1 of these beliefs is the belief that our people drive our outcomes. We believe that to optimize outcomes, it's important we maintain strong risk culture and values, And then this must be supported by strong processes, governance and incentives. It's a real privilege to be in a position to continue to support these ambitions, both in my ongoing role as Chair of our Life Investment Committee and in my role as CEO of Operations and Technology. As you've seen today, our businesses have ambitious growth agendas, Being in a position to bridge the commercial and operational has been officially powerful as we explore some of the more innovative solutions. I believe that digital modern ways of working will be critical for our success as an innovative, disciplined and customer centric business.
I also believe success requires strong strategic partnership with our business. This is why I was excited by that opportunity to lead the operations and technology function. Today, I'd like to talk briefly to our leading capabilities and how they will facilitate our growth strategy and talk about the bank integration and the platform it will provide us. So to put operations and technology in context of the overall business, our sum 300 employees support the execution and delivery of our 3 businesses' objectives. We do this through the close working relationship of our operations team, technology and our program office.
We cover a wide range of activities, including investment administration, contact center, facilities, core infrastructure, digital and project delivery. By providing strong strategic partnership to the 3 businesses, we support their growth and provide the foundations for an excellent customer experience. Our team has a proven track record of delivery. Our high reliable core operations are built on a legacy freight platform, with a single customer register and administration system supporting our businesses. Over the recent past, we've supported the business through significant growth, not just in assets under management, but also in breadth, with new jurisdictions such as Singapore, as Nick mentioned before, and also complexity, with new trading strategies, for example, for Challenger Investment Solutions and IDEA.
Our customer service is market leading. Angela referred to our overall satisfaction scores for contact center and administration services over 91%, and we have a Net Promoter Score of 35%. Wealth Insights has also voted us the leading Australian Wealth Management call center for the last 5 years. The quality of our offering is also validated by the support of the Ferrante boutiques that all utilize our platform. And they've also been tested by the disruptions of COVID-nineteen.
In a matter of weeks, we had essentially all staff and all activities operating remotely, including call center, investment administration and all investment activities. This all occurred smoothly with no impact to our customers or to the running of our platform. We've continued to embrace modern ways of working, with strong adoption of cloud based collaboration tools, including DocuSign, WebEx and Microsoft's 365 Suite, now all deeply embedded in our day to day activities. We are in the final stages of a laptop rollout to all staff, further supporting our team's capacity to operate in new hybrid working environments, aiding productivity and engagement. And we've implemented scaled Agile for nimble and disciplined project delivery.
We have proven our execution capability. This year, we successfully upgraded our general ledger and our key HR platforms on time and on budget. This has allowed us to consolidate these core corporate platforms to a single scalable cloud based solution. We also completed major upgrade to our Investor Online, now utilizing Azure Cloud, which enables rapid delivery. It will also support Challenger Life with its ongoing product innovation and customer centricity.
We have built integrations to support annuities on major platforms, including CFS, Panorama, Hub24, Netwealth as well as directly to a range of super funds, including both retail and profit for member. In Funds Management, we've supported the business in its launch of new products, such as the ActiveX series of active ETFs. So this proven execution capability is now being brought to bear on the bank integration. Michael has spoken to you about the business plan for MMLF. From an operating perspective, we are also well positioned.
The bank will provide a leading technology platform. MMLF has a legacy free, scalable, cloud based technology platform. Its core banking platform, Temenos TRANZACT, supports digital self-service and origination of the bank's product set, including mortgages. The bank also uses the INJU to support payments across a range of platforms, including direct debit cards, direct entry and BPAY. It will also soon support NPP, Australia's new payments platform.
The bank will leverage our existing capabilities. Notably, it will utilize our investment management, client operations, call center and marketing resources. MLMF staff will also relocate to our existing Challenger premises in Melbourne. And we're geared for delivery of future innovations. As Michael has outlined, the integration is proceeding well.
Our teams have been working closely together, assisted by our strongly aligned cultural values and purpose. The technology capabilities are in place for both the banking and investments platforms, and we are utilizing agile processes to ensure nimble and disciplined delivery as we support the delivery of that bank's product strategy. So just to recap, Operations and Technology are an important strategic partner to our business, supporting their growth. We have a track record of delivery and are well positioned to extract operating leverage and scale benefits. And we have a leading banking technology platform that is legacy free and highly scalable.
Thanks again. Richard, I think, is going to wrap up now.
Okay. Thanks a lot, Chris. Thank you. Now before I close and then we move on to Q and A, I wanted to turn to our financial outlook and give you an update on where we're expecting to end for FY 2021 and then take a look forward into FY 2022 and provide some guidance there as well. So firstly, as we've previously announced, we expect to achieve a normalized net profit before tax outcome at the bottom end of our original guidance range being $390,000,000 to $440,000,000 for FY 2021.
This reflects, among other things, the more challenging investment market conditions and, in particular, tighter credit spreads relative to where we started the year. We expect Life's cash operating earnings margin, so our COE margin, to close FY 2021 at around 2.45 percent for the whole year. And then furthermore, we expect that to be stable over the course of FY 2022. At the end of FY 2021, Life's PCA ratio is expected to be around 1.7x, which is at the top end of our extended PCA range. PCA ratio has benefited from significant positive investment experience over the course of the year and also from the release of Life Risk Capital in relation to our UK Longevity Reinsurance business.
In Funds Management, we expect the quality of income to continue to improve with greater contribution coming from fund based income, which will in turn support and expand the fund based income margin as we head into FY 2022. Now given the proximity to the end of our financial year, today we're issuing FY 2022 profit guidance, with a normalized net profit before tax expected to be within a range of $430,000,000 to $480,000,000 Furthermore, the midpoint of this range represents our best estimate and would see us achieve our normalized ROE target being 12% above the RBA cash rate. So as I said at the outset, we're in good shape, and we have a clear strategy for growth. Let me close by expanding a little on the strategic priorities that we've focused on to achieve those growth ambitions in the immediate term. You can see that the customer is at the center of our strategy as we strive to build on the strong foundations that we've created and to reach more customers in more ways.
