This article appeared in the October 2013 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
By Robin Bowerman, Vanguard
In the year to June 2013, self-managed super fund (SMSF) assets grew to $495 billion, 32 per cent of the overall super industry. This continuing growth story has meant ongoing work by the financial services industry to service SMSF investors' needs.
The Vanguard/Investment Trends SMSF Planner Report, released recently, provides a great insight into this important sector of the super industry.
Almost 2000 SMSF trustees took part in the survey, conducted in March and April 2013, and the results suggest a skew towards a "barbell" portfolio construction approach, with heavy weightings to direct shares and cash.
At the time of the survey, SMSF trustees had $223 billion invested in direct shares, representing 45 per cent of the total assets invested, and $140 billion (33 per cent) in cash. Although direct shares accounted for almost half the total asset pool, SMSF investors, on average, held only 18 different shares in their portfolio.
Of the cash allocation, $46 billion was classified as excess cash, or cash that would normally be invested in other investments but for market volatility. This amount fell by $4 billion in the 12 months to April 2013.
Around 83 per cent of investors said that when they do invest their excess cash, they will put at least some of it in direct share investments. The intention to invest in term deposits and cash products has fallen sharply.
Spreading the risk
Despite the lack of diversification suggested by these findings, the research also showed that some SMSF investors are seeing the benefits of investing in exchange-traded funds (ETFs) - a product category that allows investors to complement a direct share portfolio by spreading the risk across a greater number of shares, removing the single-share risk and ensuring a good spread of investment across different industries and sectors within markets.
Eight per cent of SMSFs now hold ETFs in their portfolios, making up about one per cent of total SMSF investments. This total percentage is still relatively low in the overall asset pool, but the number of SMSF investors holding ETFs has increased by 28 per cent over the 12 months to April 2013. The vast majority of SMSFs that invest in ETFs use broadly diversified Australian and international equity products.
For those who held ETFs in their portfolios, the top three reasons cited were favourable market conditions, added diversification and value for money.
ETFs offer greater control over investments by ensuring the portfolio achieves market returns, often at very low cost compared to actively managed funds. Also, ETFs provide the opportunity to quickly, easily and cost effectively rebalance a portfolio to align with strategic asset allocations; the typically low turnover of underlying holdings can deliver tax efficiencies; and regular information provided to the market makes ETFs transparent to prospective and existing investors.
They also suit existing direct share investors because they trade in the same way through a broker.
Importance of asset allocation
The heavy preference to invest in equities and cash products suggests also that investors could benefit from taking a more strategic view of their asset allocation plan.
One reasonable benchmark for investors might be diversified funds, which most super funds and many fund managers offer. Most professional investors will start with an asset allocation plan to construct these funds - looking at the most reasonable mix of assets based on risk profiles, such as conservative, balanced, growth and high growth. This also relates to age, because individual risk preferences usually change as people get closer to retirement.
The chart below shows the example of Vanguard's diversified growth fund - 70 per cent allocation to growth assets (shares and property) and 30 per cent allocation to income-producing assets (fixed income and cash). This is compared with the asset allocation findings from the Vanguard/Investment Trends SMSF report. The big differences are the absence of international shares and fixed income assets in the SMSF portfolio.
Vanguard’s diversified growth fund
70% allocation to growth assets (shares and property) and 30% to income-producing assets
Source: Vanguard and Investment Trends
Of course, not all investors' needs line up neatly into a diversified fund portfolio. However, there may be room to increase diversification where a portfolio is heavily weighted towards domestic Australian assets while lacking exposure to quality, defensive fixed income.
In the past, accessing fixed income such as government bonds has been difficult for many retail Australian investors, which may have contributed to low exposure to fixed income and high holdings of cash and term deposits. However, with a range of fixed-income ETFs now available, SMSF investors can access fixed-income funds in the same way they would traditionally trade shares.
Despite the asset class being out of favour in recent times, investing in good-quality fixed income remains the only true diversifier to equities. Fixed income can introduce three key elements to a portfolio - diversification, a steady income stream and capital stability. For a broad portfolio of bonds, these coupon (or interest) payments can constitute a reliable stream of income, which is particularly important in preparing for retirement years. Investments in international assets can also provide valuable diversification benefits for investors, given Australia represents only about 3 per cent of the global investable marketplace.
In looking at the changes SMSFs are planning for the year ahead there are signs of a shift towards greater diversification, with the research finding a 54 per cent increase in the number of SMSFs intending to invest in ETFs in the coming year. More than 60 ETFs are listed on ASX, offering access to all the major asset classes, so there will be no shortage of choices for SMSF trustees.
There is a deep body of academic research that highlights the single most important decision any investor makes is asset allocation, because this has the most impact on returns from investment (aside from decisions on shares to invest in and timing).
The latest study reconfirms that many SMSFs use a financial adviser or accountant to complement or validate their investment decisions. Having a good adviser who plays the role of financial coach and technical expert on the complexities of the superannuation regulatory regime can be a very worthwhile investment.
About the author
Robin Bowerman is Principal, Head of Market Development and Communications, at Vanguard.
Fixed Income Exchange Traded Funds has useful information on the features, benefits and risks of ASX-listed bond ETFs.
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