The art of exposure- When it comes to allocating, balance is everything

If there has been one constant driving superannuation fund returns over the past two years it has been exposure to Australian equities.

Asset consultants may increasingly be urging their clients to increase their exposure to a range of other asset classes, including international equities and alternatives, but it is the research houses that are most clearly revealing the bottom line — an appropriate exposure to Australian equities continues to pay dividends.

Super Review examined the data provided by a number of the major research houses and found the top performing funds all had one thing in common — an appropriate and strategic exposure to Australian equities.

Sydney-based ratings house SuperRatings left no one in any doubt of its analysis of the importance of Australian equities exposure when it released its analysis of April returns.

SuperRatings managing director Jeff Bresnahan made his views clear when he stated that the “the old adage that asset allocation determines over 80 per cent of returns certainly appears to be holding true for the 2006-07 financial year”.

He said the top 10 performing funds were holding an average of 6.3 per cent (35.0 per cent against 28.7 per cent) more in Aussie equities (the best performing asset class), whilst relatively avoiding the worst performing asset class of fixed interest by holding an average of 8.1 per cent (17.0 per cent against 25.1 per cent) lower exposure to this sector.

“In turn, this has led to those top 10 funds returning a median 14.8 per cent against a median of 12.2 per cent for the bottom 10 funds of our 50 largest balanced investment options for the 10 months ending 30 April, 2007,” he said.

The latest Intech Investment Consultants research confirms the reality when it states, “All major growth asset sectors have delivered strong performance this financial year to date, driving the strength of the median growth fund return. Australian shares and both domestic and international property sectors have risen significantly for the financial year to date, with returns above 20 per cent.”

Looking at the individual sectors, the Intech data said Australian shares were the major driver of the strong returns for the median growth super fund for the March quarter, returning 7.0 per cent.

It said the Australian market had experienced just one negative quarterly return since the recovery from the bear market in early 2003, with the S&P/ASX 300 Index returning 22.4 per cent in financial year to date terms, providing a significant contribution to the median return.

Looking at international equities, the Intech analysis said international markets had also been strong in local currency and hedged terms.

“The MSCI World ex-Australia Hedged Index returned 16.2 per cent in financial year to date terms. The unhedged return was much lower at 6.4 per cent, hurt by the strong $A appreciation,” it said.

Intech said Australian listed property produced a negative return this quarter, making it the fourth since January 1, 2000.

“The S&P/ASX 300 Property Index has returned 23.2 per cent,” it said. “International listed property finished the previous three financial years well above 20 per cent, and the current financial year appears to be heading in a similar direction (29.4 per cent).”

Looking at fixed income investments, the Intech analysis said Australian bond yields had risen during the quarter, driven by fears of tightening domestic monetary policy and global bond market weakness.

It said Australian government bonds had returned 1.4 per cent over the quarter, international government bonds had returned 1.3 per cent while cash had returned 1.6 per cent.

Intech said bonds have under-performed most asset classes for the financial year to date, however, both Australian and international bonds had generated positive real returns, outperforming Australian headline inflation by 2.6 per cent and 4.9 per cent respectively.

While an appropriate exposure to Australian equities appears to have been the key to ensuring adequate returns, Bresnahan’s latest SuperRatings analysis makes clear that it is also a balancing act by quoting the chief investment officer of the Catholic Super Fund, Tim Hughes, who explained Catholic Super’s relative out-performance in the following terms: “We were only marginally overweight Australian equities and it has had very little influence on our performance. Rather, in descending order of importance, our returns have come from the following factors: being underweight fixed interest in favour of diversified hedge fund portfolios and lowly geared core direct property; the out-performance of our Australian share managers through a period when the average manager has under-performed the index; out-performance by our international share managers; the fund’s conservative risk-based approach to currency exposures (which has meant that it has been largely hedged over recent months) and very strong performance in our infrastructure portfolio.”

The senior researcher with the Association of Superannuation Funds ofAustralia, Ross Clare, said while there had been much discussion about a move away from Australian equity with respect to asset allocation strategy, he believed it remained a core focus for most funds.

“There has been a drift towards international equity and alternatives, but I think domestic equities remain a key element for most funds, notwithstanding the advice they may be receiving from some quarters,” he said.

Clare said while there had been suggestions domestic equity was now over-priced and Australian superannuation funds would find better value offshore, this was not necessarily supported by the essential arithmetic.

“Australian equities may represent only about 2 per cent of the world market, but it has been a very rewarding 2 per cent,” he said.

The managing director of Frontier InvestmentConsulting, Fiona Trafford-Walker, makes no bones about the fact that Frontier is amongst those consultancies suggesting to clients they adopt a more diversified approach when it comes to asset allocation. Trafford-Walker makes clear that this does not mean Frontier underestimates the value of Australian equities within an asset allocation strategy but, rather, that there is better value to be derived in other areas such as international equities, direct property and alternative investments.