Firstly, this means being available to customers through a broad range of distribution channels. The acquisition of My Life, My Finance will support this strategy with a digital banking platform and a familiar product offering that provides a great basis for us to build on the direct channel in particular. Being a desirable partner for intermediaries remains a key element of our strategy, and this is an area where we have a very strong and proven track record. We have deep relationships with advisers, and we'll continue to enhance our processes and practices to ensure that our valued support that we provide valued support and we're easy to do business with. And for institutional partners, we will continue to work with them in developing solutions for both their pre and post retiree members post retirement members.
And we'll maintain and grow our Global Funds Management footprint. Nick has spoken to the investment we've made to date in Funds Management, which has really driven the success we've seen in that business over the course of this year. Our second focus area is on the range of products that we offer to support better outcomes in retirement. We believe that we can better meet our customers' retirement needs by broadening that range, return deposits providing the immediate opportunity to do this. Maximizing the value we create as a whole requires us to leverage the capabilities from across the group.
The combination of product and distribution capabilities we have across our funds management, life and soon the bank, create a very special opportunity to establish and to grow customer relationships. It also helps us retain and develop great talent and to develop the leaders of the future for our business. Finally, we'll be able to strengthen the resilience and sustainability of our business. We'll continue to advocate for government policy that supports better outcomes for retirees. Our superannuation system is world class, yet most retirees still worry about running out of money.
Our guaranteed products are a clear part of the solution, and we're excited about the role they can play as the system evolves to better address the unique challenges that confront members in retirement. We have an ambitious customer vision to provide 1 in 5 Australian retiree households with improved financial outcomes as consumers of Challenger Products by 2,030. We believe that we can provide older, middle income Australians with a better retirement outcome through the financial security our capabilities put us in a unique position to be able to provide. So thank you for listening this morning. I hope you've got a real sense and insight into the strength of our business and our strategy and our plans to build on the great Challenger franchise that you see before you today.
So that really concludes the formal part of our presentations. And I invite you to join me and I'll invite the other presenters up to the stage to join me for Q and A. And to facilitate that, I'll pass back to Stu.
Great. Thanks, Richard. Just as a matter of protocol, we will take questions in the room first before turning to the online questions, which are starting to come in. So if you are online, feel free to send them through. We've got some roving mics, so please raise your hand if you're in the room and like to ask a question.
Could I just remind you to state your name and the company you represent when asking a question? Thank you.
It's Anthony Hu at CLSA. Can I just ask a question around your guidance, particularly around the COE margin, the Life business? You guided 245 basis points. First half was 255, so that implies second half is quite a significant fall. Can you just talk through the drivers there in terms of the expected benefit from the cash deployment versus the impact of the credit spreads the credit spreads impact?
And then what the outlook is for 2022 in terms of those particular drivers?
Well, I might make a comment from a Life perspective, and then Richard, you might want to add something from group. Look, I think there are a few contributors to the variation between COI margin in the first half and second half. One of them on the positive side would be deployment of cash, and that will feed into FY 2022 also. But we've also talked about adjustment to our pricing that has occurred over FY 2021, but in particular, in Q3. So that is having an impact also.
And of course, on the downside, we've had the tightening of credit spreads. So in the first half, our investment opportunities, particularly in Q1, were stronger than they were in Q3. That would be 3 broad comments I'd make, Richard. I don't know if there's anything.
Yes. Maybe just to say that looking forward, as we get the full benefit of that deployment, that's the basis on which we're expecting 245 as being at the stabilized COE margin and that that's consistent with the new ROE target we've said being the RBA cash rate plus 12%.
Is the impact from the credit spreads, is that still ongoing? And you expect it to further impact 2022?
That's fully reflected in the guidance that we've provided there. So both where we are from an annuity pricing point of view and the prevailing level of credit spreads are all reflected in that guidance and our expectation of the COE margin. To the extent that conditions normalize a little, then that would represent some upside against that.
Can I just maybe put
it another way? In your 2022 guidance, are you assuming credit spreads stay as they are from here?
Yes. That is that's broadly speaking true.
Thank you.
A couple
of questions. I might just start on some of the numbers, Richard, you put on Slide 49 around the second half twenty twenty one mark to market gain. Just wondering if you can talk through sort of exactly what you're assuming over the month of June there. That seems like you're talking around GBP 325,000,000 for second half. And also sort of what that GBP 150,000,000 Life risk net capital release is, which jointly look like they sort of boost your book value by about $0.60 a share?
Yes, great. Kieran, thanks. I'll grab all of that. So yes, the investment experience reflects everything up to the end of May and then also what we know of the revaluations we'll have in the illiquid part of our portfolio during the month of June. It does exclude the more volatile liquids part of the portfolio.
So to the extent there are movements in credit spreads, then that will create a little bit of a move from there. So that you have seen a strong performance from an investment experience perspective in the second half, reflecting some revaluations on the illiquid part of the portfolio. And so that's the first thing. And then Kieran, to your question on the Life Risk Capital release and the impact that that's had. So we talked a little bit during the presentation, or I mentioned, a restructuring of 1 of our longevity swaps, which had the effect of releasing capital of $150,000,000 which is then available obviously for redeployment and has contributed to where we've ended up at 1.7 times PCA.
And so that's also then effectively in the CET1 numbers that we'll finish the year at.
The present value of that life risk book, which I think previously was about $820,000,000 give or take, that hasn't changed as a result of that in terms of the profit recognition moving forward?
Yes. So just to be clear on that, the normalized profit emergence remains the same. So all that's happened here is that whereas previously and across the book more broadly, there is significant collateral posted reflecting the extent to which these longevity swaps have kind of moved in the money for us. We've effectively, in relation to one of those transactions, monetized part of that, which was effectively a release of $200,000,000 of collateral, against which there's a $50,000,000 capital charge itself, so a net release of $50,000,000 in CET1. But the important thing is that the earnings footprint of that business remains the same in a normalized sense going forward over the future.
And second question, just sort of looking further forward. I guess, your capital position today is very strong, particularly with those gains and releases coming through this period, that you are sort of signaling a high level of sort of capital requirements around the business, lower ROE commensurate with that. How does that all influence how you think about the dividend policy as you look out 2 to 3 years from now?
Yes. Okay. Thanks, Kieran. So obviously, dividend the dividend policy is a matter for the board ultimately. But what I can say is that our policy remains to pay between 45% 50% of normalized net profit after tax.
