With volatility continuing in global share markets, most commentators are busy trying to work out where listed markets are headed. But before you check your investment crystal ball, it’s worth taking a moment to consider exactly what these investments are, and how superannuation funds blend a variety of investment structures to help boost, and smooth, investment returns to members.
Super funds: aiming for steady investment returns
A large superannuation fund’s investment strategy is usually built around the goal of creating a strong but smooth stream of investment returns over time. For the strong investment performance part they usually invest in listed assets like shares, however, a common characteristic of these listed investments can be lots of volatility. For the ‘smooth stream of investment returns over time’ bit, many super funds invest in unlisted investments that are linked to an underlying real asset like a shopping centre or office building, and which in turn provides a stable flow of income to investors from rental payments.
By mixing more volatile investment returns from listed investments (such as shares), with steadier returns from unlisted investments (such as direct property or infrastructure), super funds aim to stabilise the investment returns they credit to fund members’ balances.
Listed and unlisted investments: what are they?
Both listed and unlisted investments allow investors to buy an investment asset and potentially earn a return. The key distinction between listed and unlisted investments is the structure, with each one having a different way of buying and selling the investment.
Although the underlying investment asset (for example, bonds) may be the same, the different structure means listed and unlisted investments often perform very differently. On many occasions, the value and investment return received from investments covering exactly the same asset class (for example, listed property and direct property) is not the same.
1. Listed investments
The majority of investments made by large super funds tend to be listed assets, which simply means the investments are ‘quoted’ or ‘listed’ on a secondary market, for example, the Australian Securities Exchange (ASX) or the US-based NASDAQ, or the London Stock Exchange (FTSE). Being listed means investors participating in that market can buy and sell their investments on a regular (usually daily) basis on the relevant market exchange. Many super funds compare their fund’s performance against a benchmark, such as a market index. These indices reflect the performance of an asset class, or sub-category of an asset class (for example the All Ordinaries Index or S&P/ASX 200 Resources Index).
In Australia, the main asset classes (other than listed company shares) and investment structures investing in underlying asset classes, and listed on the ASX include:
- Bonds: A bond represents a product that reflects a fixed-term loan between a government or company, and an investor. Listing a bond product allows investors to sell the loan or bond to another investor at the market price.
- Hybrid securities: Such listed securities combine elements of both debt and equity. Examples include the floating interest rate notes that convert to shares issued by major banks.
- Exchange Traded Products: ETPs give investors exposure to shares or other assets by tracking the performance of an index such as the US-based S&P 500 Index or a commodity like gold. A popular example of an ETP is an exchanged-traded fund (ETF).
- Managed funds: These funds pool the money of individual investors and include share funds, property funds, listed investment companies (LICs), Australian real estate investment trusts (A-REITs), infrastructure funds and absolute return funds.
- Warrants, options and derivatives: These sophisticated investment tools provide investors with alternative ways to invest in large companies, currencies and commodities.
2. Unlisted investments
Although most investors are familiar with listed investments, not every investment is listed on a securities exchange. Unlisted investments are not traded as frequently as listed investments and investors usually buy ‘units’ in a trust which holds the underlying assets. The trust’s assets can all be invested in a single asset class such as property or private equity, or one large asset such as an airport or oil pipeline.
Many large super funds take the unlisted route when it comes to asset classes like infrastructure and private equity as the investments are huge. Usually, super funds and other investors will pool their money and each take a part-share in the asset. Super funds take this consortium approach as going alone on such a major investment would significantly reduce diversification within their investment portfolio, and increase the risk associated with such a sizeable investment.
For more information about infrastructure investments, see SuperGuide article Infrastructure assets: why your super fund loves it when you fly.
Although not on the same scale, SMSFs can also invest in unlisted assets. Some SMSFs participate in direct property syndicates or schemes where small investors invest together to buy commercial, retail or industrial properties. These syndicates give SMSFs the opportunity to directly invest in larger properties with potentially better quality tenants on long-term leases, and the potential for capital growth.
SMSFs are also using an unlisted investment structure when they choose to invest in the managed funds publicly offered by large investment companies. Managed funds are an easy way for smaller investors to invest in difficult-to-access assets such as international shares, emerging markets and global property.
Listed and unlisted investments: comparing the two
Each investment structure has different characteristics:
|Listed assets||Unlisted assets|
|Public market.||Private market.|
|Continuous asset pricing when securities exchange is open.||Regular pricing (every 3–12 months) by professional valuer.
Managed funds normally offer daily pricing.
|Unstable pricing, often reflects market sentiment. May not reflect full asset value.||More stable valuations. Based on estimated capital value and similar transactions.|
|Easy to sell the asset when market open (high liquidity).||More difficult to exit the investment quickly (illiquid).|
|Subject to market listing rules.||Governed by investment trust rules.|
|Often higher debt (gearing) levels.||Usually lower gearing for property and higher for infrastructure.|
Source: Table compiled by author from various sources, including ASX, investment managers and major super funds.
Unlisted investments and super funds
Although large super funds use unlisted investments as a way to generate steady investment returns for their fund members, this approach is not without its critics. There is concern about the less frequent valuations of large unlisted investments and the difficulties involved in selling them quickly, if the super fund needs to recoup its money rapidly.
Another issue that concerns some industry observers is that large super funds generally allow fund members to switch between a range of investment options, which means the super fund must have sufficient money available to ensure members can readily move between investment options. To ensure this investment option mobility can happen, super funds usually cap the level of unlisted assets they hold and carefully balance these allocations with a higher proportion of listed assets that can be readily bought and sold.
For more information about super fund investments, see SuperGuide’s special section, Investment strategies for superannuation funds, and the following SuperGuide articles:
- Infrastructure assets: why your super fund loves it when you fly
- Asset classes: Naming the investment winners for the 2016/2017 financial year (and previous years)
- Investment performance: Assess your super fund in 4 steps
- Want investments that help you sleep? Understand your risk profile
- Super stars! Top 30 super funds over 5 years
- Retirement performers! Top 30 pension funds over 5 years
- Mirror, mirror… what super fund is the best performing of all?
- Investment performance: we’re the best super fund. No we’re the best.
- SMSF investment: What assets do DIY super trustees prefer?