What exactly is a 'balanced' fund?

PORTFOLIO POINT: Legislators need to step in to force fund managers into “truth in labelling” to help super members. The existing schemozzle really isn’t a hard fix.

That different “balanced” super funds can have such divergent results is a constant source of amazement to most investors. Even worse, it’s an ongoing source of confusion for the average superannuation member.

Despite the warnings, some people do select super funds on the basis of the previous year’s performance, oblivious to the underlying reasons for its short-term outperformance in the first place, leading to the plaintive cry: “Why did my balanced fund do so much worse than the others in this table?”

The conventional wisdom – reinforced by the mainstream media – is that it’s largely about management skill. The general perception is that one super fund did better than another similarly named super fund because one fund had superior stock-picking skills.

Most super funds (particularly in the industry, corporate and government fund space) are actually not stock pickers. They outsource that function to investment houses. In essence, most managed fund super funds use “the MLC approach”. They “manage the managers”; usually with several investment houses operating and managing their clients’ funds for them.

Those managers are then the stock pickers; sometimes they’ll get it right, sometimes wrong.

How well one fund does in relation to another (the degree depends on which source you read) is far more heavily impacted by the asset allocation chosen for the fund. This means the proportions allocated to cash, fixed interest, property and shares, and is something fund trustees usually control.

Asset allocation for each fund under a super trustee’s charge is a bigger determinant of performance. That is, in years when shares do brilliantly, it stands to reason that funds that have more of a weighting to shares will have done better than funds more heavily invested in cash, no matter whether they got the individual stocks right. And vice versa.

That is, up to 80% of returns are from the asset class allocation than actual stock picking.

Go and look at a random bunch of funds that call themselves “balanced”. Check their performances and you will probably find that even though the “label” is the same, the performance figures could be as much as 5–8 percentage points apart for a one-year period. (It’s likely to be far less over three to five years.)

If you want to find out why, you need to look at what they are invested in. For the 12 months to June 30, 2010, you might find that one of them has as much as 75% of their money in “growth” assets of shares and property. And that might have beaten a competitor by the length of the Flemington straight, because the second super fund had only 50% of member money in shares and property. In the down years of 2007-08 and 2008-09, the performance was probably reversed. Even if the fund with 50% shares picked great shares in which to invest, it’s unlikely to beat the fund with 75% allocation to shares.

But they can both be called “balanced” funds.

This debate is known as “truth in labelling”. This particular argument is firing up again in the backrooms of the nation’s fund managers, and about time.

Most Australians have heard of the term “balanced fund”. In the mainstream media it suggests a homogenous style of fund. However, there is no industry standard definition as to what a balanced fund is. (And there is no definition for any other style of fund either, including “growth”, “high growth”, “conservative”, etc.) A balanced fund can, technically, be used to describe something with a smattering of shares or something with almost everything in shares.

How will Joe Public know what sort of risk they’re taking when they buy into a balanced fund?

They won’t. They can’t. They don’t.

There is an urgent need to simplify labelling. Industry has tried, and is trying, but has failed miserably to reach agreement on definitions. But they’ve been failing to do so for years.

ASFA chief Pauline Vamos claims an agreement is close between industry parties. But the “working groups” are working on very limited areas. And they’ve discussed this before with no success.

It’s too late. It’s time for government to step in to set the rules for what is a balanced fund, in the same way rules were set to cover labelling for “made in Australia”, “produced in Australia”, “Australian-owned”, etc.

It needs to be something simple, to help super fund members, such a number next to the letter G, which represents how much of the fund’s assets are in defined “growth” assets, such as G60, or G70, or G50. But it needs to be universal.

It would be so much easier for people to compare if a short explanation was provided by all funds before you started comparing the ABC Balanced (G70) to the LMN Balanced (G50). You’d have a very good idea about how aggressive the fund was invested immediately.

Sure, this doesn’t necessarily allow for super funds to make ongoing changes to their makeup. (Arguably, they shouldn’t be making major changes without the consent of their members. But that’s an argument for another day ...)

The problem is that the industry can’t agree on anything. They’ve been fighting for aeons. But while defining “balanced” and “growth”, etc, has been difficult, the real problem is apparently being caused by the definition or classification of assets and whether they go under the “growth” or “income” category.

They can’t agree on how property – or specific types of property – will be classified. Where do you put the various types of hedge funds?

The argument is becoming ridiculous and far more complicated that necessary.

The government needs to make a stand. “Hey, new boy. Yeah you, Bill Shorten. There’s an easy win to chalk up here. Come in here and legislate. Or delegate to the ATO or ASIC. End this petty rubbish fighting, please.”

Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.