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Defensive assets, such as cash and bonds, produce lower returns over time than growth investments like equities. But defensive investments are useful for mitigating risk and generating income in self-managed superannuation fund portfolios.
“It’s important to have defensive assets to provide a stable income and liquidity so the investment can be easily accessed,” says Industry Fund Services head of technical services and advice enablement Craig Sankey.
SMSFs with members approaching retirement commonly increase their defensives exposure to ensure they can pay pensions and protect the fund from capital losses.
“Some assets can go up and down, boom and bust, and that’s not appropriate for some people, especially in retirement,” Sankey says.
The challenge is that managing risk by including defensive investments comes at a cost to returns, says IFM Investors chief economist Alex Joiner.
Cash and term deposits are the most popular defensive investments held by SMSFs, with around 20 per cent of all SMSF assets allocated to savings products, according to Australian Taxation Office statistics from December 2020.
Cash and term deposits are easily accessible and pose very little risk to the principal value, but Joiner says the Reserve Bank of Australia’s official cash rate is unlikely to rise much above its current rate of 0.1 per cent before 2024.
Government bonds, the other mainstay of defensive portfolios, are also delivering low returns. Australian 10-year government bonds were yielding just 1.7 per cent in May 2021, down from an average of around 5.5 per cent through the early 2000s.
“There has been a structural decline in bond yields so that means there are just not the returns that we used to get,” Joiner says.
Corporate bonds may offer higher returns, but Sankey says SMSFs considering such investments need to understand the underlying assets.
“You have got to be aware that when you take on high returns you take on more risk. [Higher yielding] investments are probably not as defensive as some other fixed interest investments,” he warns.
To manage risk while seeking to maximise income, SMSFs can diversify their defensive investments.
“Diversifying within the defensive assets gives your whole portfolio greater diversification, which means lower risk overall,” says Sankey.
In income-producing investments, diversification means not only buying a range of assets, but also buying investments with different timeframes to avoid locking into low interest rates. SMSFs can achieve this by buying bonds with varying durations, or investing through diversified exchange traded funds or managed investment products.
Alternative income options
Sankey suggests SMSFs also look beyond the traditional asset classes.
“These days there are more opportunities for alternative types of defensives: assets like unlisted property and infrastructure that have growth and defensive characteristics,” Sankey says.
Many SMSF investors are attracted to direct residential and commercial property. Over 15 per cent of SMSF assets are held in direct property, ATO statistics show.
Rental properties are relatively easy for SMSFs to acquire and housing markets have recently experienced significant price growth. While stagnant rental rates have meant lower yields, investors have benefited from capital gains.
However, rental properties offer limited diversification benefits as few SMSFs hold more than one property.
Unlisted property funds or trusts offer greater diversity of underlying assets, as well as access to institutional-grade investments and professional managers to optimise investment performance.
Unlisted infrastructure also has both growth and defensive characteristics, and performance is unrelated to equity or bond markets which makes it useful for diversifying portfolios, Joiner says.
“You certainly have the potential to bolster your returns. Returns are not highly correlated with financial markets and they are less volatile than financial markets. Those are the characteristics that someone wants in their portfolio as they approach retirement,” Joiner says.
SMSFs can invest in unlisted infrastructure through managed investment products such as managed funds or the Self-Managed Invest option offered by Hostplus.
Including a variety of defensive assets in the SMSF portfolio helps to protect against losses and can bring extra income into the fund.
Hostplus Self-Managed Invest (SMI) is issued by Host-Plus Pty Limited ABN 79 008 634 704, AFSL 244392 as trustee for the Hostplus Pooled Superannuation Trust (PST) ABN 13 140 019 340. This information contains general advice only and does not take into account your personal objectives, financial situation or needs. You should consider if this information is appropriate for you in light of your circumstances before acting on it. Please read the Hostplus Self-Managed Invest (SMI) Product Disclosure Statement (PDS), available at www.smi.hostplus.com.au before making a decision about Hostplus SMI.