Did your SMSF smash the average?

SUMMARY: Playing it safe gave no help for returns in 2017. It was all about risk. Did you get your SMSF to beat 7.93%?

Every streak must come to an end. And for FY2017, that meant a year where being too defensive was a serious drag on your portfolio.

It was a year in which the more aggressive you could allow yourself to be, the more your SMSF portfolio was rewarded, with Australian and international shares providing the only real growth for the year.

The best performer of the last decade, fixed interest/bond investments, had a rare howler, falling into negative territory. Cash, as we know, has been struggling for years to keep pace with inflation and had another anaemic year.

To have growth, you really needed to have equities in your portfolio. And, preferably, a good split into international equities.

The point of this (annual) column is to give you the yardstick by which to judge your own performance as an investment manager for your SMSF. Each year, I take a look at the sort of number you should be aiming to beat with your SMSF’s performance.

I do this in July by aggregating the performance, according to a risk profile asset allocation spread, of a range of Vanguard index funds.

This year, that number is 7.93%. (Last year, it was 5.05%.) That is the performance you could have roughly achieved if you’d done nothing … except leave your funds sitting, passively, across index funds designed to represent a “moderate” or “balanced” risk profile.

This particular column is now in its eighth year. (You will find previous years returns and columns in Eureka Report’s archives on 27/7/16, 15/7/15, 21/7/14, 22/7/13, 25/7/12, 3/8/11 and 21/7/10.)

It was a year that was probably pretty kind to average Australian SMSF trustees, who largely hold most of their assets in Australian shares and cash. Of the seven asset classes we measure, Australian shares finished the year second, while cash finished third.

But the pack leader was, again, international shares. For the majority of the past eight years, having international shares in your portfolio would have added to your investment returns. And, via Vanguard (managed funds or exchange-traded funds), can be accessed easily and cheaply.

So, how did each of the asset classes perform in FY2017?

The returns of the individual Vanguard sector funds (after fees) were:

• Cash Reserve Fund: 1.8%
• Australian Fixed Interest: 0.08%
• International Fixed Interest (hedged): -1.29%
• Australian Property Securities: -5.55%
• International Property Securities (hedged): -0.14% (unhedged at -4.72%)
• Australian Shares: 13.66%
• International Shares (hedged): 20.55% (unhedged at 14.91%)

I have continued to use hedged versions of the international products to take out the added risk from currency. This year, an appreciation in the Australian dollar meant hedged versions performed worse. But in both FY15 and FY16, the falling Aussie dollar added significantly to performance.

What can be determined by the raw data is that being too defensive in 2017 produced very poor results. Cash returns continued to fall (to below 2%), while a particularly bumpy June stripped away a few percentage points from the performance of fixed interest, both domestic and foreign, turning them, on average, negative.

Which has been rare in recent times for this asset class. Fixed interest investments have actually been the best performer of the last decade.

Since July 2007, just before the peak of the market, fixed interest has averaged around 6.5% after management fees. That sounds like an appalling return for the “best” asset class of the last decade, but don’t forget about the equities mess running from November 2007 to March 2009. Over the same period, Australian shares have returned 3.25% and international shares 6.14%.

Needless to say that being all in cash and fixed interest was a near disaster in 2017. Many really defensive portfolios would have failed to beat inflation.

But they weren’t the worst performers of the year. Property, both domestic and international, took out that category, after being the standout performer of recent years.

SMSFs really needed to be in shares, local and international, to have positive returns in 2017.

The more aggressive you were last year, the better your returns, as you will see from table 1.

Table 1: One year returns for FY17

Note: The performance figures under the asset classes is the amount, in percentage points, that the asset class contributed to the “Total” column. See Table 3 for asset allocation.

Double-digit returns didn’t come unless you had around 75% or more of your investments sitting in growth assets (shares and property).

However, for one year, property was obviously a drag on performance. That certainly isn’t the case if you start to look at three year figures.

The returns of the individual sector funds for Vanguard (after fees) for three years were:

• Cash Reserve Fund: 2.13%
• Australian Fixed Interest: 4.05%
• International Fixed Interest (hedged): 4.96%
• Australian Property Securities: 12.15%
• International Property Securities (hedged): 8.42%
• Australian Shares: 6.44%
• International Shares (hedged): 9.72%

Australian property the best performer? The only one in double digits? Yes, the 24% and 20% returns of the previous two years (FY16 and FY15) managed to hold up this year’s performance, which was the worst of my measured asset classes.

Table 2: Three year returns (FY15, FY16 and FY17)

Returns for the three years have somewhat “normalised”. The higher the risk you are prepared to take, over the “medium” term, the higher have been your returns.

If we truly are in a lower-return environment than what we had previously come to accept as routine, then these three-year returns are getting close to what would be considered normal, with pure high-risk assets returning more than 8% over management fees.

The RBA’s most recent inflation figures say 2.1%, so a medium-risk asset portfolio (Moderate) is returning approximately 4.5% over inflation. Lower-risk porfolios (Conservative), are about 3.6% above inflation.

If you haven’t done a risk profile recently, you will be able to find a number of reasonable and free ones available, including on the www.investsmart.com.au site, or my own website, www.brucebrammallfinancial.com.au on the “about us” page.

They will at least give you some food for thought in regards to how you could broaden your own investment allocation to help improve, or smooth, your own returns. And, more importantly, to give you a good idea whether the risk you are taking in your own portfolio matches your comfort with risk.

Table 3: Asset allocation across risk profiles

Notes on this annual exercise: The point of this annual column is to show SMSF trustees what sort of returns they could have achieved if they left everything to index fund managers, who charge tiny fees to try to get a return within a small margin for error from the major indicies.

I realise that’s not why most trustees take on the role, or start their own SMSF, but this column is also designed to be a reminder of how you can take on the investment risks about which you believe you might have some expertise (such as, perhaps, Australian shares, cash and maybe even fixed interest), while outsourcing the investment management for other asset classes, such as international shares and property, or even domestic REITs to low-cost index fund managers.

Mainly, it is designed to give you a benchmark for you to use to compare your SMSF’s performance.

*****

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is managing director of Bruce Brammall Financial and is both a licensed financial adviser and mortgage broker. E: bruce@brucebrammallfinancial.com.au . Bruce’s new book, Mortgages Made Easy, is available now.