DIY super funds cash dilemma

Cashed-up DIY super funds are in a dilemma. Trustees of these funds are typically watching with frustration as share prices rocket upwards, uncertain about whether it is too late to re-enter the market.

This caught-in-the-headlights syndrome could be widespread given that the local market has already risen 50% since early March, yet many funds still appear to be overweight in cash, depending upon the source of the data.

And even when fund trustees decide to significantly lift their share exposure, many may be uncertain how to achieve this in a way that will minimise risks in a highly-volatile market.

Unfortunately, much of the information about how much cash the typical self-managed fund holds is often anecdotal, conflicting or outdated.

The Australian Taxation Office, as regulator of self-managed super, releases estimates of the average asset allocation of Australia’s 410,500 DIY funds, grouping “cash, debt securities and term deposits [of any maturity date]” together in a single classification. This does not provide a useful guide to cash holdings of the funds.

Further, the ATO’s broad data is not up-to-date. Its latest-available figures for asset allocations may be to June 30 this year but this is actually “extrapolated” from 2007-08 fund returns. In other words, it’s a guess that is updated until the information actually becomes available from fund returns for 2008-09.

Out of interest, DIY funds held an average of 30% of their assets in “cash, debt securities and term deposits” at the end of June, according to ATO estimates – which is identical to many of the most-popular default portfolios operated by the large super funds.

Fortunately, the tax office apparently has plans to require DIY funds to provide more exacting details of their portfolio’s asset allocation.

DIY fund administration group Multiport regularly surveys the asset allocations of a random selection of 1,000 funds receiving its administration service. And the latest Multiport SMSF Investment Trends Survey points to high levels of cash among its fund clients; yet there is a clear move to invest more of that cash in shares.

As at September 30, the 1,000 funds surveyed held an average of 25.3% of their portfolios, or about $220,000 each, in cash and short-term deposits – down from 28.8% in December.

These funds had increased their average exposure to Australian shares to 38.9% of their portfolios – up from 33.9% on June 30. And their holdings in international shares hover around 7% of their portfolios, almost identical to three months earlier.

As share prices rose, asset allocation in shares should have also risen – without necessarily any formal change in strategies by fund trustees. However, Multiport says the funds surveyed have not been letting contributions build up in cash as they had for much of the past 18 months.

Interestingly, Graeme Colley, national technical manager for ING Australia and superannuation strategy manager for its self-managed super administration division Super Concepts, has a different impression about the exposure to cash among Super Concepts’ clients.

Colley says funds using Super Concepts administration services would have a much lower exposure to cash and cash-like securities. Indeed, these funds generally had not sold shares during the market downturn but some had slightly increased their cash holdings by keeping contributions made during the bear market in cash.

Regardless of the average cash holdings of DIY funds, there is no doubt that individual funds should now be examining their own exposure to cash and making decisions about whether any of this money should be shifted into the sharemarket.

The considerations for self-managed funds regarding whether to increase their exposure to shares can be somewhat different to many personal investors. This is because of such factors as the dollar value of assets in their portfolios as well as their responsibilities to different members who may have different needs for access to benefits and different tolerances to risk.

Here are four strategies for trustees of cashed-up DIY funds who are hesitating about getting back into the sharemarket:

1. Don’t think you have left it too late to increase your fund’s share exposure.

Peter Fry, director of Fry Financial Services in Victoria and a self-managed super fund specialist, says he is frequently being asked by fund trustees whether they have left it too late.

Fry’s firm takes the view that while some clients may have missed the rebound in the market to this point, the most crucial consideration for long-term investors is their length of time in the market.

Alan Freshwater, co-principal of financial planning group RetireInvest in Sydney’s Bondi, has a similar attitude. He says that cashed-up DIY funds have missed a very strong rally. “But that is history.”

Freshwater says that if fund trustees take the view that growth assets will outperform non-growth assets over the long-term, “they have not left it too late” to re-enter the market.

2. Have an organised strategy to re-enter the sharemarket.

A decision to invest a sizeable amount of cash into the sharemarket should be based on a proper investment analysis, says Fry. Further, funds should have a careful strategy for investing that cash, he adds.

Fry suggests that particularly if fund trustees are nervous about the market, they could consider investing their available cash in perhaps three lots over the next three months or so.

“Watch what the market does,” he advises. Depending upon how the market moves, trustees could decide to hold off investing more cash for a time or invest more at one time.”

Whenever moving more cash into the sharemarket, Fry says that trustees should take into account their funds’ strategic or long-term asset allocation, the fund’s compulsory investment strategy, and its liquidity requirements. For instance, a fund paying pensions would typically have different liquidity needs to a fund where all of the members are in the accumulation phase.

And he emphasises that just because a DIY fund has, say, $200,000 or so in cash, doesn’t mean that the fund is free to invest all of that money into the sharemarket.

Fry says that one of the considerations for fund trustees at this time is whether to rebalance to their funds’ portfolios back to their funds’ long asset allocation or whether to take some profits from shares given the sharp rebound in the market.

Alan Freshwater from RetireInvest, says a key issue for fund trustees is how far have their funds’ portfolios moved away from their long-term asset allocation during the bear market.

Freshwater gives the example of a fund with a long-term asset allocation of, say, 65-70% in growth assets (mainly shares and property) with the remainder in non-growth assets (mainly bonds and cash). He says if this fund has moved to a 50/50 split between growth and non-growth investments to ride out the downturn, it is about “15% out of line”.

Like Fry, Freshwater emphasises the merits of investing cash progressively back into the market rather than all at once. “The more you put in [to the sharemarket] in one chunk, the more you are making a timing call,” he says. And as SmartCompany has emphasised in the past, even professional investors rarely succeed in timing the markets – that is picking the best times to buy or sell.

Freshwater says that investors who invest cash progressively into shares – practising what is widely known as dollar-cost averaging – are acting in a disciplined, non-emotional way.

3. Review your fund’s long-term asset allocation.

Fry says fund trustees should consider reviewing the suitability of their fund’s long-term asset allocation before making a large investment. And that would also apply when looking at moving a significant amount of cash into shares.

In any case, Fry recommends that long-term asset allocations always be reviewed annually, and trustees should think about increasing the reviews to every six months given the bear market.

Freshwater says that if trustees feel uncomfortable with a fund’s long-term asset allocation after the experience of the bear market, it may be time to review it. His suggestion is to obtain professional advice based on the personal circumstances of a fund’s members.

4. Consider the increasingly popular core-and-satellite approach when increasing exposure to shares.

Typically, this approach involves using conventional index funds or exchange traded funds (ETFs) that track large market indices as the core of a share portfolio while investing in a “satellite” of direct shares and active equity funds.

A careful choice of index funds or ETFs can provide the basis of a widely diversified, low-cost share portfolio.

Fry points out that the independently-minded philosophy among self-managed super trustees in general means that their funds tend to have many direct investments. However, his firm sometimes recommends index funds to gain a broad exposure to the market where a DIY fund has direct share investments weighted in a particular area.

Depending on the circumstances, he says, the index fund or funds might not necessarily form the core of a DIY fund’s equity portfolio.

Freshwater describes the core-satellite approach using index funds (or ETFs) as well as direct shares and actively-managed equity funds as one of the possible alternatives for investors. And he emphasises the importance of an adequately diversified portfolio.

One of the big lessons from the global financial crisis, says Freshwater, is the protection provided by a widely diversified portfolio. This diversification should be across asset classes (and within those asset classes), fund managers and listed companies.