Concentration is generally a trait to be encouraged.
Parents of teenage high school students, for example, will be passionate advocates of the virtues of concentration on a piece of homework that lasts longer than a TV ad break or between Facebook posts.
Concentration on the task at hand will generally win plaudits for improved productivity in the workplace.
But in the investment world concentration has a regular bedfellow, an alter ego if you will, and it is called risk.
Taking on risk is part and parcel of investing. The theory is that taking on higher levels of risk will, over the long run, be rewarded with higher returns. That is an underlying belief in the way most portfolios – be they in large super funds or from a financial adviser – are constructed. Typically they range from conservative to balanced to growth with the portfolio’s asset allocation being principally defined by the level of market risk they are exposed to.
In that sense market risk is something to be embraced rather than shunned – particularly if you are a younger investor with a lifetime of work and earnings ahead of you. But for older investors – those in their retirement years – the onus shifts to a more defensive approach and with that the need for a clear understanding of how much investment risk you are taking on.
For instance, the 2016 Vanguard/Investment Trends Self-Managed Super Fund research study that was released this month has highlighted the levels of concentration risk within a significant number of SMSF portfolios.
The research study – covering more than 3500 self-managed super fund (SMSF) trustees and in its twelfth year – found that 60 per cent of SMSFs say that they have more than half of their assets invested in one investment class.
Drilling down further into the data we find that 38 per cent of those SMSFs have more than half their assets invested in direct Australian shares – cash comes a clear second with 11 per cent of the SMSFs surveyed nominating that as where they have more than half their SMSF investments.
Peel back another layer and the SMSF trustees surveyed by Investment Trends tell us that 28 per cent of those with a portfolio concentrated on domestic shares have more than 50 per cent of their portfolio in Australian bank shares, while seven per cent are concentrated in resource stocks.
This is where the natural concentration of the Australian sharemarket and economy – banks and mining companies account for nearly 60 per cent of the broad sharemarket index – works against the principle of managing investment market risk by diversifying across a broad range of asset classes.
Regular subscribers will not be surprised that concentration risk is again being called out as a cause for concern, it is a topic that has been visited regularly over the years as more and better data on SMSF portfolios is published.
Almost certainly this will prompt correspondence from some trustees explaining they are relaxed about the risk as long as the banks continue to pay steady dividend streams to provide retirement income. And where investors/trustees have consciously recognised and accepted the risk within a portfolio that is their prerogative
But what SMSF trustees are calling out strongly in this year’s Investment Trends study is that making investment decisions is getting harder. Rewind a few years and a concentrated portfolio of bank and mining shares combined with a strong allocation to term deposits yielding five to six per cent motored along quite nicely for SMSFs with reasonable return expectations.
Since then the environment has changed dramatically – particularly on the interest rate front for term deposits.
SMSF trustees now cite "choosing what to invest in" as their number one challenge in running their personal super fund and their expectations for future market returns have fallen sharply since March last year.
When it comes to how and where SMSF trustees intend to invest in the future three clear trends emerged:
- A shift back to using managed funds (managed fund use fell steadily after the global financial crisis) and increasing use of other investment vehicles like ETFs
- The driver for increasing investment in funds/ETFs is to get greater international diversification
- Rising demand for advice services
Despite a backdrop of lower expectations for market returns, these shifts in demand are a positive sign in terms of turning the tide against over-concentrated SMSF portfolios. Tapping managed investment vehicles, which can provide broader exposure across markets, sectors and geographies, can be a valuable tool for achieving diversification and spreading risk, while a good financial adviser can help provide a clear road map to reach stated financial goals through an appropriate investment strategy.
In the current environment, where setting a portfolio’s risk correctly is increasingly important, investors can afford to let their attention wander. If your mind happens to stray across a diverse mix of asset classes and investment markets, then diversity can prove to be an investing virtue.
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Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment. |
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