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It’s a common saying that we shouldn’t put ‘all our eggs in one basket’.
Although it’s a lesson many smaller investors and super savers forget, it’s one large super funds always follow.
So, why are large super funds so committed to diversification and what are the lessons smaller investors can learn from it?
Diversification: What is it and why does it matter?
When it comes to the science of investing, diversification is a fundamental rule for investors 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 business or asset class, you don’t lose all your cash.
Diversification also helps to reduce the impact of the various investment risks your portfolio faces. For more on investment risk, read SuperGuide article 9 investment risks and how they can affect your super.
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Why large super funds diversify
When it comes to protecting the millions of dollars they invest on behalf of their members, large 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 members.
3 lessons from large super funds
In large super funds, diversification takes several forms:
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 tangible 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.
On the other hand, nearly half of the SMSF trustees in a 2017 AMP Capital study believed a portfolio invested in 20 stocks was well diversified. Unfortunately, when an asset class like shares slides, all the investments within it generally head south too.
For more information about super fund investments, read SuperGuide article Super investing: Are your investing in infrastructure? and Super investing for beginners.
What smaller 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.
Lesson 2: Diversify within asset classes too
Large super funds diversify within an asset class by investing in different sectors within it. This helps protect against the risk a single share or bond will fall in value.
While different assets classes don’t usually 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.
What smaller investors can learn
- Diversify both across and within an asset class. 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.
- Rebalance your portfolio (or use a 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. Consider your entire investment portfolio. If you have multiple super accounts, investment properties or managed funds, think about how diversified the portfolio is as a whole.
Lesson 3: Diversify using different approaches
Large super funds believe sources of investment risk and return change over time, so they diversify on multiple levels.
They recognise that diversifying investment styles, investment vehicles and even time periods can help smooth investment returns and protect against risk.
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, they blend a range of managers for the entire portfolio and each asset class.
For more information, read SuperGuide article Super investing: What are listed and unlisted investments?
What smaller investors can learn
- Include both listed and unlisted investment vehicles in your portfolio. For example, consider using A-REITS (listed real estate trusts) and direct property holdings.
- Select a mix of growth and income investments such as shares and bonds, or a blend of managed funds and investment options focussed on different investment goals.
- 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.
- Choose a selection of investment managers following different investment styles, such as value, growth or multi-asset.
SMSF tip: ATO is cracking down on SMSF diversification
Almost a quarter of SMSFs had at least 50% of their portfolio invested in cash and term deposits during 2016/2017, according to ATO data.
Given these figures, the regulator is concerned some SMSF trustees are not adequately diversifying their fund’s investments and are putting members at unnecessary risk if a major investment fails.
The ATO has announced plans to contact almost 17,700 SMSF trustees if its records indicate the fund is holding 90% or more of its funds in one asset, or a single asset class.
For more information, read SuperGuide article How to create an SMSF investment strategy (including example documents).