Why super funds diversify and what you can learn from it

It’s a common saying that you shouldn’t put ‘all your eggs in one basket’ and it’s particularly true when it comes to your finances.

Although it’s a lesson many smaller investors and super savers forget, it’s one thriving super funds – both large funds and SMSFs – always follow.

So, why are the people who run successful super funds so committed to diversification and what are the lessons all super members can learn from it?

Diversification: What is it and why does it matter?

When it comes to the practice of investing, diversification is a fundamental rule for anyone wanting to protect their investment portfolio against unpredictable markets.

Put simply, diversification is the process of splitting your money across a range of investments and asset classes to receive returns from different sources. It also helps ensure if things go wrong with one particular business or asset class, you don’t lose all your cash.

Diversification also helps reduce the potential impact of the various investment risks your portfolio faces. As all investments carry some level of risk, you can avoid being exposed to too much risk by spreading your investments widely.

With a diversified portfolio, positive returns from the asset classes that perform well balance out any negative returns from asset classes that don’t perform. Over time, this means you receive a smoother stream of investment returns. It also helps avoid big losses, which is really important wherever you are on your retirement savings journey.

Why super funds diversify

When it comes to protecting the dollars they invest on behalf of their members, super funds have a big responsibility. So, they aim to safeguard members’ money by diversifying their investments as much as possible.

Check any super fund’s investment philosophy and it’s sure to mention blending the fund’s assets to construct ‘a well-diversified portfolio’ that gains from rising markets and ‘protects wealth in falling markets’.

Super funds seek to invest as widely as possible using both local and international assets to reduce investment risk. As different asset classes generally don’t move in sync, they also use a mix of assets and asset classes to boost the chance of delivering strong, stable investment returns to their members.

3 lessons from successful super funds

To ensure the retirement savings of members grow and are protected from potential investment risks, super funds use the principal of diversification in several different ways. This approach can provide useful lessons for smaller investors and fund members:

Lesson 1: Diversify across asset classes

Large super funds diversify across all the major asset classes, investing in a mix of shares, bonds, private equity, infrastructure and property.

Funds invest in most leading Aussie and international companies, as well as real property and infrastructure assets like capital city airports, major seaports, toll roads, energy distribution networks and student accommodation. They also seek returns from venture capital and private equity investments.

It’s an approach also taken by the most successful SMSFs, with a 2022 report finding SMSFs with diversified asset allocations achieved higher returns. The report found SMSFs that diversified across four or more asset classes had a better investment performance than those invested in only one or two asset classes.

What individual investors can learn

• Ensure you spread your super and other investments across a wide range of asset classes or select a diversified investment option.
• Ensure your portfolio doesn’t focus too much on term deposits, cash, property or shares. Include exposure to a range of asset classes.
• Consider investing in managed funds specialising in assets like infrastructure to gain exposure to these harder-to-access asset classes. The growth in exchange traded funds (ETFs), which can be bought and sold easily on the ASX, have made it easier for individual investors to plug gaps in their portfolio such as global shares and bonds.

Lesson 2: Diversify within asset classes too

Well-managed super funds also diversify within an asset class by investing in different sectors within it. This helps protect against the risk a single share, bond or property will fall in value.

While different asset classes don’t necessarily rise and fall at the same time, neither do industry sectors within an asset class. By selecting a range of different sectors, countries and even regions within a particular asset class such as Australian retail, European residential and US industrial property, super funds aim to increase the odds different parts of their portfolio will hold their value if others drop.

Under-diversified portfolios have a far greater potential to suffer from significant losses than those spread more widely. In periods of high volatility, good diversification across and within a portfolio can help reduce losses and make a real difference to your retirement outcome.

What individual investors can learn

• Diversify both across and within asset classes. The Australian sharemarket has 11 sectors, 24 industry groups, 68 industries and 157 sub-industries, so select a broad mix of companies.
• Include a mix of different countries and regions within an asset class to protect against local economic conditions and political risks.
• Rebalance your portfolio (or use a lifecycle super fund that does it automatically) if investment market volatility has thrown your asset allocation out of whack.
• Don’t just think about your super savings. Consider your entire investment portfolio. If you have multiple super accounts, investment properties or managed funds, think about how diversified your portfolio is as a whole.

Lesson 3: Diversify using different approaches

Successful super funds believe sources of investment risk and return change over time, so they diversify on multiple levels.

They recognise that diversifying the investment styles and investment vehicles they use can help smooth investment returns and protect against risk. Sensible diversification also involves diversifying over time periods, as some asset classes tend to perform over longer periods, while others provide returns over shorter time periods.

Super funds use both listed and unlisted investments, active and passive management and a mix of investment managers following different investment styles to build a well-diversified portfolio. Rather than relying on a single investment manager or strategy, they blend a range of managers for the entire portfolio and each asset class.

Diversification can also be achieved through techniques such as dollar cost averaging, where you buy into an asset class over time rather than all at once. This means you buy when the market is up as well as well as when it’s down, so over time you pay the average price for an investment rather than trying to time the market and end up paying top price at the peak of a market cycle.  

What individual investors can learn

• Include both listed and unlisted investment vehicles in your portfolio. For example, if you have the means consider using a mix of REITS (listed real estate investment trusts) and direct property holdings for the property portion of your investment portfolio.
• Select a mix of growth and income investments such as shares and bonds, or a blend of managed funds and investment options focused on different investment goals.
• Choose a selection of investment managers following different investment styles, such as value, growth or multi-asset.
• Consider investing or making super contributions at regular intervals rather than all at once, so you diversify your entry price and reduce your timing risk. Learn about dollar cost averaging.