Did your SMSF top a return of 9.16 per cent?

Bruce Brammall, 24 July, 2019, Eureka Report

money growing out of the ground

 

 

 

 

 

 

 

SUMMARY: Being the “right kind” of defensive paid well for super fund investors last year. Did your SMSF top a return of 9.16%?

It’s not often that defensive investors will be as well rewarded as they were last financial year.

It’s not that just playing defence left you on top. More aggressive investors still finished top of the leaderboard, with a reward for the extra risk they took in shares and property. But many who swam in the shallow end of the pool got unexpectedly high returns.

However, simply being defensive wasn’t the answer. You needed to be the right sort of defensive to have been rewarded in FY19.

And the right sort of defensive, clearly, was not cash. Interest rates in Australia did little throughout the year – which was reflecting a global pattern – before falling right at the end. Returns on cash were, let’s be honest, pathetic.

No, being rewarded for going light on the risk was the other sort of defensives … bonds.

Bonds – more broadly known as fixed interest investments – had a stellar year, particularly in Australia. Bond sector (government bonds, Australian and international fixed interest and corporate debt) returns ranged between 6.5% and 10.3%. This from an asset class that is, overall, the next “safest” to cash, and considerably less volatile, and therefore risky, than property and shares.

But it’s likely, if not probable, that vast swathes of Australian self-managed super funds missed out on the relatively low-risk bumper returns from fixed interest in FY19. Why? Because SMSFs tend to be overweight to the sectors they understand. That is, we tend to be overweight to cash and Australian equities – way out on the two extremes of the risk/return universe.

This lack of diversification often comes at a cost. For most of the last decade, not being invested in international shares has been a drag on your returns. This year, it’s bonds.

Fixed interest returns are driven by many factors. But probably the most significant is interest rates. If interest rates go down, bond prices tend to go up.

And it was this, or the anticipation of falling interest rates, that led to rising returns from fixed interest, particularly in the second half of the financial year.

The point is to show you what sort of return you needed to have achieved last financial year, in order to have justified your spot as “investment manager” of your SMSF and allowed yourself some proper diversification across asset classes.

The returns below are calculated based on replacing your management skill, time and experience, with “no management risk” index funds.

And the return that the “average” SMSF investor could have achieved in the recently completed financial year – what you could consider your benchmark – was 9.16%. This is what you could have received by not actively investing, but investing across a “moderate” or “balanced” portfolio of assets, after fees.

That is, you could have done almost nothing but hand over your investments to the likes of Vanguard, and you would have got 9.16% return on your investment.

Here’s how. The following are the returns you would have achieved by investing with index fund manager Vanguard last year, across the asset classes listed.

For individual fund returns, over one year, the returns were:

  • Cash Reserve Fund: 2.57%
  • Australian Fixed Interest: 9.36%
  • International Fixed Interest (hedged): 6.79%
  • Australian Property Securities: 19.25%
  • International Property Securities (hedged): 7.81% (unhedged at 13.68%)
  • Australian Shares: 11.2%
  • International Shares (hedged): 6.43% (unhedged at 12.1%)

Australian property was the winner, followed by Australian shares and then Australian fixed interest. The trifecta! This is heavily against the trend of the last decade.

The next table shows the returns you would have got if you had diversified across the above asset classes, according to reasonably classic investment theory. (The actual percentages are listed further down in this column. But in essence, the more aggressive you become, the more of your money moves out of cash and fixed interest and into property and shares.)

Table 1: One year returns for FY19 by risk profile

Risk Cash Fixed Property Australian International Total
Profile   Interest   Shares Shares  
Defensive 1.03 5.08 0.00 0.00 0.00 6.10
Conservative 0.51 5.08 0.76 1.01 0.39 7.75
Moderately Conservative 0.26 4.23 1.52 1.90 0.84 8.75
Moderate 0.13 2.96 1.52 3.14 1.41 9.16
Moderately Aggressive 0.13 1.27 1.52 4.48 1.93 9.33
Aggressive 0.00 0.00 1.52 5.60 2.57 9.70

Note: The returns listed above are the portion that each asset class contributes to the “total”.