We're in a strong position being at around 1.7 times our PCA ratio. We've got organic profit signature of the Life business and the Funds Management business, which now more than offsets our corporate cost base and the subscale bank. So that gives us capacity to grow and we're comfortable with where the dividend policy is.
Thanks. If I can just sneak in one last question for Angela. Go for it. Just keen on sort of if you can give us a little bit more color around the interactions you're having with institutions, industry funds around sort of the lead up to July next year and the introduction of Sippers. What role do you think Challenger will actually play sort of when we see those products come to fruition?
Yes, absolutely. So there's a lot of activity. I think it's fair to say it's something I've been signaling for a little while now. We've been talking about retirement income for a really long time, but we've been somewhat of a lone voice. But more recently, I think there is so much more activity in this space.
Most of the major super funds have someone who is responsible for retirement income now. I mean, there's no doubt they've still got a lot of other competing priorities. But we've had a lot of workshops, a lot of quite detailed discussions with a few funds. And so there's no doubt that a lot of them are quite progressed in their thinking around what that could look like. I would say there are no easy answers.
It's we're really making a new market here. We're dealing with a new, almost global phenomenon of an aging population and how you turn turn more significant savings than probably anybody in an everyday sense an average Australian would have had and how you kind of turn that into an ongoing income stream. So different funds, it depends a little bit on their member demographics, etcetera. But we've done series of different types of modeling to look at how can you consider best interest duty in relation to the different members in your cohort, different members in your fund, how can you cohort those members to try to come up with solutions that will fit across them. So unfortunately, it's obviously quite sensitive, and we're not in a position to actually share it.
But there is a lot of activity, working through how much of that ends up crystallizing. The big challenges, I would say, the themes that are coming through from funds is they want it to be scalable. I would say that on the whole, their risk averse is the wrong word, but they're wanting to know what their options would be if there isn't big take up and those kinds of things. So look, I would say it's promising, but there's but it is an entirely new space, and we're exploring new territory.
It's Nigel Pizzaway from Citi. Question on the margins more broadly. I mean, previously, you've said you have a decent 12 month look through on what the margins are going to be with the main variance being hedge fund distributions. Obviously, what happened in the 3rd quarter has caused significant uncertainty on that. So can you sort of maybe give us the latest on that?
Do you think you've got confidence now in looking forward 12 months into margins? And what factors would move the margins from sort of top end to the question, Nigel. I think reflecting some of the uncertainty that you're referring to, we've tried to be
even more transparent this time around with our guidance and in particular, calling out that our best estimate for FY 2022 is in the middle of the guidance range that we've provided today. It should tell you something quite precise around where we think we're going to end up. And that's both in terms of the normalized net profit before tax, but then in terms of the we've clarified what that translates to in terms of the stabilized NCOE margin and then also that, that will be a number that is consistent with our new ROE target. It remains the case that there are variables which can cause that number obviously to be different to the middle of the range, and that's why we have a $50,000,000 range. And you pointed out one of them, which is the distributions from our absolute return funds and then the real assets portfolio and equity and alternatives portfolio more broadly.
We're still in a pandemic. And whilst we have factored in higher vacancy rates, for example, in our property portfolio into that guidance, there's still some residual uncertainty around that as well. So the middle of the range is where, at this point in time, we expect to be, but there is obviously scope for both outperformance and underperformance against that.
In short, you have a reasonable it sounds like you have a reasonable degree of confidence that it's going to be somewhere within the range and that 12 month look through you sort of had before is still relevant.
Yes. We notwithstanding the variety of things that have been a feature of this year, we've still ended up within the range that we provided at the start of the year, and we're deliberate about the size of that range to try and put something forward that we can be confident that we'll hit. Obviously, the only range you can be 100% confident you're going to hit is a very wide one indeed. So there's no guarantees other than those associated with our lifetime CPI indexed annuity streams. But yes, I think it's fair to say we have a reasonable degree of confidence that we'll end up in that range, Nigel.
Thanks.
Okay. And then maybe the second question is just on maturities. I mean, obviously, previously, you were saying that so you're reasonably confident that maturities were going to drop off and that was going to help book growth moving forward. You've now written quite a few short dated institutional annuities, which I believe have a 1 year term. So obviously, that changes the pattern a bit.
So can you sort of, reflecting that, give us some sort of color on what you're expecting maturities now to do?
I'm happy to pick that one up. You're absolutely right. I mean, we if we were looking at the book and looking at maturities for FY 2021 and what we were expecting for FY 2022, we were expecting that maturity rate to come down slightly. We're now expecting it to be broadly in line with what we've seen for FY 2021. So about similar given the new shorter tenor business that we've written over this year.
And then come down thereafter unless you're on more short dated, is that fair enough?
Correct. Correct, yes.
Yes. And so I think one comment I made during the Q3 update was that the or actually perhaps to clarify, the tenor of that the Institutional business written in the Q3 was around 1.2 years. There's quite a lot of it. So obviously, that can move the needle in terms of what has been for this year, a 27% maturity rate and now what we expect to be similar levels into next year. Whereas I think, Naljik, you put out a research report a while ago quite reasonably putting that more like 22% and that and the new business has kind of moved the needle on that.
But importantly, it being short term duration in itself doesn't cast a shadow as to the maturity rates in subsequent years. So we would still expect, insofar as the weighted average life of the business we are writing is lengthening, that over time, maturity rates will come down.
Okay. Thank you.
Laffer Thani from MST. My first question is in relation to the retirement income covenant as a follow-up. Do you see any risk of it not getting through given the environment of resistance to any further superannuation change? And do you or do you see any changes in the legislation from what's currently proposed? So,
Les, great question. I think it's pretty topical given the comings and goings around this. I think there's always risk as to the government's ability to pass legislation, including in this area and including really sensible reforms. I would just echo the comments I made in the presentation that and then perhaps to elaborate, both the Treasurer and Senator Hume have reiterated multiple times in recent times their commitment to the retirement covenant. And moreover, Senator Hume has called it out, if you like, as being the next cab off the rank once the Your Future Your Super reforms pass.
It's probably not for me to speculate as to when those reforms will pass. And so my expectation is that we will have draft legislation for consultation over the course of the rest of this year and that we're still on track for that to be legislated to come into effect on 1 July 2022.
