Don't be caught napping
With the cash rate falling, SMSF trustees may need to tweak their defensive holdings to attain higher yields.
With the cash rate falling, SMSF trustees may need to tweak their defensive holdings to attain higher yields. Trustees of self-managed superannuation funds have a strong preference for investing in shares, cash and fixed interest. According to the Australian Taxation Office, SMSF trustees invest 32 per cent of their money in equities and 28 per cent in cash and term deposits.A strong weighting towards cash and fixed interest would have helped produce a good investment return in the year to June. The median return of the capital-stable funds surveyed by SuperRatings was 4.1 per cent for the year to June.The ATO's figures are based on a survey of self-managed accounts at the end of the 2009-10 financial year.More recent research shows not much has changed. According to the SMSF administration company Multiport, as of June 30 this year, self-managed funds had 35 per cent of their money in Australian equities, 27 per cent in cash and term deposits, and 10.5 per cent in fixed-income securities.SuperRatings says the average asset allocation in a capital-stable super fund is 40.2 per cent fixed interest, 22.6 per cent cash, 12.1 per cent Australian shares, 10.1 per cent international shares, 9 per cent alternatives, and 6.1 per cent property.Growth portfolios in the SuperRatings survey lost an average of 1 per cent in the year to June, while balanced funds were up an average of 0.5 per cent.The return for capital-stable super portfolios over the past five years is an average of 3 per cent a year, compared with an average loss of 1.7 per cent a year for growth portfolios, and a loss of 0.2 per cent a year for balanced funds over the same period.Defensive assets have produced good returns throughout the financial crisis but now investment strategists are warning that cash and fixed interest may not be the best assets to be holding in the period ahead.The head of investment strategy at AMP Capital, Shane Oliver, says: "Throughout 2010 and into 2011, there were very attractive rates of interest being offered on bank term deposits."The trouble now is that the cash rate is falling as the Reserve Bank has cut rates to deal with softer than expected economic conditions. And just as term-deposit yields have fallen, so too have government bond yields."As bond yields fell over the past 18 months, bond prices went up, producing capital gains for fixed-income investors.Bond yields have fallen to record lows. Anyone getting into bonds now will get a yield of not much more than 3 per cent if they hold the securities to maturity. And if bond yields start to rise again, investors will be exposed to the risk of capital loss.Oliver says investors who are looking for the defensive qualities of a fixed-income security as well as a higher yield should consider corporate credit. Investment-grade corporate bonds are yielding about 6 per cent.Investors have had plenty to choose from in the corporate bond market. About $8 billion in subordinated notes and convertible preference shares have been issued over the past 12 months, and all of them have been listed on the ASX. The leading banks have been big issuers and so have companies such as Woolworths, Tabcorp and, most recently, Caltex.Typical of the returns on offer in this market is an issue of Westpac subordinated notes, launched last month and closing on August 16, paying a floating rate of 2.75 per cent above the 90-day bank bill rate. With the bank bill rate about 3.5 per cent, the notes will pay more than 6 per cent.Compared with this, the best six-month term-deposit rates on offer at the moment are about 5 per cent. Westpac's notes have a fixed maturity date of August 2022 but may be redeemed at the bank's discretion in August 2017.The executive director of fixed-income strategy at JBWere Wealth Management, Laurie Conheady, agrees investors need to take care with their cash and fixed-income investments.Conheady says most of the recent fixed-income returns have come from capital gains, as the price of bonds and other fixed-income securities have rallied strongly.The yield on a 10-year Commonwealth bond has been below 3 per cent this year, reflecting strong demand for the securities. Conheady says these long-term government bond rates are at levels last seen in the 1950s."While a repeat of the double-digit returns on government bonds is possible, we believe it is unlikely," he says. "Even if capital values remain at current levels, the relatively low running yields associated with current inflated values point to better risk-reward opportunities elsewhere."We suggest investors look to floating-rate corporate bonds and better-quality hybrids as a way to improve returns and diversify portfolios."