The end of the financial year is a traditional time to take stock and see how one’s portfolio has performed. From both from anecdotal and statistical reports, I’d expect that most Australian investors have been on a wild ride over the past four months as the coronavirus pandemic has played havoc with their portfolios.
One of these statistical reports is the Australian Taxation Office’s (ATO) quarterly update on the asset allocation of self-managed superannuation funds‘ (SMSF) funds, which provides a useful look into how assets are currently split amongst self-directed superannuants. The most current data stands at September 2019, but the numbers have been remarkably constant for a while. It shows a huge overallocation to risky assets, being equities and property. You can see the split in the chart below.
Managed funds, both listed and unlisted, account for 22.1 per cent of all assets. The key assumption here is that the managed funds selected by SMSF owners are split in the same proportions as their direct holdings, i.e. equities are 57.4 per cent and property is 33.5 per cent of all managed funds. I’ve assumed that no cash is held in a managed fund, as cash allocations in these funds are presumably ‘dry powder’ waiting to be applied to that particular asset class rather than a permanent allocation to cash as an investor might place, for e.g., in a term deposit.
The actual allocation to directly owned bonds is just 1.5 per cent of all assets.
Jack Bogle, the founder of famed investment house Vanguard, used a simple rule of thumb to describe his views on asset allocation. It very much follows the KISS principle of Keep It Simple, Stupid. “Own your age in bonds,” was Bogle’s view.
What this means in practice is that the asset allocation held by SMSF owners in Australia is suitable for someone in their 30s who is looking to build wealth by taking risk with their capital, not those in retirement who are looking for stability of that capital that they have worked their lives to build up and which they need to provide them with a secure income stream to fund living expenses. Yet these are our self-managed pension portfolios! Not appropriate at all!
Putting Bogle’s advice into practice, meanwhile, would look something like the below chart, with the investor dynamically adjusting their exposure to the three major asset classes (again for simplicity) as they age.
We would never suggest that you divest of ‘growth assets’ completely (we actually prefer the term ‘risk’, because growth implies getting bigger over time – and as we have just been reminded of, this does not always happen), but reduce the exposure as time moves along.
Note that this is how we compare on asset allocation globally – it is still poor.
As we have pointed out many times in the past, this risky allocation has worked relatively well for Australian investors given the hitherto uninterrupted economic expansion we have experienced for the past 29 years, before the coronavirus pandemic ruined everyone’s party globally.
That being said, as you can see from the Vanguard returns chart we have shared previously, Australian shares are now back close to the long-term bond index level if you look at performance back to 1990.
For the rest of the world, this is just another recession to deal with, to go along with the early 2000’s tech wreck and the GFC in 2008/9. But three recessions in 20 years seems a lot to me…
As you can see from the below chart, in each case global equites declined by approximately 50 per cent in each case from peak to trough, before taking approximately two years to recover.
I expect the economic damage from this pandemic to persist longer than is currently priced in, and so there is potential for risk asset prices to fall further from here, given the speed of the recovery being based on hope, not reality. Based on history, which as we know does not repeat but it sure does rhyme, we can likely expect another 18 months or so of economic pain before we really start to see a proper recovery.
As in previous recessions, there has been a classic ‘bear-market bounce’. This offers investors another opportunity, very recently since the last all-time highs in stocks, to exit these riskier positions and move their asset allocations to a less risky position for the next few years and avoid the pain of potential future downturn in risky asset prices.
Clearly, there has been unprecedented central bank intervention and fiscal stimulus, but remember that all of this support is just to plug the short-term gap – it is not necessarily a total net stimulus. The world economy was slowing long before coronavirus became the straw that broke that particular camel’s back. It therefore follows that now is a good time to reassess asset allocations of SMSFs in particular and bring them more into line with global best practice.
For example, the UK pension fund average allocation to bonds is 30.2 per cent and in the US it is 26.9 per cent. The respective allocation to equities is 9 per cent and 33.5 per cent, and to cash just 2.2 per cent and 0.5 per cent respectively as can be seen in the OECD Pension Fund asset allocation data above.
There has been a timely reminder of what can happen to funds over-exposed to risk assets, and yet there is also an opportunity to correct that misallocation without suffering a heavy loss.
This is likely to set up investors better for the likely drawdown to come and also to provide the security of capital and predictability of income from bonds vs equities (note that dividends, particularly bank dividends, have been cut significantly, in some cases to zero as with ANZ and WBC). So, if want to know more about the benefits bonds can offer your portfolio, you know where I am.
IMPORTANT LEGAL INFO This article is of a general nature and FYI only, because it doesn’t take into account your financial situation, objectives or needs. That means it’s not financial product advice and shouldn’t be relied upon as if it is. Before making a financial decision, you should work out if the info is appropriate for your situation and get independent, licensed financial services advice.
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