The title for this article can be taken two ways:
Avoid toppling over or avoid losing the balance of your investing accounts.
In fact it’s a combination of both interpretations.
We know that to have harmony in our lives we need balance. Too much of anything — exercise, alcohol, work, idleness, fatty foods, exposure to sun — runs the risk of tipping us too far in one direction and is a threat to our physical and mental wellbeing.
The investing world is subject to the same universal principles of balance. Yet the investment industry has become decidedly unbalanced in its approach to ‘balanced’ investing.
Back in the 1980s, when my career in financial planning started, the typical balanced fund portfolio was:
It was a time honoured asset allocation model. However, that changed during the 1990s.
The 1990s witnessed a recovery in the share market (after the 1987 ‘Black Monday’ setback). At the same time the property market was dormant and interest rates were falling. With the share market posting solid gains the public began to embrace the concept of investing in shares.
Research houses started publishing performance tables that ranked the rates of return the funds achieved in order.
Sub-par performance was the ‘kiss of death’ to a fund — money stopped flowing in and started flowing out.
The ‘balanced’ funds gradually increased their weightings in the asset class (namely shares) that helped deliver the vital superior performance that ensured funds kept coming.
The balanced funds these days bear little resemblance to the time honoured balanced fund of old.
Below is the Sunsuper Balanced fund. (In all fairness to Sunsuper this is pretty much the same asset allocation for nearly all industry super funds.)
There are a few interesting features in this snapshot.
Note the statement (emphasis mine): ‘Suited to investors who want to generate wealth over the long-term while being sensitive to the relative performance of other large Australian Superannuation funds.’
De-coded this means ‘we have to closely correlate with how other funds perform to ensure you don’t switch funds.’ If the other funds lose 10% then it is ok if we lose 10%. Everything has to be relative.
Note the indicator on the right is referred to as ‘Risk and Return’. This leads the investor to think ‘if I accept higher risk then I’ll receive a higher return’.
This is completely erroneous. High risk DOES NOT equal a corresponding high return. In some cases HIGH RISK results in complete LOSS OF CAPITAL. In my opinion the indicator should be labelled ‘RISK’ only.
Anyway, the needle on the poorly named ‘Risk and Return’ indicator is sitting much higher than where it should be for a time honoured balanced fund.
The reason for the higher risk reading is that the benchmark allocation for shares (Australian & International), private capital and hedge funds adds up to 69% of the fund. Balanced? I think not.
Now look at the Allowable Range percentage figure. This is the range the investment manager can move within when considering the fund’s asset allocation. Note the higher tolerances in shares compared to property, fixed interest and cash.
This is a reflection of the investment industry’s absolute belief in the share market’s ability to deliver superior performance.
On this last point, I wonder how the fund asset allocation would have been between 1968 and 1982 when the All Ordinaries index gained a total of 10% over the entire 14 year period? My guess is the love affair with shares would have gone very sour some time during the mid to late 1970s.
The last two points are relevant considering The Australian Financial Review’s recent article, titled: ‘Day of Reckoning for shares “inevitable”’. The first paragraph was:
‘One of the world’s most revered investors, Howard Marks, has challenged Australia’s superannuation industry to rethink its love affair with shares and warned that a “day of reckoning” for stocks is inevitable.’
To be fair to the investment industry, the love affair is not without merit. In early 1982 the All Ordinaries Index sat at a mere 500 points. Over the past 32years the market has increased eleven times over.
A little perspective on how impressive the past 32-years has been. In 1950 the All Ords was 100 points and reached 500 points in 1982 — a modest five-fold increase.
It is easy to select different periods to give you different outcomes, but whichever way you ‘slice and dice’ the market’s performance since early 1980s, it is a period without peer.
The market’s record breaking performance just happened to coincide with greatest ever credit bubble in history. What a coincidence!
As the credit bubble deflates could this portend a sustained period of mean correcting sub-par performance? Howard Marks offers this warning:
‘The mere fact an aggressive strategy wins in a winning period doesn’t prove it is the right strategy for all periods.’
My guess is Howard Mark’s cautionary words have fallen on deaf ears within the investment industry.
The industry, especially at the big end, is all about ‘herding’. None of them will be maverick enough to adopt a genuine and time honoured balanced fund approach — the risk of being out of step with their competitors is too great.
They would all rather go over the cliff together and then report to members ‘that relative to the industry average loss of 30%, we only lost 28%’. This is somehow meant to make you feel better because you were with the ‘best of the worst’. How comforting.
Markets work in very big cycles, sometimes taking decades to fully express their positive or negative intentions.
The longer the market trends in one direction, the greater the belief becomes that this is the way it will always be. The current weightings within nearly all balanced funds is a clear indication the investment industry believes the past 32 years is going to be replicated over the next 32 years.
Dangerous thinking. Contraction follows expansion. The unbalanced funds are at risk of underperformance in the coming years. Ironically a sustained period of underperformance will force them to re-consider their overweight share exposure. This will be a case of ‘too little, too late’.
To avoid losing your balance, take control of your asset allocation.
Don’t be afraid to instruct your investment manager to switch your funds into more defensive assets. Remember it’s your money NOT theirs.
for The Daily Reckoning Australia