Plenty of investors would have easily topped 10% this year, and possibly for each of the three previous years.

Obviously, it was a year you wanted to be light on in cash (but this can only be discovered in hindsight) and heavy in other asset classes.

But it is rare indeed to have a year of strong returns where “conservative” and “moderately conservative” are within two percentage points of an “aggressive” investor. (See below in regards to the equivalent calculations for three-year returns.) And this is solely due to the bump from fixed interest.

So, here is a yardstick, against which to measure your performance as your SMSF’s investment manager for FY19.

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If you’re not interested in one-year returns, then have a look at the same methodology used to determine a “management free” return over three years.

Three-year returns take some of the noise out of year-to-year returns (though five and 10 years obviously do a better job) and allow you to sit back and compare returns, given your role as investment manager of your SMSF doesn’t require you to achieve specific returns (as for industry and retail funds, who need the manager’s return to be stellar for marketing purposes).

You’ve got time to be more patient with your assets.

Here are the equivalent figures pulled for a three-year period ending 30 June, 2019.

  • Cash Reserve Fund: 2.18%
  • Australian Fixed Interest: 4.03%
  • International Fixed Interest (hedged): 2.51%
  • Australian Property Securities: 8.37%
  • International Property Securities (hedged): 4.38%
  • Australian Shares: 12.64%
  • International Shares (hedged): 12.68%

This is looking more like “normal” returns. Average returns from shares have beaten property, which has beaten fixed interest, which has beaten cash. This is roughly the natural order of asset classes over the longer term.

Again, if you’d left it to Vanguard to manage your money for the past three years, these are the returns you would have got, according to your own risk profile.

Table 2: Three year returns (FY17, FY18 and FY19)

Risk Cash Fixed Property Australian International Total
Profile   Interest   Shares Shares  
Defensive 0.87 2.10 0.00 0.00 0.00 2.97
Conservative 0.44 2.10 0.35 1.14 0.76 4.78
Moderately Conservative 0.22 1.75 0.70 2.15 1.65 6.46
Moderate 0.11 1.22 0.70 3.54 2.79 8.36
Moderately Aggressive 0.11 0.52 0.70 5.06 3.80 10.19
Aggressive 0.00 0.00 0.70 6.32 5.07 12.09

The most important difference to notice about the one-year versus three-year returns is the spread has widened considerably. This is the opposite of what would normally be expected, as returns tend to come closer together, or normalise, over longer periods.

This is yet another surprise caused by the strong performance of bonds during FY19.

The variance from defensive to aggressive over one year is only 3.6 percentage points, but over three years is actually more than 9 percentage points.

So, if you are looking to value your investment expertise over a longer period of time, this is the table you should be looking at.

“Moderate” investors should have been aiming to be a return of 8.36% over the last three years, while aggressive investors should have nearly been in the teens and ultra-defensive investors at sub-3%.

Risk profiles and calculations of returns

For those wanting to know what asset allocations were used to achieve the blended risk profile performance figures above, see table 3.

Table 3: Asset allocation across risk profiles

Asset Class Defensive Conservative Moderately conservative Moderate Moderately  aggressive Aggressive
Cash 40% 20% 10% 5% 5% 0%
Fixed Interest 60% 60% 50% 35% 15% 0%
Property 0% 5% 10% 10% 10% 10%
Australian Shares 0% 9% 17% 28% 40% 50%
International Shares 0% 6% 13% 22% 30% 40%
Total 100% 100% 100% 100% 100% 100%

For fixed interest, property and international shares, a split of 65% domestic and 35% international was used.

Notes on this annual report: The point of this annual report 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.

This is not why most trustees take on the role, or start their own SMSF, but this article 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.

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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 .

 

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