The Revealing Truth – Why You Shouldn’t Compare Returns
What a year it has been for share markets and super funds.
A journey from strength to strength resulted in industry funds holding most of the top awards for the highest investment returns last financial year, ending 30 June 2018.
There is no magic pill or secret technology at play here. While returns are influenced by many things, there is typically one crucial factor determining the outcome of most superannuation fund returns, including your own… it’s called asset allocation.
Asset allocation, put simply, is the decision to balance investment in:
● Defensive assets; this includes cash, term deposits and fixed interest
● Growth assets; this includes all shares, property, infrastructure, alternatives, and accumulating debt to increase investment capacity (this is called leveraging).
So why have some funds outperformed the rest?
When it comes to asset allocation the asset classes I’ve mentioned above (Growth vs Defensive) have started to ‘blend’. For example, some super funds (indeed some on the top of the returns list) are beginning to call infrastructure and property assets ‘defensive’ while some funds are even going into debt (leveraging) and calling this a ‘balanced’ approach to investing.
This is an obvious indication of something significant; the asset allocation of superannuation is changing, becoming more aggressive and taking on significantly more risk. Crucially, one thing is staying the same – the one thing that shouldn’t in a situation like this – which is the name.
This problem is a BIG ONE.
Of the top 22 returning ‘Growth’ funds recorded in the Australian Financial Review (AFR) last financial year, over half of them were called “balanced” in the name of the fund.
In theory this may seem ideal, but the reality is considerably darker and concerning given that some of these ‘balanced’ funds are just as aggressive as a ‘high growth’ or ‘high risk’ portfolio. This means that some of these theoretically ‘balanced’ funds have as little as 10% (or less) in truly defensive assets, and this is something to be genuinely concerned about.
While this strategy had favourable outcomes for investors last financial year, there will absolutely be years where the opposite occurs, and the downside risk is BIG.
Our concern is for those unsuspecting people lured into these funds by the misleading title and the apparently ‘amazing’ and ‘top rated’ returns. Not having the necessary tools or information to properly assess what they are getting into, people step out of great performing funds with appropriate levels of risk and move into high-risk portfolios with appropriate levels of returns.
The thing to remember with taking on more risk is it should result in an increased opportunity for better returns. Considering that last financial year was a great year for shares, then in truth some of these funds haven’t had great returns, but only appropriate levels of returns given the higher level of risk they are taking. This is a notable difference to ‘great returns’.
Here is the run-down on asset allocation when it comes to investing:
|Level 1||Conservative risk portfolios||90% in truly defensive assets|
|Level 2||Defensive risk portfolios||70% in truly defensive assets|
|Level 3||Balanced risk portfolios||50% in truly defensive assets|
|Level 4||Growth risk portfolios||30% in truly defensive assets|
|Level 5||High Growth risk portfolios||10% in truly defensive assets|
Keep in mind these allocations will naturally have variations around 10% either way in different circumstances depending on an individual’s personal preferences. When we talk about truly defensive assets, though, we actually mean good quality, truly defensive assets.
Cash. Fixed Interest. Term Deposits. Simple.
A few reasons why this ‘blend’ of asset allocation is beginning to occur could be because of consumer pressure and dare I say it… greed.
When interest rates are at all-time lows it means that truly defensive assets provide very low returns, often meaning that returns of portfolios can also start to drop below their long-term averages. If your fund returns start to drop into this range and you compare it to 3, 4 or 5 years ago, you might just think that your fund is performing poorly when it is in fact doing quite well.
We all want better, if not the best, so when the AFR publishes a list of top returning funds and it is 3%, 4% or 5% better than your own fund, many people are quick to make the move chasing a greater return. This then places pressure on the original fund to compete and improve its performance, forcing them to become more aggressive and so on in a dangerous cycle.
This is the same type of process we saw leading up to the Global Financial Crisis. The competitive pressure to outperform lead to a lot more than ‘blending’ asset allocation, as we saw the physical creation of new assets, tax deductible investment schemes and entirely new categories of asset classes! The outcomes from these inventions ended badly for many investors, despite them being labelled ‘defensive assets’.
We largely all want more. We generally all feel like we need more. But do we truly know what we have, what we are chasing, or what we need? The skill is actually in understanding how much risk you want, need or can afford to take and then invest accordingly, through all market cycles.
Unfortunately looking at the investment menu or asset allocation of your superannuation fund online will no longer answer the question about risk. You need a thorough understanding of what they (and by association you) are physically investing in. What are the assets? Where are they based? Is there leveraging in the portfolio? Are these defensive assets truly defensive assets? As the saying goes, if it sounds too good to be true, it probably is!
Whether you have a SMSF, retail super fund or industry super fund the message I hope you take from this article is:
(a) Understand what you are investing in.
(b) NEVER chase returns.
(c) Greed is a powerful emotion and will often mask itself as common-sense, entitlement or need.
(d) Truly defensive assets consist of only genuine defensive assets. At the moment they are delivering low returns, BUT they are protecting your portfolio.
Be assertive and don’t mindlessly follow the pack. Given that the largest asset of most Australian’s (outside of the family home) is superannuation, please take the time to consider whether you truly understand everything your superannuation fund is investing in, because if you don’t your money could well be exposed to greater risk than you expect.