Self Managed Super Fund’s (SMSF’s) cash balances have fallen in the past five years, and it’s a trend expected to accelerate on the back of new challenges caused by COVID-19, and amid growing certainty that interest rates will stay low for a long time.
It was falling interest rates that dominated the headlines for SMSF’s during 2018 and 2019, a situation that forced many investors to sit down and reconsider their investment strategies. This was reflected in the September 2019 statistics released by the Australian Tax Office (ATO) which showed that over the previous 5 years, SMSF’s on average had reduced their cash balances by over six per cent. Its a trend likely to accelerate.
Record low interest rates, coupled with new COVID-19-induced challenges, including falling share dividends and uncertain property and rental markets, has placed further strain on cash flows, and is expected to lead to a wave of diversification as SMSF’s seek to prop up income flows.
In the recent reporting season SMSF’s were hard hit by announcements from Australia’s Big 4 banks that dividends were being reduced or suspended, a move that is expected to be mirrored in other key industries heavily impacted by COVID-19 including airlines, hospitality and tourism.
Historically, the strong dividend programs of Australia’s blue chip companies have proved lucrative for SMSF’s, reducing the incentive to consider other investment avenues. Unfortunately, it has also led to portfolio’s being too concentrated and subject to shock from unforeseen events.
Continued market volatility coupled with the flow on effects of COVID-19 and rock bottom interest rates has Australia’s wealthiest SMSF investors actively seeking opportunities outside of the traditional asset classes.
When savvy SMSF investors consider how they want their portfolio to perform, they don’t just think about returns. A key consideration is the ability to be able to withstand unexpected market events.
What we are seeing
At Citi, we have noticed an increase in SMSF’s wanting to lock in returns and reduce risk, primarily driven by increasing risk associated with ongoing uncertainty and instability in the market.
These factors are driving a renewed focus on income options like corporate bonds and tailored investments, which offer investors access to equities in a structure that can reduce risk, and which provides an agreed rate of income upfront.
During the first two months of this year we saw a 165 per cent increase in bond transactions and more than a 240 per cent increase in tailored investment transactions over the same period last year
Why are SMSF investors turning to fixed income?
The benefits of investing in fixed income for SMSF clients is two-fold.
Fixed income tends to be more resilient during times of market volatility. Adding fixed income to an equity portfolio using bonds can have a dramatic effect in reducing unpredictability in portfolio returns, without overly hindering performance.
It is also a source of reliable income with interest payments guaranteed by the issuer upfront and paid regularly, assuming the company does not default. Our clients focus on investment grade local and global companies, with strong balance sheets and a track record of performance and risk management.
The security of reliable cash flow is an appealing lure for many clients, and provides increased confidence that funds are available during times of stress.
Another key trend we have observed is a significant increase in foreign exchange transactions, with a 77 per cent increase in transactions in the first quarter of this year compared to the same quarter last year.
This foreign exchange movement has primarily been into US dollars as investors shift to take advantage of the USD’s safe haven status.
For SMSF’s, investing outside of Australian denominated assets has not been a widely utilised strategy. However investors who hold positions in foreign currency are able to easily access further investment opportunities in those currencies. This provides important hedging and diversification in those portfolios.
With our global expertise and experience, we has long advocated for portfolios being diversified not just by asset class but also by geography and currency.
Leonie is an SMSF specialist with Citi.
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