Everything SMSF trustees need to know about rebalancing

As well as explaining why the trustees think the above allocations are appropriate for members, 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. That means if asset allocations change due to significant market movements, or simply due to the passage of time, trustees will need to rebalance their assets back into their specified ranges.

Timing

While an investment strategy might state that trustees need to rebalance at the earliest opportunity, when markets are volatile it can be difficult to work out when is the appropriate time to do so.

In 2020, markets fell by just over 36% during March when the Covid-19 pandemic began. But just one month later, 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 a slightly less eye-watering 27%. In this situation, SMSF trustees would have been better off waiting a month or two to rebalance.

But nobody has a crystal ball, so instead of trying to time markets SMSF trustees may be better off reviewing their asset allocations at least annually at a trustee meeting and rebalancing them if their asset allocations are way off mark.

Let’s take the simple example of an SMSF with the asset allocations outlined above and a starting balance of $100,000 and look at what happened during 2022.

Below is a table of asset class total returns included in AMP head of investment strategy and chief economist Shane Oliver’s wrap-up of the year.

Investment returns for major asset classes

Using the above asset class performances, our hypothetical SMSF with a balance of $100,000 at the start of 2022 would have ended the year with allocations and a closing balance as follows:

Fortunately, all allocations are within their stated bands and no rebalancing is required in this instance, even with the volatility in markets experienced over the year.

Costs

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 can add up.

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 on to high-performing assets at the cost of the overall portfolio.

Rebalancing when certain assets or asset classes have outperformed, to reinvest in assets or asset classes with growth potential, also has the desirable effect of selling high and buying low.

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, or starting an additional pension for another member reaching retirement, would be expected to operate with 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 super funds have rebalancing mechanisms and policies built in. For example, during Covid-19 and the government’s early superannuation release scheme, some super funds were required to move out of equity holdings and into cash to accommodate a large number of members reallocating to cash and to fund the significant amount of withdrawals that were allowed under the scheme.

The bottom line

Rebalancing is especially important for SMSFs with concentrated holdings in a single asset class. The impact of one highly performing (or underperforming) share on overall asset class allocations for an SMSF will be much greater for an SMSF with just 10 equity holdings compared to one with 100.

Similarly, an SMSF with one investment property will be highly exposed to a broad property market fall or a circumstance that impacts the value of their property.

All SMSFs, even those with a well-diversified portfolio, would do well to monitor their allocations to various asset classes on a regular basis.