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When a self-managed superannuation fund (SMSF) is set up, one of the first things trustees need to do is agree on and write an investment strategy.
An investment strategy does not need to be long but it does need to include the fund’s investment objectives and how they cater to the trustees’ needs (Read our article here for more information). A trustee in retirement phase, for example, will have a different investment strategy to a younger trustee in accumulation phase. The overall strategy for the fund will combine the two member’s strategies.
An investment strategy will include asset allocations split across growth and defensive style investments, which might look something like this:
- Equities 0–70%
- Australian 0–60%
- Global 0–20%
- Cash or fixed income 0–20%
- Property 10%
- Listed property trusts 5%
- Unlisted property trusts 5%
- Alternatives 0–5%
It might also include a statement like this:
If, due to significant market movements, any asset class becomes over allocated, the trustees will rebalance the portfolio at the earliest opportunity or the next trustee meeting, whichever occurs first.
An investment strategy is not just a guide, it’s a policy document for the fund by which trustees need to abide by. That means if asset allocations change due to significant market movements like those we have just had and are continuing to experience, trustees will need to rebalance their assets back into their specified ranges.
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While an investment strategy might state that trustees need to rebalance at the earliest opportunity, during times of extreme volatility like we have recently seen, trustees could consider waiting in the short term to see if markets correct at all. Also, given the wide ranges above, allocations could still be within those ranges even with a big fall in a particular asset class.
COVID-19 has hit equity markets everywhere. In Australia, the S&P/ASX 200 hit a high of 7138.96 on 21 February 2020 and then fell to a low of 4546.04 on 23 March 2020. That’s a drop of 36.3%. The US’s Dow Jones Industrial Average (DJIA) fell by a similar amount over the same month. But a month later, on 21 April 2020, markets had recovered some of those losses and the two-month fall from the S&P/ASX 200’s high on 21 February 2020 was only 27%. The DJIA was down just 20% over the same period.
Using this data, let’s take the very simple example of ABC SMSF with assets of $100,000 with the following asset allocation outlined in its investment strategy.
|Cash or fixed income||0–25%||20%||$20,000|
|Listed property trusts||5%||$5,000|
|Unlisted property trusts||5%||$5,000|
36% drop in Australian and US equities
|Range||Initial allocation||New amount||New allocation|
|Cash or fixed income||0–25%||20%||$20,000||27.4%|
|Listed property trusts||5%||$3,200||4.4%|
|Unlisted property trusts||5%||$5,000||6.8%|
27% drop in Australian equities 20% drop in US equities
|Range||Initial allocation||New amount||New allocation|
|Cash or fixed income||0–25%||20%||$20,000||25%|
|Listed property trusts||5%||$3,650||4.5%|
|Unlisted property trusts||5%||$5,000||6.2%|
For the purposes of simplicity we’ve assumed that fixed income has held its value and listed property has fallen by as much as the overall market.
The above example highlights that the initial monthly fall of 36% would prompt a rebalancing of funds as the cash or fixed income allocation exceeded its asset range (as had Australian property). By waiting just one month, the need to rebalance was minimised as at that point Australian property was the only asset class that fell outside its asset allocation range.
There is obviously a cost involved in rebalancing for an SMSF. If equities are held directly, the main cost in selling down shares and buying other assets would be the brokerage costs and the potential for missed dividends. But, if managed funds are held for certain asset classes there may also be exit fees to pay, or income payments to forfeit. If rebalancing was conducted two or three times a year, the costs are obviously going to add up.
Although investment strategies may state that a fund’s assets need to be rebalanced at the earliest opportunity, funds could exercise discretion during extreme market volatility. Market movements should be monitored and the need for rebalancing should be considered at least at six monthly intervals.
Asset allocation ranges in investment strategies, and rebalancing directives, are often applied when a particular asset class may exceed its targeted allocation due to the outperformance of one or two equities or assets. Rebalancing back to the fund’s originally stated asset allocations, in these instances, prevents trustees from holding onto high performing assets at the cost of the overall risk of the portfolio growing.
Moving from accumulation to retirement phase
Rebalancing may be more urgent for a fund moving from accumulation phase into retirement phase. A fund that is commencing a pension for the first time, or starting an additional pension for another member reaching retirement, would be expected to require greater liquidity and could need assets rebalanced following a review and revision of the investment strategy.
Large superannuation funds
It’s worth noting that large superannuation funds have rebalancing mechanisms and policies built in and many have recently been moving out of some equity holdings, and into cash, to accommodate a large number of members reallocating to cash.
Superannuation funds are also expecting a significant number of Australians to take advantage of the Government’s early superannuation access scheme, which was announced as part of COVID-19 stimulus measures.