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Compare the pear… apples and oranges

What’s in a name?

Industry and retail superannuation funds usually offer multi asset ‘balanced’ or ‘growth’ oriented investment options, which become their ‘flagship/default’ funds. But what does it really mean to be ‘balanced’? Are are all ‘balanced’ funds the same?

The term ‘balanced fund’ originally meant a balance between defensive and growth assets. To accurately reflect its name, a balanced fund should have equal defensive and growth assets but the investment management sector has generally settled on about 60% growth assets for this. Vanguard’s Balanced Index Fund reported 49.8% of growth assets on 30th June 2018, while the Morningstar Balanced Fund held 52%. Our interpretation of a balanced investor profile is about 60% allocated to growth assets.

Defensive Assets:

Defensive investments are typically defined as an investment with a stable capital value that pays a steady stream of interest or income until that capital is repaid. The Australian Securities and Investment Commission (ASIC) defines defensive assets as cash and government bonds. You could also include Term Deposits and high-grade corporate bonds.

Cash and deposits are defensive because they hold their value when share markets fall. High-grade bonds are traditionally a good foil for growth assets as they often rise in value when share markets fall significantly.

Just because an asset delivers a strong income stream, this does not make it defensive. Telstra is a good example, where most of its returns come from fully franked dividends but its share price has dropped 60 percent since 2015.

Growth Assets:

Growth assets are typically those where you own equity in an asset – like shares, property and infrastructure. In this way, your capital is at risk as your investment can move up and down over time with the markets. Meanwhile, these investments usually also pay you rent or dividends.

Don’t judge a book by its cover

So are all ‘balanced funds’ really balanced?

For some years now, the flagship industry super funds have been more aggressively invested, with 70% or more in growth assets. In hindsight, this has been shrewd but are they risking an asset allocation disaster? What happens to the performance of these funds when markets inevitably experience corrections and falls? Can they really expect to reliably pick a changing trend?

The table below depicts the percentage of defensive assets vs growth assets of some of the bigger ‘balanced’ Industry Funds:

The best form of defence is growth?

What is even more startling is that when you dig deeper on the defensive investments of some of these funds, you find that in fact they are what would typically be defined as growth assets.

Take Host Plus for example, the number one performing ‘balanced’ fund in Australia in the last year. With 76% of the investments in growth assets, it’s no wonder they performed well in a year where stock markets were strong. Dig deeper and you’ll find that within the 24% allocation to defensive assets, 5% was infrastructure and 9% was property, assets that can fall in value especially with a sharp rise in interest rates. So when adjusted, we find that 90% of the Host Plus investments were actually in growth assets.

In this context, let’s point out that infrastructure and property is often unlisted (not tradeable on the stock market) and illiquid (not able to be cashed out quickly), with a price that’s not valued on a daily basis like other assets. During the Financial Crisis, some super funds stopped members from transferring money out because they were unable to sell illiquid unlisted assets. MTAA super, for example, lost $1.6 billion due to poor hedging of unlisted assets.  In 2011 UniSuper warned its defined benefit members that it may not be able to deliver on its promised benefits if markets did not recover.

So when we compare the pear, we find in fact it was an apple all along.

A better name for these kinds of funds would be ‘high growth’ fund. Viewed in this risk-adjusted way, the Host Plus ‘Balanced’ Fund slightly underperformed Vanguard’s High Growth Fund over the last 10 years.

Of course, there is a place for high growth investing. But it doesn’t suit everyone. And do balanced investors realise they are investing with this risk?

What’s an investor to do?

To be fair, Host Plus and other Industry Funds are making some good investments including into venture capital and infrastructure projects that will benefit Australia. Also, compared to disastrous bank-owned retail super products, industry funds consistently come out ahead.

Perversely, if you have ample capital you can more readily bear the risk involved in investing more in growth assets but it’s unwise if your capital is stretched to meet your income. Higher risk has worked fine over years now for industry super funds as they report strong returns above their peers. But considering the average Industry super balance is only about $320,000 for men and $190,000 for women, are they exposing their investors to more risk than older investors with small balances should take? Has their marketing attracted new investors by pushing up returns and using ‘mislabelled’ investment categories?

At Wotherspoon Wealth, we follow a process to help investors determine their personal tolerance for risk. We then design a portfolio that allows these investors to reach their desired long-term returns while taking risks they can tolerate through all market cycles. This provides peace of mind, avoiding unnecessary risk. When compared on a risk-adjusted basis (comparing apples for apples), our client portfolios match or exceed industry fund returns but they do so with more deliberate suitability. To find out more, read our Investment Philosophy.

Of course, everyone likes good returns but losing capital is less tasteful (especially if you’re unaware of the risk). As Warren Buffett famously said, ‘only when the tide goes out do you discover who’s been swimming naked.’

Want to understand your personal risk score? Contact us now for your free risk tolerance assessment.

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Disclaimer: All information in this article is intended to be general in nature for discussion purposes only. So you should not rely on it and seek personalised professional advice before making any decision.