SMSFs need to make more informed investment decisions
A well-informed and strategic approach to selecting active managers often delivers an attractive payoff
Making well informed investment decisions is critically important to enable SMSFs to reach their financial goals. They need to decide whether they have a preference for diversified funds/multi asset offerings (where asset classes are already pre-mixed for them by the manager) or whether they choose to make their own asset allocation choices. If they select the latter route, then they need to decide whether to manage their money actively or passively and then whether these are invested via managed funds, ETFs/M-funds or whether to hold stocks directly. Here we offer some thoughts that might be useful to those SMSFs who make their own decisions regarding asset mixes, with a focus on listed assets.
First, let’s talk about the prevailing market environment
The last decade has been marked by a boom in the mid-2000s, which ultimately gave rise to debt and asset bubbles, followed by the GFC and then by an extraordinary monetary stimulus program by all the major Central Banks. China’s rise and then slowdown has had (and will continue to have) an enormous impact on the global and on Australian economies and markets. As policy decisions have made ‘true fundamentals’ obscure and volatile, markets have been driven by sentiment (risk on/risk off); and by a handful of big picture themes, some of the most visible of these being risk assets (a major beneficiary of monetary stimulus); Technology (smartphones made Apple into the most valuable stock in the World; Tesla made hybrid and electric cars a commercial proposition); Resources and Energy (dynamics in China demand have driven the boom and decline in Resources as well as many emerging economies); and ‘the global hunt for yield’. The global monetary stimulus has led to a collapse in yields of ‘traditional’ income assets, thus forcing income-seeking investors into riskier assets that offer better yields, such as high dividend stocks and credit.
So, active or passive?
Passive investors believe that markets are efficient, and that it is impossible for an investor to consistently earn returns in excess of those delivered by the market. Active management is premised on the belief that pricing anomalies do exist and that skilled active investors can exploit these and outperform the market. Of course, to succeed an active manager must understand the key market drivers and the types of anomalies/inefficiencies that it gives rise to – and have the skill and the process to exploit these. As a group, active managers haven’t consistently delivered excess returns in the post-GFC environment. However, there have been clear winners and losers amongst them.
Since the mid-2000s, the market environment has favoured those active managers who are experts at thematic and macro positioning of their portfolios; and those who have strong risk management discipline and keep their sector/countries/currencies positioning close to that of the market index (thus minimising top down active risk), but focused on selecting best stocks from within those ‘groupings’. In contrast, the ‘old fashioned’ stock pickers, who are not skilled at managing or at minimising their top down exposures, have been amongst the disadvantaged. From the style perspective, ‘core style rotators’ have been successful at exploiting themes and sentiment; the monetary stimulus and the resulting demand for income stocks and inflation in prices have benefited managers who focus on income stream but put at disadvantage those managers with a strong preference for ‘cheap’ stocks.
‘Smart beta’ or active management?
‘Smart beta’ strategies are a potential alternative to ‘style driven’ active management. We believe that ‘factor based investing’ is a more appropriate term. Portfolios of this sort are highly customisable and can be designed to suit an individual’s investment needs. They can be used to deliver broadly diversified exposures to certain investment styles - for example, an exposure to ‘value’– with or without additional focus on quality; or to a sustainable income stream. If these products are constructed well, factor based investing can offer a more predictable (but not necessarily more attractive) pattern of performance than an actively managed equivalent, and costs less. A skilled investor may be able to add value by ‘rotating’ across different smart betas as market conditions change.
While factor based strategies make perfect sense in theory, it is important to note their limitations. These strategies invest in a large number of stocks that possess the desired characteristic(s) without having an in-depth understanding of each individual company – which active managers do have. Also, many off-the-shelf smart beta products are relatively naively constructed and therefore, can carry undesirable ‘incidental’ exposures (for example, to sectors and/or currencies). Finally, smart beta products focus mostly on equities. There aren’t many in the fixed income/credit space.
Managed Funds, ETFs, M-funds, SMAs or direct holdings?
While Managed Funds have traditionally been most widely used as the means to access fund managers (both active and passive), ETFs/ETPs/M Funds are gaining in popularity. While in the past ETFs provided a passive exposure to an index, more recently some active managers are making their products available in an ETF/ETP or in an M Fund format. These are traded on stock exchanges, which greatly simplifies the implementation side of investing.
Some SMSFs choose to hold stocks directly for tax and cost considerations. These considerations are valid but this approach can be extremely risky, particularly when market volatility increases. It is important for these holdings to be professionally advised; the advising party needs to have portfolio construction expertise and have its interests aligned to clients’ interests.
Many SMSFs use broker recommendations and broker model portfolios to guide their portfolio decisions. Although this approach is sounder than having no advice at all, brokers have no professional portfolio managers on their staff and therefore, are not best equipped to construct portfolios and to navigate these, particularly through challenging environments. Also, by nature of their business, brokers are paid to hold shorter term perspective on stocks. Hence should an SMSF utilise broker models, it needs to examine their long term track record; and understand the levels of stock turnover, as the value of the trade commissions that SMSF pays may be high. Also importantly, managing a portfolio of direct stocks is a labour intensive exercise and there is real value in getting the insight of a professionally trained investor while still keeping ownership of the assets directly. One way to address these issues is to invest in model portfolios that are supplied by professional fund managers, albeit this can be quite an administrative burden; better still use Separately Managed Accounts (SMAs) where you give the manager the ability to trade on your behalf but you still have the transparency and direct holdings in the stocks.
Our experience indicates that a well-informed and strategic approach to selecting active managers delivers an attractive payoff – the key to success is to choose active managers who have the set of competencies that positions them well to deal with the prevailing market environment. Irrespective of whether an SMSF chooses to invest with active managers or passively, whether it invests in Managed Funds, ETFs, within an SMA or directly, in order for it to deliver on its financial goals the SMSF must be managed holistically to minimise undesired exposures that cause unrewarded risks.
About the author
Tanya Debakhapouve leads a team focused on single sector funds and manager research with sector specific factor based solutions and separately managed accounts. She joined AMP Capital in June 2006, initially in the role of Portfolio Manager before being promoted to Senior Portfolio Manager and then Head of Multi-Manager, Public Markets.