Australia’s SMSFs benefited from a positive year for Australian stocks and residential property in fiscal 2017. However, achieving the same results could prove more problematic in the year ahead without the right investment strategy and appropriate risk management.
For fiscal 2017, total returns on Australian shares as measured by the All Ordinaries Accumulation Index were 13.1 per cent, the biggest rise in three years and ahead of the 20-year average of 10.8 per cent. Residential property investors, particularly those in Melbourne and Sydney, enjoyed an average 13.2 per cent rise in returns on dwellings.
The only disappointment was the return on government bonds, which dropped by 0.8 per cent for the weakest result in 23 years.
However, looking at the ASX data more closely shows some mixed performances in fiscal 2017. Among the industry sub-sectors, consumer durables and apparel rose by over 40 per cent, followed by food, beverages and tobacco (up 29 per cent) and capital goods (up 26 per cent). Yet at the other end, the telecommunications sector suffered a fall of over 26 per cent, followed by real estate (down around 9 per cent).
For SMSF investors, fiscal 2017 should have produced mildly positive returns, given the average asset allocation of 31 per cent in listed shares, 26 per cent to cash and term deposits, 11 per cent in non-residential real property, 9 per cent in unlisted trusts and 5 per cent in other managed investments, according to ATO data.
Cloudy outlook
Looking ahead to fiscal 2018, however, and the outlook appears less bright.
Among the risks are whether United States President Donald Trump’s promised tax cuts and infrastructure spending can get through Congress, and whether the avowedly protectionist Trump sparks a trade war with China. Other risks include the looming threat from North Korea, which could engulf Australia’s two biggest trading partners, and Britain’s exit from the eurozone.
At home, the recent drop in house prices in Sydney and Melbourne could be a signal that the bubble is beginning to burst in these overheated markets. Sluggish wages growth and rising household costs, including electricity and health insurance, will do little to sustain consumption spending either.
A sudden sharp downturn in China, major contraction in house prices or interest rate shock from the Reserve Bank of Australia could tip an already vulnerable economy into recession.
While none of these risks may eventuate, Benjamin Disraeli’s famous quote is worth remembering: “I am prepared for the worst, but hope for the best.”
SMSF investors would therefore be wise to continue their long-established practice of maintaining a healthy cash buffer. Australia’s biggest investor, the $148 billion Future Fund, had 20 per cent of its total asset allocation in cash as at 31 March, with 15 per cent in alternative assets, 11 per cent in debt securities and 29 per cent in equities.
Commenting on its asset allocation, Future Fund chairman Peter Costello said the fund “remains conscious of uncertainty around global growth, global monetary policy, international political tensions and the potential for shocks to investment markets. We also expect prospective returns to be lower than in recent times”.
Reducing risk
Diversification has been described as “the only free lunch in finance” and effective diversification is crucial to successful investment management. With Australia’s stock market representing just 2 per cent of the global market, there is an obvious need for local investors to diversify internationally, particularly given the concentration of financial and resources stocks in the local bourse.
However, combining a low-return investment such as cash with higher-risk investments such as shares and property does not necessarily produce a high overall risk-adjusted return, particularly since falling share prices can flow on to property prices if overall economic conditions deteriorate.
Alternative assets are another means of reducing risk, as seen by the Future Fund’s $26 billion allocation to this asset class.
In this regard, one such option is the Rushton Conservative Global Market Neutral Fund, which offers minimal share market risk, a high level of diversification and a low level of volatility.
Due to its low correlation to most other investments, it offers the potential to enhance the return of an overall investment portfolio, while lowering risk, and is ideally suited to wholesale investors seeking long-term double-digit returns through all economic conditions, with very low volatility.
In recent months, there have been numerous warnings of a looming market crash by such notable investors as Bill Gross and Jim Rogers. With long-term US data showing a bear market occurs around once every 3.5 years on average, with an average fall of 35 per cent, SMSF investors would do well to heed the warnings.
