New year’s resolutions and portfolio rebalancing face common challenges. Both spring from the best of intentions. Both can drift into the background as the holiday season draws to a close, and the urgency and demands of everyday life return.
For self-managed super funds (SMSFs), the more relaxed pace of life earlier in the year often presents the opportunity to review the fund’s portfolio and investment strategy.
Setting a fund’s asset allocation is arguably the most important decision SMSF trustees make.
At a time when there are heightened levels of uncertainty on the geopolitical stage, the value of rebalancing the portfolio periodically to keep it within the risk ranges you are comfortable possibly takes on even more importance.
As 2017 gets into full swing, it is worth reflecting on the year just gone. For SMSF trustees, a challenge can be knowing how your fund is performing and a critical data point is knowing what to benchmark your fund against.
Broad-based market index funds provide an easy and accessible way to measure your fund’s performance, while mainstream super funds are another point of reference.
In 2016, defensive assets like fixed interest did their job of providing stability to portfolios, with the Australian fixed interest index delivering 2.7 per cent and Australian government bonds 2.5 per cent.
Australian shares enjoyed another year of double digit returns with the Australian shares index fund delivering 11.5 per cent and the high-yield index fund slightly lower at 10.6 per cent.
International shares delivered 8.03 per cent on an unhedged basis, while if the currency impact was hedged out, the return was higher at 10.4 per cent.
Emerging markets and international small companies delivered 11.03 per cent and 13.02 per cent respectively on an unhedged basis. Global infrastructure index – a specialist asset class that can be hard for SMSFs to access directly – ended 2016 up 12.66 per cent.
On the property front, Australian listed property returned 13 per cent, while international listed property was 6.69 per cent with currency hedging.
When reviewing individual asset classes, the danger and/or temptation is to focus on the top-performing sector. At this point, it is worth remembering that past performance is never guaranteed to be repeated next year.
Potentially, a more meaningful benchmark for an SMSF to look at is the performance of diversified funds that invest in a spread of asset classes based on target risk levels.
In 2016, the conservative Vanguard index fund returned 6.06 per cent, the balanced fund 7.35 per cent, the growth fund 8.5 per cent and high growth 9.67 per cent.
The key comparison point here with an SMSF is understanding the portfolio split between defensive and growth assets. For example, a balanced fund is 50/50 while a growth fund is 70/30 growth assets to defensive assets.
The rebalancing question comes into play after one asset class has had a significant growth (or loss).
A typical SMSF has strong allocation to Australian shares, and according to Investment Trends research, around 40 per cent of an average SMSF portfolio is in local shares. Given 2016 returns of 11.5 per cent for the Australian share market, portfolios are likely to have moved out of target asset allocation ranges.
This is why the discipline of regular reviews of the SMSF portfolio’s asset allocation is so valuable.
If you find your SMSF portfolio has moved outside the tolerance levels you or your adviser has set, the next question is how do you go about rebalancing to get it back to the point where you are comfortable with the allocation.
The simplest way is to use new cash flows/contributions to buy more of the asset class that is now underweight.
Where it is more complex is if you do not have cash flows to work with and therefore need to consider selling some assets to provide the cash for the rebalance. This can involve both transaction costs and have potential tax implications, so it can be good to seek expert advice either from a financial adviser or an accountant specialising in SMSF work.
The concept of rebalancing is one of those things that is simple to say but harder to carry through. One of the emotional hurdles many investors struggle with when it comes time to rebalance is the reality that you are buying into the weakest performing asset class and potentially selling your strongest performing asset.
That can cause investors to procrastinate, which is when rebalancing ends up in the company of other well-intentioned new year’s resolutions.
Robin Bowerman, head of market strategy and communications, Vanguard Australia