I would add to that too. I'm not going to suggest for a second that the legislation won't help, but I think there is a growing momentum in the super funds to address retirement income. In some ways, the anticipation of it has prompted that thinking. And I do think there are some funds who won't necessarily need that to take action.
Okay. Second question is in relation to Funds Management business. There's been some media speculation that part of it might be for sale. Is there some frustration from where you guys sit in terms of see through value for what's been pointed out as one of the fastest growing businesses in Australia? And just a second component to that, could you talk about your existing capacity within that business at this point in time?
I might pick up the first question here. Yes, sure. And then you can take up the business related question. So yes, I'm aware, obviously, of the speculation there. And my reflections would be the following: that this has been a standout performer as a business.
The Funds Management business more broadly has made a massive contribution and
is making
a materially growing contribution to the group. And you can also see from the strategy that I outlined today the role that Funds Management plays in terms of that broadening of product sets and the way those product sets work together to deliver financial security for retirement. So it's strategically important from that perspective. There are also, as we've talked about before and mentioned before, strong synergies which exist between various parts of the group, including shared operating costs. And Angela talked about the harnessing the capabilities of SIPAM, in particular, in the lending activities that the Life company and our institutional partners undertake together effectively with Sipam as the asset manager.
But all
of that said, it's incumbent on the board to consider questions around what the right future for the business is. And at a time when if the company is trading at a level which is at a discount to what would be a sum of reasonably valued parts, then the board takes those sorts of questions very seriously. And it has, and I would say that the dominant consideration at this point remains the synergies and strategic value of the Funds Management business overall.
Okay. So on capacity, the way you should think about it, I made the comment about Aussie Equity Managers in the institutional space. There's obviously less capacity there because we have grown those businesses very significantly. So that doesn't mean that's the end of the road by any means. There's product development opportunities for those managers, a number of them are doing that.
But there's also the opportunities that retail present, where your average margin will be 3 times what your institutional margin will be. So where there might be capacity constraint there, a lot of our business is in fixed income markets, which are clearly broader and deeper, and so we don't feel there's any constraints that are reasonable there. And then we create capacity on the platform. I mentioned product development, but also through formation of new boutiques or the partnerships, which we've added. So headline, it's more than double where we are today, but that doesn't account for necessarily new boutiques and new product development.
So capacity doesn't feel a constraint other than what I mentioned in Institutional and Domestic Equities.
I'll squeeze in one more question in relation to the bank and the term deposits. Now it's a big change, right? Most term deposits are a year or less tenor. You guys are looking to expand to a 5 year TD product. What research or discussions have you had with advisers so far in relation to product formulation, whether it will there will be take up in interest and the benefits of them doing TDs versus annuities?
Yes. Good question. Firstly, one of the really interesting things around TDs is the behavioral elements behind besides just the contracted terms. So for example, a 6 month TD might really have a behavioral life of 2 years or now because it gets rolled sort of several times. I also think TDs play a number of different roles in people's sort of wealth allocation.
It could be the defensive part of their portfolio. It could be a place where people just park money for a period of time. And some of the markets that we're targeting here are actually a little bit broader as well. For example, in the broker space, in the high net worth space, people might place money across a number of different banks because they effectively want to diversify their risk, if you like. We have engaged with the financial advice platforms.
It's fair to say one of the things that has happened in post COVID with the advent of the term funding facility out of the RBA, the traditional banks have been sort of flushed with liquidity and funding, if you like. So term deposits hasn't been the desired source of funding for a lot of the major banks, which means that they've really sort of dropped the rates quite significantly, and they're only offering around 20, 25 to 35 basis points for 1 year business. So you can imagine that there'd be quite a bit of interest for a more compelling offer by Challenger.
It's Andy Chuk from Macquarie, being just the first question on the ROE target. So the implied second half 'twenty one of ROE is about 10.7%. Can you sort of just clarify the 'twenty two targets, which is 12.1 percent? Is that an average for the whole year? Or is that an exit rate?
So
the new target being 12% above the RBA cash rate is a target from this point forward. So it's consistent with the earnings guidance we've given, with the center of the range there being our best estimate, and it's designed to sort of apply from the start of FY 2022 onwards. Now as we've previously explained, due to the slow primarily due to the slow deployment of cash and liquids over the course of the year, it's always been our expectation that we would underperform our ROE target. And that's also true
of the new target. So that if
we were applying the new target to FY 2021, then we would come in slightly under that, reflecting that slow deployment. But I guess what I can say is that the new target applies from the start of this next financial year and that our central estimate for the year is consistent with meeting that target. And perhaps just to reiterate that it does reflect to the questions earlier, the current credit spread environment, so to the extent that it's a very tight environment as our risk premiums more broadly. So to the extent that investment market conditions normalize, either because some of the private sector crowding out of credit creation by the Central Bank eases somewhat, then that normalization would be supportive of outperforming the target.
Great. Thanks for that. The next question is just around a note for on Slide 49, just around the restructure of the 2 longevity transactions. Can I just confirm when in the period that was done?
Do you want to make any other comments on those transactions?
So the restructure of the Life risk, you mean?
Yes. I think you're referring to the restructure of the Life current risk transactions?
Yes. That's the restructure well, it took some time. Obviously, it was in gestation for a little while, but it's quite recent. So we've only just completed that transaction kind of in the last few weeks actually.
Fantastic. And just one quick one last one for me, please. Could I just confirm for the rental abatement in FY 2021, what's the latest expectations for that as that moves?
So there's really no material update on that from where we updated the market in our first half. So you'll recall that we when we started the year, we were expecting $22,000,000 of abatements. We updated the market at the half that we expected that to be somewhere between $10,000,000 $12,000,000 and there's no there's no material update to give in relation to where that's going to end.
Great. That's all for me. Pleasure.
Svettha Parameshwaran from JPMorgan. A couple of questions, if I can. Just first, just on just the opportunity from the Retirement Incomes covenant. Is it I mean, my observation is that it seemed like a couple of years ago, it was much more in the forefront of your thinking in terms of your strategy, whereas it seems today like it's been quite very much deemphasized versus the other opportunities in the bank and that's the opportunities that might be there in the Wholesale Life channel. Is that a fair reflection of how you see the opportunities going forward?
