Passive investment strategies and illiquidity issues within the industry fund sector could spell big trouble for your retirement nest egg. The biggest indicator industry funds are in trouble is they have asked to borrow money from the government to meet redemptions. If you have your superannuation invested in an industry fund, then you should be concerned in this new coronavirus economy.
Passive Investment Detrimental in a Bear Market
Industry funds have traditionally promoted themselves as low cost funds. The reason they are low cost is that they tend to structure their funds (your money) as “passive” investments (also known as index funds). A passive/index fund is an investment strategy that tracks a market index, or a specific market segment, to determine what to invest in.
For example, an index that has four sectors as shown below will automatically buy a specific amount every time money goes in regardless of what is happening in the world (e.g. regardless of market change due to the coronavirus).
|INVESTMENT||ALLOCATION (%)||AMOUNT ($)|
|Mining e.g. BHP||25%||$25|
|Online e.g. Amazon||25%||$25|
|Travel/Airlines e.g. Qantas||25%||$25|
|Retail e.g. Myer||25%||$25|
*This table is for illustrative purposes only.
The issue with this type of investment strategy is that, whilst it does keep fees low for members, indexing does not consider the balance sheet and strength of a company, which becomes crucial in times of financial stress. At a time like this when world economies are free falling, consideration needs to be given to the strength of individual segments and businesses within those segments. Now is the time to be picking winners and avoiding the losers. Our economy will get through this challenge and it will recover but the recovery will not be equal. Some businesses will recover, some will thrive, and others will never return.
For example, the travel industry (airlines, cruise companies, travel agents) has been gutted, retail is down, restaurants, coffee shops, pubs and clubs have been shut or are operating as takeaway only, which will significantly impact the viability of the businesses within these industries. Whilst companies such as Netflix, Amazon, Goggle, Apple and Facebook are all still trading, some even making more money because of increased demand for these services due to so many of us hibernating at home.
The alternative is to consider using active fund management. Active management is the use of a human element and uses analytical research, forecasts, and the manager’s own professional judgment and experience to make investment decisions on what securities to buy, hold and sell.
In our new coronavirus economy, now is the time to pick quality businesses to invest in, not companies with lots of debt that can’t pay their bills. Now is the time for active fund management, where mangers can select quality assets that have a higher chance of being able to rebound through this crisis.
The COVID-19 crisis has exposed illiquidity issues within industry funds, as recently reported in the Sydney Morning Herald, Macrobusiness and the Australian Financial Review. Industry funds have used “boomtime” assumptions to inflate valuations of their unlisted assets (assets not held on the stock exchange such as property) to boost their performance relative to retail funds. Two decades of uninterrupted economic growth means the industry funds have gotten away with this. But now their chickens have come home to roost. Mismanagement has exposed industry fund members to risks they may have not been told about.
Industry super funds currently hold huge amounts of unlisted assets that take a long time to sell. The economic crisis has caused industry funds to slash the valuations of illiquid assets in their “balanced” funds to avoid redeeming members, or members who switch out of balanced funds into cash options, getting a windfall at the expense of members who remain in balanced funds.
This means that their Australian and international shares will need to be sold to meet redemptions at a point in time where they are at their lowest value. They will be turning their paper losses into actual loses because members want to withdraw money. This crystallises losses and completely changes the risk of the investment.
What big industry fund have sold to members as “balanced” funds do not look so balanced any more.
Early Access to Super
This issue of liquidity is further compounded since the government has announced the “early access to your super” scheme, as part of the coronavirus stimulus package, whereby members in financial trouble are able to withdraw up to $10,000 this and the following financial year. Additionally, the usual inflow of cash through member contributions has reduced through members losing their jobs or working less hours.
What Should I Do?
During a “bear market” quality matters most. We want our superannuation to be invested in companies that we can’t live without and are strong and are able to bounce back. How and what is your superannuation invested in? If you want quality now is the time to consider active management and a portfolio that is specifically designed to meet your needs, not a generic passive investment.
If you would like to take control of your superannuation, make sure it is invested in a way that meets your needs, and takes into account the coronavirus challenge then it is time to get personal advice and a strategy in place.
If you need help from a financial adviser contact the team at Elliot Watson Financial Planning 02 4038 1623.
The information within, including tax, does not consider your personal circumstances and is general advice only. It has been prepared without taking into account any of your individual objectives, financial solutions or needs. Before acting on this information you should consider its appropriateness, having regard to your own objectives, financial situation and needs. You should read the relevant Product Disclosure Statements and seek personal advice from a qualified financial adviser.
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