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(August-2003) Knocking the balance out of balanced funds
Acrobats do it for a living, justice does it blindfolded and the ABC has lost it (according to any Government of the day).
Balance is a fine line between one thing and another. So why is it that Australian balanced funds have spent the last 10 years steadily going for growth?
Not that this is a bad thing because we all understand that risk is the price to pay for reward. We see repeated again and again a pattern where growth assets outperform defensive investments over the longer term. There are no 20 year periods in the last century where equities have underperformed cash. There are a few where they have come close, but in Australian or US history at least, investors have been repeatedly rewarded for taking long-term equity risk.
The implication seems to be as long as we believe in a growing economy and a positive equity risk premium (however small), we stand an increased chance of being delighted with eventual outcomes.
When we remember that the average retirement for Australians is in excess of 20 years, almost all of us reading this magazine are aiming at a 30-50 year investment. However, risk is not an automatic right to reward, as many of us have noted when opening the year-end statement from our own super provider. There is a risk of a heavy dose of disappointment over shorter periods.
This risk is very real. Australian investors spent the 1990s enjoying handsome positive returns from their balanced funds when measured on July-June financial years, whereas the same funds, measured over January - December calendar years showed somewhat more volatility.
Of course there was no real difference in volatility, but a measurement fluke where we focused on financial year-end statements. They made us all feel comfortable with allocations that steadily increased exposure to equities and, in particular, international equities which heaped extra currency risk on top.
In 1990, the Mercer Pooled Fund Survey average exposure to growth assets was around 60 per cent while it stood at over 72 per cent in May 2003. Rainmaker figures show that for some super schemes, particularly government and industry funds, the shifts towards growth allocations are even more dramatic.
No survey adequately covers the treatment of currency, but most international equity exposure is not pure. A good portion of currency exchange rate risk is mixed in with super fund trustees adding (or subtracting) “alpha” by their decisions to hedge or not to hedge that exposure.
This begs the question: How balanced are balanced funds? The answer is: Not very.
When looking at the volatility of short term returns for balanced funds with 70/30 exposure compared with 80/20 funds, (typical balanced versus typical growth funds) we see no appreciable difference. Worse still, we see little statistical difference between the volatility of a 70/30 fund and an all-equity portfolio.
In terms of return, however, our research shows a lower average return from 70/30 funds depending which period is discussed. The early 1990s saw stunning, never to be repeated, returns from fixed interest investments. They enjoyed a tail wind as inflationary expectations carried fixed interest to a new level of valuation. Going forward, most commentators see little tail wind and more hard slog as equities offer volatility with plenty of negative years (as much as one in four) with a higher average return (around 8 per cent) than that for fixed interest (5-6 per cent). Effectively the traditional balanced fund looks like a low-return all-equity fund.
In this environment we can say one of two things:
* No, short-term equity risk is not for me — I want certainty and I’m happy to get a lower return (and less spending power long-term). Or, we can say;
* Yes, I am a long-term investor and final spending power is important to me — I want all-equity return, I’ll weather the poor years and grit my teeth, but please do not drag down my returns with fixed interest.
In such a world, the traditional balanced fund looks unlikely to survive. It is too risky for some because it has the same volatility as all-equity portfolios (one negative year in four on average), and it simply drags down performance for a true all-equity long-term investor.
It could be that we learn that balancing on a fence for too long can be more painful than living with a choice.
— David Brown is a senior fund manager at the Queensland Investment Corporation
AUTHOR
External
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