Maybe I'll just make the strategic observation to start with, Sid, and then Angie can comment further on the opportunity in the space more broadly. It is still our activity in with intermediaries and with institutions as part of that, so both advisers and institutions, remains absolutely central to our strategy. We are saying that we're broadening our distribution activities out, so we want to access customers, which include the members of superannuation funds, who will be our partners in providing retirement income solutions. Those customers, we want to expand our access to customers into other channels, including direct channels and initially by virtue of the acquisition of the bank. So whilst we are broadening our strategy sees us broadening out the way we access customers, in some ways, we're doubling down on our commitment to the intermediated channels.
And so the formation of partnerships with major super funds is a very important part of that strategy. And we see the retirement income covenant as an important enabler in that regard. I'm not sure whether there's anything you want to add to
the commentary about that. No, I think I mean it's not almost either or. It's still important, but there's another big and which is captured in that broader strategy.
Okay. Fair enough. Okay. Maybe just a question on the bank then. I mean, you mentioned that the bank obviously won't be reaching the group ROE targets at the moment.
But could you find out on how much scale you think you need to actually get there? How much capital needs to be invested to get to scale and to hit those ROE targets?
Yes. So I think we've previously stated in terms of like the number of sales, so broadly around $600,000,000 of sales will get us to sort of breakeven point. And I think you can probably take that and extrapolate from that to work out once we're achieving our ROE target. It will take time. The bank presently is making a modest loss.
I talked about the fact that we're we need to sort of still build out more capability, whether that's around lending and risk management. And that's why we're saying that we're not expecting a material impact on earnings for FY 2022 as a group overall. And it could take a few financial reporting periods before the banks are at scale and contributing to the group ROE in a material way.
Okay. And just a final question, if I can. Just on Slide 24, where you talk about the your front book economics being able to get an 11.8% return on CET1 after expenses. I mean, if we tax that and we allocate corporate costs, that seems to drop that number to, on my calculation, something like a 7% normalized return after tax. Is that how does that compare with your cost of capital?
What do you think your cost of capital is? Does that actually cover it?
Well, I
think there's a bit of a group aspect to that. So I might you might prefer to comment, Richard?
Yes. Thanks, Sid. I suppose in some ways, it's not for me to tell the market what our cost of capital is. It's the market, formulates and reflects that back to us. But it is incumbent on us to have a view around that.
And what I would say, Sid, is that I think that a 12% plus the RBA cash rate, pretax ROE is in excess of our cost of capital and that the settings of the business, particularly when you consider the reduced risk that we are embedding in the earnings profile by virtue of our shift in capital settings from, you like, 1.45 times PCA on average to 1.6 times PCA on average when you take account of the fact that, that translates to roughly a 2% shift in what one should expect in terms of a sensible risk return trade off, that I still feel that's an attractive return on equity and one which is in excess of our cost of capital.
There's also that group versus life.
Yes. No, good point. Thank you. And so within that, of course, we've got a growing Funds Management business, which is more than offsetting corporate costs going forward and more than compensating for the subscale bank. Thanks.
And you're exactly right. Thanks.
James Cordrucks here from Credit Suisse. Just a couple of questions on annuity pricing and term deposit pricing. So you talked to some positive pricing initiatives that are underway. But when you look in the market, it seems like you're still pricing term annuities at 100 basis point premium to term deposits. So is there more work you could do on that front?
And have you tested the elasticity of demand there to see if there's a volume trade off? And then I guess maybe a follow-up on the bank. Does term deposit pricing, can that be kind of lower than term annuity pricing, given you're not trying to win share away from the TD market?
I'll make a couple of comments on term annuities first and then maybe pass to you, Michael. Yes, look, it's it is an imprecise science trying to look at the elasticity. One of the things that I would say is the toughest competition is not from the majors. So whilst the banks might be positioning at kind of 25 basis points, that is definitely not where the neobanks and other players are. So our distribution team would definitely find we can find some pretty exciting deals.
And even sometimes from those big banks too, there will be special pricing that will be very significantly above what might be advertised. So we really try to apply a very strong pricing discipline. Obviously, we take into account that competitive position, but we come back to that ROE. It's a big backbone in our business. And so long as we feel we can make those ROEs, that will be where we price.
Yes. And in relation to the TD business, I mentioned in the presentation that there's obviously nuances and differences between the Life capital rules and bank rules. But essentially, when we take into account asset mix and duration and things like that, we're expecting the outcomes to be sort of broadly similar from a capital perspective. And so the bank's initially at scale, but if you assume the bank sits at scale and we're looking to price at ROE, I would say in terms of capacity to pay, our capacity to pay is similar to sort of on term annuities. Now where we ultimately end up paying, well, I think it's a bit too early for us to tell that because it's going to be dependent on competitive dynamics, the efficiency of distribution and so forth and general diversification, these are all still open questions.
And I think we want to be able to do some price experimentation. I think actually, that's the really exciting thing about the bank strategy is it's going to allow us to do that.
Thank you. Just one more question on the capital. So you've increased your capital target, targeting to operate at 1.6 rather than 1.45. From a CET1 perspective, how much of that increase is going to come from CET1 versus the hybrids? And do you have a new target for CET1, which I think was previously 0.8 to 1.1 times?
Yes. Okay, great question and quite a nuanced one as well. So what James is asking about there is the composition of our excess capital above the minimums. And bearing in mind that these ranges, the revised and extended PCA range, we've talked about 1.3 to 1.7 and then also a corresponding, if you like, CET1 range. These are outworkings of our risk management framework and in particular, our internal capital adequacy assessment process, which is a statutory document.
And that's just an important context because there can but there are really 2 constraints from a statutory point of view, the prudential capital amount and then that amount of the prudential capital amount, which can be comprised of hybrid capital, so additional Tier 1 and Tier 2 capital. So you're right to ask that question. What I would say is that all of our surplus capital really needs to be in the form of Common Equity Tier 1 because what it is essentially designed to do is create a shock absorber so that when you have a market shock, you can remain above the statutory minimum. So the first question is where is the which one is constraining? And then we take our excess capital from there.
So I think, James, to answer your question directly, Dan, your second question on what this corresponds to for a CET1 ratio, you can say that that's 0.8 to 1.2. And so there's in both cases, there's 40% of the PCA as a surplus capital. And so that's in reference to a minimum PCA of 1.3 or a minimum common equity Tier one ratio of 0.8.
