By James Dunn
It is still one of the big anomalies in self-managed superannuation: the hole in the asset allocation where fixed income should be.
According to Australian Taxation Office (ATO) statistics, as at March 2016 Australian SMSFs held just 1.2% of their assets in debt securities, compared to 30.2% in shares, 27.3% in cash, and 17.4% in property.
The SMSFs also hold 13.7% of their assets in listed and unlisted trusts, some of which might be bond funds, but the numbers tell a story of distinct lack of interest in fixed income.
SMSFs are very different from the professional super funds. According to research firm Super Ratings, the median balanced fund – the kind of fund that holds the vast majority of non-SMSF super – allocates its assets as follows: Australian shares, 26.5%; international shares, 26%; alternative assets, 17.3%; fixed income, 15%; property, 10%; and cash, 4%.
Even these professional allocations are out of step with pension funds around the world. According to data from the 2015 OECD Pensions in Focus report, the average pension fund (in a sample of 31 developed countries) holds 51.3% of its assets in bills and bonds, and 23.7% of its assets in shares.
Australian super funds are simply not as interested in bonds as their world counterparts – but Australia’s SMSFs don’t seem interested in them at all.
There are good explanations for this. Until recently, Australian retail investors could not get access to bonds, except through bond funds. And Australian investors have built up a strong bias towards domestic shares, driven by the benefits of franking credits. Many SMSFs view Australian shares as assets that produce both capital gain and income. According to August 2015 research by the Association of Superannuation Funds of Australia (ASFA), dividend imputation improves returns on domestic shares by about 1.3 percentage points a year for super fund members in accumulation phase, and by 1.5 percentage points for members in pension phase.
But the capital price risk of relying on shares for income demands some diversification – and bonds can give a portfolio a degree of capital stability, another source of income and returns correlated differently to shares.
Over the last few years, accessibility to bonds has opened up greatly for retail investors, using the liquid marketplace of the Australian Securities Exchange (ASX). Since 2012, a menu of fixed-income exchange-traded funds (ETF) has been listed in Australia, which offer investors exposure, in one ASX-listed stock, to a fixed-income portfolio comprising investment-grade securities, Australian commonwealth government bonds and state government bonds.
Global fixed-income ETFs tap into international sovereign bonds, bonds from ‘supra-national’ issuers (for example, the World Bank) and companies. The global bond ETFs also add high-yield bonds (corporate bonds not rated investment-grade) and emerging-market bonds to the local menu.
At 30 June 2016, there were 12 domestic fixed income ETFs holding $2.1 billion and five global fixed income ETFs holding $40.3 million. These products are very cheap, managed for 0.2% –0.51 % a year, and cost normal brokerage to buy and sell. Investors can invest any amount of money they choose, establishing a bond allocation by simply buying one ASX-listed stock.
The ASX also hosts a product called exchange-traded bonds (XTBs), which give investors the performance of domestic investment-grade corporate bonds. There are 39 XTBs currently trading on the ASX, all senior unsecured bonds, which are issues at the top of the respective companies’ capital hierarchy. Another 17 issues, 11 fixed-rate and six floating-rate, are in the approval process at ASX. There were $10 million worth of XTB transactions in 2015, but that has increased to $100 million already this year.
Finally, the fixed income asset class is well represented on the ASX’s mFund service, launched in May 2014, which allows investors to buy and sell managed funds directly on the ASX in the same way – and for the same cost – as they buy and sell shares, without having to use a financial planner or a platform. There are currently 32 fixed income mFunds that offer investment in global and domestic corporate bonds.
The ASX says the average number of mFund transactions has almost tripled – up 184% – on a year ago, coming from a small base, to 491 a month, for an average transaction value of $27,680 at August 2016. The two main trends, it says, are mFunds being used to access Australian share funds – but small/mid/micro-cap funds and strategy-based (for example, income-focused funds – and fixed income funds, in particular, global fixed income funds. About 85% of mFund transactions are SMSFs – both advised and independent – as SMSF trustees seek to diversify their portfolios and apply their cash holdings in other asset classes.
It has never been easier for investors to put part of their portfolio into fixed income, particularly the higher-yielding corporate bond sector, increasing the effective diversification, and clearly, SMSFs are starting to do just that. And it’s arguably never been more necessary that SMSFs diversify in this way, lessening what is a heavy dependence on the share market.
By James Dunn