Many trustees have never had to run a self-managed super fund through a recession. So to survive this period, experts recommend avoiding selling when markets are at their nadir, focusing on fundamentals and looking for opportunities to acquire well-priced quality businesses.
AJ Financial Planning founder Alex Jamieson says sequencing risk is the biggest issue for SMSF investors right now, especially for the recently retired who are drawing down on their super and facing negative returns. Sequencing risk is the potential for someone’s super not to last their lifetime due to a serious market correction typically at or near retirement.
“It’s important these investors don’t panic and heavily liquidate portions of the growth aspect of the portfolio back to cash and fixed interest. Time will often solve sequencing risk. Rather than liquidate or go to cash, it may be more appropriate to allocate up to 10 per cent of fund to growth-based assets,” Jamieson notes.
In this situation, depending on the fund member’s risk appetite, investment strategy and the fund’s trust deed, leverage may be a suitable approach to generate returns.
“Consider ETFs with internal gearing, so you don’t have to worry about margin calls, unlike other gearing options. But keep in mind any gearing strategy can magnify gains and losses,” he adds.
Also think through whether to remain in any underperforming assets, says Jamieson. “Diversification means owning underperforming dogs. So take a critical look at the positions in your portfolio. If the outlook for the asset looks grim, you may decide to cut the loss and move onto something else that has better potential to bounce back. Put on your capitalist hat and kick the non-performing shares off the bus. There is no shortage of companies tapping on the window wanting to join your bus ride. So get a little ruthless.”
Bennelong Funds Management account director, research relationships, Stuart Fechner, takes a similar albeit more seasonal approach. “Although it’s winter, the recent events and volatility in markets are an opportunity for a spring clean.”
Fechner says diversification is especially important when markets are volatile. “Investors may hold a range of different investments. But the portfolio may not really be diversified if they have all behaved in a similar fashion recently. You can tilt your portfolio overweight and underweight to favoured and non-favoured sectors and stocks, but overall it’s a very sensible risk return management approach to maintain a well-diversified portfolio.”
Practical matters
There are other steps SMSFs can take to put their fund in the best possible position through any recession.
Under recent changes to the minimum pension drawdown rules, SMSFs that may have experienced a significant drop in the value of their portfolio over recent months have an opportunity to halve the amount they withdraw annually. SMSFs in pension phase can halve their payments for the 2019/20 and 2020/21 financial years.
“This measure was announced in March 2020 as part of the government’s COVID-19 relief package and coincides with significant stock market volatility globally. It allows retirees to stay invested in the market to avoid crystallising losses and provide time for asset prices to recover,” Pride Advice senior financial adviser Tony Davison explains.
“While the principle behind the minimum pension drawdown rule is sound and reinforces the purpose of superannuation, which is to provide income in retirement and reduce dependence on the Age Pension, the changes recognise that during a sharp market downturn, the pension requirements can disadvantage retirees,” he adds.
Under the government’s COVID-19 measures, retirees currently aged 65 can also contribute to their super fund until they reach 67 without meeting the work test.
Says Davison: “These two changes may seem relatively insignificant. But they add up and give SMSF trustees an opportunity to top up their retirement savings and reconsider the tax environment for their investments.”
The impact of a recession on a SMSF’s underlying investments will depend entirely on how that SMSF is invested. Davison says if the fund is term deposit-focused, it may only mean a drop in interest paid on their account.
“It’ll be a very different story for a fund invested primarily in assets like Australian shares or commercial property. Our view is that a recession eventually represents a significant buying opportunity, given the low interest rate environment.”
The challenge is timing. No one could predict the impact COVID has had on the economy nor can anyone accurately predict what will happen in the future. The only thing a trustee can be sure of is the ability to be agile will be key to taking advantage of future buying opportunities.
As a result, SMSF trustees need to think clearly about sectors that should be resilient
in the near term. “International healthcare and technology are relatively recession-proof and can be accessed cheaply and efficiently through ETFs. It is also relatively straightforward to invest in these sectors directly in offshore assets,” Davison notes.
The local resources sector with its solid dividend returns coupled with commodity price leverage may also provide opportunities, he says. “Infrastructure is another sector that stands out as a must hold. For limited cost, investors can get solid exposure to the sector through ETFs. Investors should also spend time researching international assets. While Australian equities have been a top performer, Australia is not an investment growth engine in the way other markets are.”
Minimising exposure to underperforming sectors
Fechner says risk and return is a key consideration in this subdued economic environment. “It’s not going to take very much bad news to hit returns. So taking the risk side of the equation into account is important.”
He recommends examining which companies can weather current economic challenges. “The return focus needs to be long term but the more immediate focus needs to be whether a business can survive the current challenges.”
Fechner recommends looking for companies that are leaders within their sectors, have strong balance sheets and are still able to re-invest to stay ahead of their competition and to support future growth.
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