Vered Mathur from Citi. Just one question on that same topic of capital. Richard, you did allude there earlier that there is a derisking of your earnings as a result of moving to a higher capital target.
Just wondering if
I could delve into that a little bit further and just sort of get an idea get a view into your thoughts on how much of a buffer does that now give you so that if you were to reenter a sort
of March 2020 situation or a similar market drawdown, how much? Yes. I think the it's a really interesting question. Is there a perfect buffer to have? And it really depends on you've got to answer that question looking through the windscreen rather than the rearview mirror in some ways.
So yes, we have learned from the COVID-nineteen related shock, and that certainly informed our calibration of our new target for capital. But there's always a shock that would be big enough to bring us down to the lower end of the range. But what I and you can sort of do the math in terms of looking at what our potential capital amount is and then multiplying that by effectively the 0.15 that we're increasing it by. And then we provide sensitivities on the asset shocks that, that means we can sustain further. I do think it makes a very material difference to our ability to withstand those shocks.
And I do think that, that will deliver a more stable shareholder experience. It's more consistent with our purpose of which revolves around financial security. And then I think the return trade off is a reasonable one in that context.
And just quickly, how exactly did you I think you said you expect a 2 percentage point reduction in the cost of equities. Just wondering how you came at that?
Sorry, ask that one again.
Did you say you expected there should be a 2 percentage point reduction in the cost of capital as a result of that?
Well, what I said was that if you and actually, you can sort of do this by running the numbers through the Front Book Economics slide that Angela's presentation presents. If you look at that, 2 different is from the changed capital settings, and that is in the order of 2%. And so you can think about that as the primary driver of the shift in the target. That's it. And just pointed to a number of other factors and a number of other things that are moving around there, most notably the very tight credit spread environment that we're in.
It's Oliver Anstead from Oftar Capital. There's some fairly influential view building by influential economists about this urbanflation problem coming. Can you talk a bit about how you see if that were to happen, how you see your business reacting, not just from the point of view of sort of CAPM and the pricing of it was pricing and appetite to go term? I mean, is that something we haven't really seen in recent memory? But just curious to see what
your thoughts are on that.
Yes. As you might want to make some comments about what that might mean for the demand of some of your business products?
Yes. Well, I mean, I think there's it's a common refrain within the advice community in terms of the in some ways, no doubt that more significant returns make that equation easier for advisers anyway, and we expect that to flow through into our product. Having said that, we've been innovating quite a lot as well and looking at what are those drivers of demands, how can we position, explain and innovate the product to continue to be relevant in an ongoing lower risk environment. I don't know, Richard, whether on the group side or from an investment perspective.
Yes. Maybe one overlay I'd make to that on the demand for products which can explicitly hedge for inflation. And this is in some ways my favorite point, that inflation is not a risk because people don't expect it to be there. In some ways, the inflation risk is the risk that it just ends up in a vastly different place to where we all expected it. And we are in kind of an unprecedented environment in terms of the expansion of Global Central Bank balance sheets, and we're seeing the murmurings of what that might mean from a risk point of view.
Now for retirees, and I would say for advisers and more broadly intermediaries, there is perhaps something of a complacency and just an expectation, and it's been this sleeper risk that retirees aren't particularly focused on. But it's a really key risk in retirement, the risk that your cost of living expands at a greater rate than your assets can keep up with that. So there is something unique about our ability to provide explicitly inflation linked lifetime income streams, which become increasingly relevant if there is a if there are concerns around inflation. So I do think that will could materially move the needle in terms of demand for the product. An upward slurping yield curve, to Angela's point, makes it easier to sell some of the term product as well.
And the only other thing I'd point out is that and perhaps a reminder that our ROE target is the cash rate plus a 12% margin. So to the extent that we do have inflation and therefore correspondingly higher interest rates, that will flow through into a higher target that we would expect to be able to meet.
The other thing that I do think is quite interesting, one of the things we've seen with our new RBA cash linked option on the annuity is we see a lot of advisers hedging their own risk. So they will often, with one client, allocate some to a CPI linked and some to a rate linked product, which was not something we'd necessarily expected.
Thanks, Oliver.
Great. We might move to some questions online. And just thanks for sending them through. If your question has already been asked, I don't intend to re ask it. But that said, there is one here from a retail investor, which I think we should give them the credit of asking that we've partly covered, and that's in relation to dividend.
Just what's your expectations on the dividend?
Yes. So again, Stu, thanks for your question. The it's obviously a matter for the Board, but what I can say is that our policy for dividends is that we will pay out and continue to pay out between 45% 50% of normalized net profit after tax.
Great. Thank you. The next question comes from Simon's Assume in relation to these in terms of pricing and rollover.
Okay. So I've in some ways, I think the presentation looked through the front book economics, and that front book economics was based on where we're pricing at the moment, which is about 30 basis points lower than where it was at the beginning of the year. We have already had one institutional role, obviously, not a role of money that came in Q3, but role from previous a previous year of institutional money since that pricing adjustment. So that was encouraging. But our FY 'twenty two guidance, to be very clear, is, as Richard's indicated previously, it's based on investment conditions as we currently see them and pricing as we currently see it.
Thanks, Angela.
The next question comes from Matt Dunga from Bank of Merrill Lynch.
And there's
a couple of questions, Matt, that have already been answered, so I'll focus on what hasn't. The first is a component in relation to the COE like margins and specifically direct origination. Could you just talk a little bit more about fixed income yields and the benefit you get from direct origination and how that factors into your earnings?
Yes. So I think, interestingly, there's a couple of ways within which we benefit through that direct origination. One of them is literally just the deals we are able to do. And I think one of the statistics from the private lending side of SIPAM is about a third of them, we are bilateral. So it's we are a primary it's just the size and scale of what the opportunities we're able to see in the market.
There is also when you are the only kind of counterparty in those deals and you are dealing direct, you are able to drive the economics in a different way from when you're participating more broadly. But I think a big part of what drives our economics is actually our ability to better understand and properly assess and select the underlying credit. So when I was talking about credit spreads, one of the things that the team have seen in the market is that the relative compression has been lower in sub investment grade. But when you go into that sub investment grade, that's when it is really important that you're selecting the best quality and that you've got good assessment of that underlying credit. And I think that is where our team are really strong, where the independent credit team, where the experience, all of those things that I was talking about with the many years that we've
Joe has managed to gather $1,000,000,000 worth of deposits over 2020.
