The gymnastics of keeping your portfolio balanced

Gymnastics is a personal favourite with the different apparatus that challenge and showcase athletic grace, strength, technical abilities and blend them together into real-life drama. There are few other sports where there is the constant risk factor that comes from the slightest slip or loss of balance.

No-one needs to tell a gymnast the value of maintaining balance. And no-one watching Olympic gymnasts is in any doubt about the hard work and dedication - usually from a young age - that has gone into getting to that point.

Investors on the other hand often grapple with the issue of balance. At investor education seminars it is not uncommon to hear investors describe themselves as "property" investors or "share" investors or even as members of the ultra-conservative group that trust nothing other than bank deposits.

Building a balanced portfolio is not nearly as hard as making an Olympic gymnastic team but it does require discipline and a level of self-awareness particularly on how much risk you are comfortable taking.

The good news for investors is that unlike gymnastic routines, one small slip is unlikely to be devastating in terms of long-term portfolio performance. However, allowing portfolios to slip too far out of your risk comfort zone can be significant - particularly when a major market event like a global financial crisis comes along.

So there are two key issues for investors - setting the right asset allocation and rebalancing to stay within your risk "flags".

Understanding where to plant your risk "flags" has to be driven by your personal situation - age, financial situation, health, earnings capacity. If you are in career-best form, naturally your capacity to take risk will be significantly higher than the person about to retire.

The simplest way for most people is to invest in a multi-sector product offered by fund managers that typically are designed around a target level of risk - they range in flavours from conservative, balanced, growth or high growth.

The same applies with superannuation for retirement savings - the default MySuper products typically cluster around a 70/30 growth to income asset split but you can opt for lower or higher exposures to growth assets. With both super and non-super funds the rebalancing of the portfolio happens automatically.

It is when you drill down into the component parts of a portfolio that the complexity increases. The good news for investors who do not want to spend a lot of time on things like their portfolio's asset allocation is that well-tested market solutions are available.

There are a significant group of people who have opted - via setting up a self-managed super fund - to be more engaged in managing their investments (particularly their super but let's assume non-super investments as well). More engagement/involvement by investors is generally regarded as a good thing and around half of SMSFs work with a range of professional advisers to manage and invest their fund.

But the results of the recent Vanguard/Investment Trends survey highlights the fact that a lot of SMSFs have relatively concentrated portfolios. The survey of more than 3500 SMSF trustees found that 38 per cent of their portfolio is invested in Australian shares. And of those, 28 per cent have at least half their share portfolio in bank/financial companies.

This raises the issue of concentration risk within SMSF portfolios - an ongoing debate within the super industry and financial advisory circles over many years. The reasons behind the concentrated Australian share portfolios is reasonably well understood - about half the assets are in pension or drawdown mode and high dividend payout shares are attractive courtesy of the dividend imputation system providing tax credits and the income stream that provides. Wind back time to a few years ago and term deposits were also paying respectable yields so one of the primary objectives - to pay an income stream - could be comfortably achieved with the simple combination of share dividends and cash investments.

About now, given worldwide declining interest rates that Australia is not immune from, the average SMSF portfolio may be feeling like a gymnast that has just discovered their standard routine is no longer working as it did in the past.

The question is how to recover that sense of balance.

The Investment Trends research suggests SMSFs are already taking steps on the journey to diversify their asset allocation because the use of managed funds and ETFs has been rising steadily in recent years.

SMSF trustees are also flagging that they need - and are seeking - more advice.

So while setting the right asset allocation at a fund's portfolio level is important the process of building a broader, holistic financial plan that takes into account assets both within and outside the SMSF that widens the frame of the asset allocation question can help get the balance right between the risks and potential returns.

This article first appeared in the Australian Financial Review on 7 September 2016.

Robin Bowerman
Head of Market Strategy and Communications at Vanguard.
11 September 2016
29 August 2016