Is there Something Missing from Your Asset Allocation Model?

If you are acting as the trustee for your own SMSF, you will at some stage of your working life, have money invested in an industry or retail super fund. 

At some point in time, for one reason or another, you’ve chosen to take control of your own future prosperity and set up your SMSF. And why wouldn’t you? All the information required to make informed investment decisions is readily available, and you have the time and energy to do your own research. Managing it yourself gives you the ultimate flexibility to back your winners, to invest in areas you have knowledge in… plus, of course, you are not paying a fund manager or financial planner (or both – a planner who invests in funds)!!

Now, one thing fund managers and financial planners do well is to allocate assets across a range of different markets. In fact, the average default mix, as offered by Australian super funds, looks like this:

One could consolidate these pieces of pie in to these categories:

• Equities = 51.4%
• Fixed Interest = 14.4%
• Property = 9.5%
• Cash = 8.2%
• Other = 16.5% (likely hedge funds/private equity etc.)

Upon setting up an SMSF, what we see is that people head out and buy their favourite shares, maybe a residential or commercial property, put a bit of cash in TDs/at-call, and maybe even put some equity into a private firm. But what about that 14.4% fixed interest component?

What’s amazing is that so many people, even when it appears on their fund’s portfolio report, really have no idea what that ‘fixed interest’ piece of pie represents, and so often it is left out of an SMSF portfolio! In fact, across the entire $1bn value of SMSFs in Australia, less than 3% is in fixed interest! This is the lowest percentage in the OECD… by some margin. 

What IS fixed interest (or fixed income) anyway?

A fixed income security is an investment that provides a return in the form of periodic payments and the eventual return of principal at maturity. This is essentially bonds and hybrids. Companies and governments issue debt in these forms, as a way to raise capital. If a business wants money, they can issue shares, they can go to the bank, or they can issue a bond or hybrid. These are legal debt obligations, and any failure to repay principal or interest as part of the arrangement constitutes a default. Because fixed income ranks above ordinary shares, in that unlikely default scenario, bondholders must be paid out before shareholders can see a penny.

Why is fixed income in Australia so far behind the rest of the developed economies?

It’s really to do with access. Up until a decade ago, in Australia, bonds only traded in $500,000 parcels. Overseas, (e.g. USA) bonds can be bought and sold in denominations as small as $1000. So that large investment size here has made it impossible for the majority of private investors to access. That has since changed, and now these products can be bought and sold in $50,000 parcels, or even smaller on the ASX.

That’s the other factor which has stunted the growth of fixed income in Australia – where and how do they trade? The overwhelming majority of fixed income products trade in an ‘over-the-counter’ (OTC) market, which is a negotiated marketplace with multiple participants. This is not unlike currency, or real estate, in that there is no specific exchange. That being said, there are now a number of fixed income products trading on the ASX, and I expect this to continue to grow. There, you can buy and sell bonds and hybrids with as little as $100 in your pocket! This expansion on to the listed market can only help bring exposure, and transparency to our asset class.

What are the different types of fixed income products?

Fixed income covers all bonds and hybrids. That range is enormous – with the global bond market being four times the size of the global share market. Risk and return can be as low as a federal government bond @ 3%pa, or as high as a speculative corporate @ 18%pa! Interest payments can be set as a fixed rate, a floating rate over BBSW/LIBOR, or indexed with inflation. So if you have a particular view on rates and growth, you can assert that view on your fixed-income investments. That is: Rising rates = Buy floaters. Falling rates = Lock in a fixed rate. Inflation fears = Buy index-linked.

With a combined annual income of 7.14%pa, and an overall yield to maturity of 8.00%pa, here are three fixed-income investments that may add value to your current investment portfolio:

Cameron Window, Executive Manager – Fixed Income – MINT Partners Australia

E – cameron.window@mintpartners.com