Yes. It's a good observation. And probably a point I would have referenced myself in the answer actually is that there is evidence out there that others have been able to scale. But similar to the comments that I made earlier, the bank is currently making
a modest loss. We need to We need from Andre Stednik at Morgan Stanley. The first question is relation to the earnings in the Funds Management business and the profit margin. Andre notes that Janus Henderson has a profit margin to AUM before tax of around 21 basis points and Challengers is quite a bit lower at around 7%. What do we attribute this to?
Yes. I mean, I don't think you're making an apples for apples comparison there with Janus Henderson, but nonetheless. So the mix of the business will be an important part of it. The boutique model is one where it sees us own a minority of the equity and take other cost lines. So it is not integrated end to end funds management business.
It is a very contemporary model. It is probably one of the reasons we're able to attract and retain the type of talent that we have on that platform to raise the funds that we're able to raise. So there is a necessary trade off there. The other thing I'd note in our business in the last 5 years particularly is a significant transition to FUM based income from transaction based income. So we, in the past, had obviously lower levels of FUM, but we were delivering quite high transaction fees in certain parts of the business.
We are trying to move the business to more FUM based income, and we are seeing that materially come through the business today.
Thanks, Nick. And Andre's second question is relation to the net interest margin that the bank could generate and how it compares to the Life company at 2.5%, where majors are producing NIMs of sort of 1.6% to 2%. What do we attribute that difference to? And what does it mean in relation to ROE between the bank and the life company?
Yes. Look, given that we're yet to complete, we're not going to be putting, I guess, guidance or forecast out on NIM just yet. I'll just make a couple of observations. Ultimately, we're going to be targeting, once the business achieves scale, our ROE target, which was stated today. The other observation I'd make is like you're starting with a really small balance sheet, and it takes a while to actually sort of build up the asset base there because they're going to be lots of small slices, different deals to get a diversified portfolio.
So just it will take a few reporting periods before you get to a steady state asset base, And therefore, you're going to get a NIM that's that really sort of makes sense in a comparison sense.
Thanks, Michael. And Andre, I'd also remind you the capital bases are quite different between the bank and the life company as well, which does feed into that as well. The next question comes from Sean Ler at Morningstar. Just thinking back to the Q3 and pricing of institutional business taking longer than retail, What have you done in relation to your business to ensure that it reflects current pricing and you're achieving asset and liability mismatch matching in relation to the institutional business?
So a couple of things. I think I just want to make sure I'll answer the question, but I'm not sure I fully understood it. So you can give me some feedback, Stu, if I've missed the point. So with the institutional business, I'm not so sure that it's just the lead time. It's almost more we have been really trying to build new partnerships in that institutional channel, partly for that more investments related business, but also building those deeper relationships for retirement style business.
And we, I guess, look at what is the lifetime value of the customer in that context. And I think the credit spread movement that we had kind of happened over the course of FY 2021 was kind of unprecedented in terms of the velocity and the speed with which it happened. So it was really more in that context of how quickly do we pass on such significant changes rather than a change in policy more broadly. So being mid conversation with a couple of those big partners, it was really a balance of how quickly we passed that on. So we made a decision to both originate that business or create those relationships and adjust the pricing in terms of moving forward.
And Sean's next question is in relation to term annuities and term deposits. Can you just provide some color on crossover between term annuities and term deposits? Are they sold to different customer cohorts? Are they an alternative? And how will you package them going forward?
So I meant to grab that, Angie, and then if you can comment there, you've done a bit of talking. Look, as we prepared our investment case for this, this is obviously something that we looked closely at. And the short answer is yes and no. The 2 products, at some point, overlap. You can get a term annuity in the TD that economically perform very similar for the consumer.
But there are some important differences. There's advantages with TD is around being a very familiar product, being able to distribute perhaps with lesser advice requirements and distribute through different channels. So there'd be many customers that are purely looking for the economic outcome that TD really makes sense for. But equally, there are some unique features of term annuities that may make them more appropriate for customers. And some of those are, for example, if you're really trying to manage your income needs, you might want some of your capital being returned progressively as opposed to a full bullet repayment that typically happens with the TD at the end.
Transferring money from superannuation straight into a term annuity is a much simpler process. If you want to keep your money in super, you need to have some sort of TD wrapper sitting above the TD itself. There's also a big topic that we discussed earlier was obviously inflation, and annuities can provide some inflation protection as well. So yes, we do see the potential for there to be some overlap, but we also see a natural sort of segmentation of the market. And it was in definitely in our minds in building the investment case that we wanted to see this to be incremental growth over and above what you would see to be any overlap of product.
And I think the area, Michael, where this would be so much easier is the customers I talked about that are no longer in active advice relationships. When they come to a maturity, a term annuity is less familiar. Even customers who have term annuities, often a lot of those customers have really just gone on the recommendation of their adviser. And we all know that a term deposit is a much more familiar concept in the market. So there's a real difference there.
Yes, I agree with that. And that's sort of reflected in the relative size of the term deposit market, which is close to $1,000,000,000,000 And that's partly that familiarity and the ability to go direct is why this is a core part of the strategy going forward.
Maybe one further point that I'll add on that one as well is that you have talked about the different channels. The TD can go down. And the broker channel, you may recall that I mentioned, does in parts service advisers. But research shows that they're a very different type of adviser that would go into the major platforms. I describe them almost like a self directed adviser.
They're the ones that really want to shop around and use different offerings to get the best deals as opposed to ones that are just looking for the convenience of a major platform to help them provide all their services.
And certainly, one of the things that we come up against in selling term annuities in the retail channel is just the different advice requirements in relation to them. So the complexity around a term annuity, it's typically classified by the licensee in a different kind of bracket of complexity of advice that's required. And so paying for that advice fee is typically it's more significant for a term annuity than it would be on a term deposit.
Great. The next question comes from Tim Morrison at Allen Gray. Could you just give us a bit of color on the sub investment grade where you'll be deploying capital into it in the coming year?
Yes, sure. So I think as I mentioned that relative value, the places where I think we're seeing there are 2 aspects. 1 is where is the pickup greatest and then the other is just where is there sufficient depth in the market, and we have to consider both of those. But I would say, quite simply, it's been quite strong in ABS. That's true both domestically and globally.
