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• The latest statistics from the ATO show most self-managed super funds (SMSFs) have poorly diversified portfolios with large exposures to just three asset classes
• This suggests many SMSF’s are probably taking unnecessary investment risks and/or are missing out on the potential for higher investment returns, especially over the longer term
• If you manage your own SMSF, there may be opportunities to enhance your asset allocation strategy to improve the diversification and overall risk/return profile of your portfolio
The latest statistics released by the ATO (available here) show that most self-managed super funds (SMSFs) have portfolios which are poorly diversified.
As at 30 June 2016, the average SMSF held over 75% of their investments in just three asset classes - Australian shares and listed trusts (35% of assets), cash holdings (26%) and domestic property (15%). Investments in overseas assets represented less than 1% of SMSF portfolios.
Amongst smaller funds (i.e. those with balances below $200,000), portfolio concentration was even more pronounced. On average, these funds had more than half their investable assets in cash. Almost 80% of these funds were invested in only Australian shares and cash.
There are, of course, a number of shortcoming with the ATO data. Most of the ATO’s figures are estimates. The figures also don't distinguish between funds in pension and accumulation mode (which would typically have different asset allocations). It is also likely that the reported allocation to overseas assets is understated given it excludes investments in Australian domiciled trusts and managed funds which in turn invest offshore.
That said, the overwhelming levels of portfolio concentration in the report suggests that many SMSF’s are likely to have portfolios which are poorly constructed.
As a result, these funds are probably taking unnecessary investment risks and/or are missing out on the potential for higher investment returns.
5 TIPS TO ENHANCE DIVERSIFICATION IN YOUR SMSF
Like any investment portfolio, the asset allocation decisions of your SMSF should be tailored to suit your members’ risk profile and objectives. For some SMSFs, having a large allocation to Australian equities, cash and property may be an appropriate approach. However, for most SMSFs in accumulation mode, there are likely to be opportunities to improve asset allocations to enhance long-term investment returns and reduce risk.
If you manage your own SMSF, here are some tips to enhance the diversification of your portfolio.
1. Minimise concentration to any one asset class: The notion of not having all your “eggs in one basket” should be a cornerstone consideration for any long-term investment portfolio. If your investment "eggs" are spread across a wide variety of asset "baskets", each with different characteristics and profiles, then the negative performance of some investments will tend to be offset by the positive of performance of others. Over the longer term, the entire portfolio will be expected to yield higher and less volatile average returns. Amongst professional portfolio managers, allocations to single asset classes are often capped at 35-40% to help ensure meaningful diversification across portfolios, with lower maximum constraints (5-15%) applied to very high risk asset classes to help manage overall risk and sector exposures.
2. Ensure your Australian share portfolio is sufficiently diversified: Diversification within an asset class is often just as important as being diversified across different asset classes. This is especially the case if you hold Australian shares. A number of investment surveys have shown that the typical SMSF’s Aussie share portfolio is concentrated in a small number of stocks (typically less than 20) and predominantly exposed to the financial and resources sector. This lack of diversification within this asset class can heavily impact returns. An unexpected swing in one stock/sector (e.g. BHP in recent years) will have a marked (and unnecessarily high) impact on overall portfolio returns. The benefits of diversification (in terms of enhancing returns and lowering risk) can be seen in a simple comparison of the ASX20 (which comprises only the largest 20 stocks on the ASX) and the broader ASX200 index. Over the last 5 years, the ASX200 has outperformed the ASX20 (9.7% vs 8.7% per annum) and with lower volatility (12.8% vs 13.7%).
3. Consider the benefits of geographic diversification: The Australian share market makes up less than 2% of the world’s total by market capitalisation. As such, limiting your investment pool to just Australia will inevitably limit the investment potential and risk mitigation benefits afforded by the global market. As an example, the MSCI World Index (excluding Australia) has delivered an annualised return of 17.8% per annum over the last 5 years (to August 2016), significantly higher than the ASX200’s 9.7%, and with slightly lower volatility (11% for the 5 years to June 2016). The $123bn Future Fund currently allocates just 6% of its total portfolio to Australian equities and almost 4 times that amount in international stocks.
4. Ensure your cash allocation is appropriate: Whilst holding cash and term deposits is one way to de-risk your SMSF portfolio (and may well be appropriate in some circumstances), the current interest rate environment naturally makes it difficult to maximise capital growth for your retirement funds. For those investors with longer investment horizons, the benefits of a more diversified portfolio – albeit with higher risk – may be more appropriate, particularly if the asset allocation is carefully constructed to match your risk profile and objectives.
5. Consider the benefits of ETFs: Exchange Traded Funds (ETFs) are an ideal vehicle for SMSFs, providing immediate and highly diversified exposures to specific asset classes and having the advantage of being low cost and readily tradeable on the stock market. In just one (or a few trades) on the ASX, it is possible to invest across literally thousands of companies, sectors, asset classes and positions - instantly and inexpensively delivering a truly diversified portfolio. To find out more about ETFs, click here.
Ultimately, asset allocation decisions are complex. They require an understanding of one’s risk tolerance level and the determination of suitable investments to match specific objectives. This is where good investment advice can really make a difference. Your SMSF may be your ultimate responsibility to manage, but that doesn't mean you can’t seek the help of others.
At Six Park, we can help you create a globally diversified, professionally managed portfolio of investments for your SMSF. Click here to get a free investment recommendation from our team.