Investors warned not to exchange one risk for another
A number of Australian investors have traded equity risk for interest rate risk by switching into cash, according to exchange-traded fund (ETF) provider iShares Australia and Dr Doug Turek, managing director of Professional Wealth.
"Rather than switching between assets in response to changes in the risk environment, it is more important to imbue portfolios with all-weather defensive resilience," he said.
"Inadequately structured defensive portfolios often simply swap equity risk for interest rate risk."
Turek said the unfortunate reality was that few investors had a clear idea of how to build a defensive portfolio.
"The absence of defensive strength can have a serious impact on retirement goals," he added.
"If a portfolio includes the right defensive components, it should be able to weather interest rate falls or rises and provide enough liquidity to pay a steady pension income.
"Defensive investing should also contribute to maintaining 'real' - or after-inflation - purchasing power," Turek said.
According to Turek, interest rate risk, credit risk and inflation risk could all be dealt with via a three-component investment framework.
"As a starting hypothesis, about one-third of a defensive portfolio could be invested each in floating rate, fixed rate and inflation-linked securities," he said.
"Firstly a high credit quality, low volatility 'floating rate' component that is highly liquid and whose capital price is highly stable, can help to dilute other sources of asset price volatility and provide exposure to rising interest rates."
"Secondly, a 'fixed interest rate' component that aims to stabilise income can help investors profit if interest rates fall or there is a flight from equities during difficult times," Turek continued.
"And thirdly, an 'inflation linked' component that links returns over the long run to inflation and can help preserve the purchasing power of investors' money if interest rates don't or can't rise enough to fight inflation."
And for Tom Keenan, Director of iShares Australia, fixed income ETFs may provide investors with the perfect vehicle to access a properly diversified fixed income portfolio.
"With the introduction of ETFs, all investors now have access to a simpler, cost-effective and flexible toolkit when seeking to implement a defensive portfolio," he said.
"Having easier access to previously rare ingredients such as inflation-linked bonds has really changed the fixed income landscape."
Pointing out that inflation-linked bonds provided income that varied in line with CPI changes, Keenan said that investors were now better able to preserve the real value of their capital.
"With inflation having averaged 3 per cent a year over the past decade, and possibly headed higher in some scenarios, investors nearing retirement or in retirement can appreciate the role of inflation-linked bonds," he continued.
"And as Australia's population ages, we expect trends towards defensive portfolio construction to increase."
AUTHOR
Staff Writer
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