It's probably been the time for us to call 1 out.
Great. Thanks, Angela. The next question is from Rid sorry, from Didraghaswami. Can you please give me just a little bit more detail on asset and liability matching? And also, given that you have written business at higher cash rates, does that mean you have a higher ROE on your back book than your front book?
Well, I'll maybe let you ROE question.
Yes. Asset liability matching their names?
Yes, absolutely. So I mean, I think we've we have spoken about this quite a lot before, but a very big part of our investment process is matching the liabilities that we have from the term of the liabilities with the term of our cash flow and ensuring we're not carrying duration risk. Now that can either be through the purchase of assets like property that have got long term leases, delivering cash flows that meet those longer term liabilities. But we can also use hedging to manage some of that duration risk as well if needed. But the very simple principle is making sure that the returns that we're generating on the assets are lined up with and matching the tenor of the liabilities that we have.
And in terms of the ROE question, so yes, technically, the ROE target applying at the time of running the business is the one that you would think about. That said, as we've clarified to the market in the first half that and actually at the start of the year that the gradual deployment from a cash and liquids portfolio would result in this underperforming against the ROE target that we've had enforced during FY 2021. And then going forward for FY 2022, the new business, which we write, as demonstrated on the Front Book Economic slide, is consistent with that target and moreover that the outcomes for the group in aggregate, as reflected in our earnings guidance, is also consistent with the new target.
And a follow-up from Vid. Thanks for following straight up. Is it too simplistic to think that higher interest rates just leads to higher earnings?
Well, the reason thanks, Vid, for the question. The reason why we've got an ROE target linked to the cash rate is precisely that, that we essentially, on the balance sheet, harvest the spread between assets and liabilities, but the shareholder capital sits behind that benefits both from that spread and from the prevailing base rates. So we reflect that reality in the ROE target itself, which is a very big part of the reason why over the last decade, those interest rates have continuously decreased. The ROEs that are generated on balance sheets like ours have likewise come down.
Great.
And the next question from Andrew Buncombe at Macquarie. Appreciating no major change in asset allocation in FY 2022, over the medium term, is it reasonable to expect the business could return to a pre COVID investment asset mix?
Well, it's a great question. I'll make some comments, but Richard, you may want to add something at the end. Look, I mean, it's fair to say we have an ongoing asset allocation review process. So we are always looking at relative value. And so obviously, where pockets of relative value change, we would be looking to update our asset allocation.
But in terms, I guess, of the degree of risk, obviously, that's somewhat dependent on capital. So we have set new kind of settings or targets in relation to that capital. So any change to the asset allocation that had capital implications, we would obviously need to be revisiting that.
Yes. So that was the point I would have made is that the asset allocation is in part a function of how much capital we've got as a percentage of the total asset portfolio. And that, in conjunction with the fact that we want to operate at 1.6 times our prudential capital amount, effectively sets a limit on how much risk there can be in the portfolio. And so therefore, that will constrain the extent to which we can be in growth assets or something that doesn't create credit, for example. All of that said, the capital structure is 1 at the moment that supports that ROE target.
And as we look forward, we're not expecting material changes to the current asset allocation settings as we head through FY 2022.
Great. And we're right up on time. One final question here from Sean Ler at Morningstar. Can just given the Q Super product, could you just help me understand why Superfund would work with Challenger when they can create a retirement product themselves?
Yes. Great question. And I'll be honest, one that I anticipated, that and maybe even Magellan because we've seen a little bit of activity in the market. And I have to say, look, overall, we so welcome any of this innovation because we've been saying for quite some time, and I do truly believe this, I think our greatest competition is the status quo. Most Australian retirees are sitting with a retirement proposition that looks not dissimilar to what they had in accumulation.
And I do think there are sufficient challenges in retirement as to warrant something that goes beyond that. And so I think any activity in the market and innovation in that space adds to the voices and to the consideration of maybe this needs to be different. Q Super are a very unique super fund. And actually, our team have been chatting with Ben Hillier and the team at Q Super as they've worked on that product. We have good relationships in with Q Super.
And they're unique in the sense that they have Q Insure. So they actually have an insurance license. And so they were able to use that within their product development. I don't think there'd be many other superannuation funds that would be in that position. Nonetheless, it's great to see what they've brought to market.
And the feedback we have had there is it was really challenging even with that capability. They worked on that product over a quite extended period of time and meeting those best interest duties and the things we talked about, the wide number of stakeholders that you need to get across for a new product proposition. But it's fair to say we're watching with interest how it goes. So Do you
want to make any further observations on sort of the types of risks that, that product protects versus a product, for example? Is there any difference?
Yes. Well, I mean, it is quite different. One of the things, I mean, it's a little bit like your comment in some ways as well, Richard, in relation to inflation. It's protecting for those risks when you haven't seen them is maybe one of the hard things. But it is more self annuitization rather than guaranteed.
So there is no guarantee over a lifetime payment there. It is a pooled product. There are some other obviously, we've done a pretty deep dive how does it compare to ours. One of the things we will be quite interested in is in terms of voluntary withdrawal. It's quite restrictive.
So for 6 months, you can rethink that investment. But beyond that, there is no voluntary withdrawal. We certainly have found that within the retail space, that ability to withdraw capital is something that advisors and customers are really interested in. So again, it's another great thing in terms of having that out in the market. We can compare what's seen as attractive.
But yes, it is a it's not a guaranteed product in the way that ours is. It's really quite different.
Great. I'll hand back to Richard in a moment to close. But just a reminder of those in the room, there's some sandwiches at the end here, and the executive team are here and willing to interact with you. But I'll hand back
to Richard to
close today's session.
Right. Actually, well, I might do that from here. Well, I guess really just it falls to me to thank you for a great discussion today. It's always a treat actually to put in front of you the executive team more broadly who have been with me for a long period of time and have been part of this journey over a long period of time. And I hope that through the discussion today, you've gained some insight into the resilience and strength of the franchise, but also the exciting opportunities that are in front of us.
And I look forward to engaging with you all next time we have the opportunity to do this. Cheers.
And I are online happy to help. Thank you.
On this, I should have said as well, there's sandwiches as well we're providing. So those who want to stick around, we can chat further.