Investment Selections and Asset Classes

This stuff doesn’t need to be difficult!

When it comes to investing your super, an understanding of the following topics will assist you to make confident, sensible and suitable decisions:-

• An Introduction to Managed Funds
• Choosing an Investment Strategy
• The Basics about asset Classes
• Growth assets, income assets or both?
  
  • Cash
  • Fixed Interest
  • Property
  • Australian Shares
  • International Shares
  • Currency
• Diversification
• Investment Costs & Performance
• Secrets of Investment Success
• Investing for your life-stage
• Index Investors versus Active Investors

A short introduction to managed funds

A managed fund is an investment structure that pools people's money together to invest in a range of investments, such as shares, property and fixed interest. Nearly all superannuation investments are made through managed funds”. Total managed funds assets in Australia currently exceed $1.3 trillion and make up a large proportion of assets under management in superannuation funds.

Managed funds can provide a cost-effective way for investors to access a more diversified mix of investments than they could individually. Your money is pooled, enabling it to be invested in a range of assets that might be too difficult or expensive for you to invest in directly.

Instead of directly owning the investments yourself, the managed fund owns the underlying investments on behalf of you and all other members of the fund. Each investor is allocated units representing their share of the fund. The value of your units fluctuates  (goes up and down) with the value of the underlying investments.

Choosing your investment strategy

With the wide choice of investment options available today, how do you know which is the right strategy for you? Here are some factors to consider before choosing your investment strategy.

Investment types and risk

All investments carry some level of risk. Strictly, risk for an investment is the chance of any unexpected outcome (i.e. there is a risk you might earn more than you expected). But, sensibly enough, most of are concerned with the risk of losing some or all of our money.

Now, the type and degree of risk will vary depending on the investments you choose – and it is commonly said in investing circles that “the higher the risk the higher the potential return”. That’s actually wrong – because it’s putting the cart before the horse. The correct way of expressing this is “the higher the potential return you seek, the higher risk you are going to have to take”.

This graph shows the relationship between risk and return for each asset class.

Higher risk asset classes like shares are long-term investments, which means the longer you are invested the less likelihood of your investment value falling. One useful way of measuring risk is in terms of the likelihood of achieving a negative return in any one year - the higher the risk level of an asset class the higher the likelihood of achieving a negative return. This is shown in the graph below.

Asset classes

Asset classes are often divided into “income” (or “defensive”) and “growth” investments. We’re not sure that these terms are very useful– and we’re not alone in this. In fact, the Association of Super Funds Growth recently commented that “there is no consistency amongst the agencies or amongst superannuation funds as to which asset classes are to be classified as growth and which as defensive. Many superannuation funds have expressed concern regarding this lack of consistency and the ‘misleading’ comparisons that result.”

We think it’s better to put these labels to one side, and instead concentrate on the major return and risk characteristics of each asset class.

A summary of the asset classes:

Cash:	suits investors who prefer capital stability (i.e. small risk of loss) and regular income to long-term growth.
Fixed Interest:	suit short to medium-term investors (one to five years) seeking a steady and reliable income stream.
Property:	suits investors with a medium to long-term timeframe (five years plus) who want a combination of income and growth.
Australian Shares:	are higher risk and suit investors with a long-term timeframe (seven years or more) who are willing to take on higher-risk in pursuit of higher returns.
International shares:	are higher risk and suit investors with a long-term timeframe (seven years or more) who are willing to take on higher risk in pursuit of higher returns.
Currency:	is a high risk investment and suitable for investors with at least a medium- term timeframe (three to five years) who are willing to take on higher risks in pursuit of higher returns.

 

Asset Classes	Attributes	More Information
Cash	for short-term investors lowest risk of all asset classes can provide a steady and reliable income stream, liquidity and stable returns usually includes higher interest-paying securities than bank accounts or term deposits In TIC Super we use one of Australia’s largest banks to invest into this asset class.	Learn more about this asset class. Learn more about the fund we use for this asset class in TIC Super.
Fixed Interest	for short to medium-term investors (around three to five years) low to medium risk can provide a steady and reliable income stream and potential for capital growth usually offer a higher interest rate, or yield, than cash access Commonwealth Government, state governments, semi-government authorities and company debt from Australia or overseas In TIC Super we use the TIC Currency Fund (Capital Guaranteed Option) to invest into this asset class.	Learn more about this asset class. Learn more about the fund we use for this asset Class in TIC Super.
Property	for medium to long-term investors (five years plus) lower risk growth asset than shares returns include income and capital growth diversification benefits with access to properties in retail, office, industrial, tourism, residential and infrastructure sectors access Australian and international property security markets In TIC Super, we make use of the TIC Diversified Residential Property Fund to invest into this asset class.	Learn more about this asset class. Learn more about the fund we use for this asset Class in TIC Super.
Australian Shares	for long-term investors (seven years plus) potential for higher returns with higher risk potential for income through payment of dividends and tax benefits in the form of dividend imputation access a diversified range of companies listed on the Australian Stock Exchange In TIC Super we use the Vanguard Australian Shares Index Fund to invest into this asset class.	Learn more about this asset class. Learn more about the fund we use for this asset Class in TIC Super.
International Shares	for long-term investors (seven years plus) potential for higher returns with higher risk access industries and investment opportunities not available in Australia diversification benefits when investing in a range of countries, industries and companies. In TIC Super we use the Vanguard International Shares Index Fund to invest into this asset class.	Learn more about this asset class. Learn more about the fund we use for this asset Class in TIC Super.
Currency	For short to medium-term investors (around three to five years) High risk Potential for higher returns with higher risk Diversification benefits by providing access to the world’s largest traded market and across different major currencies In TIC Super we use the TIC Currency Fund to invest into this asset class.	Learn more about this asset class. Learn more about the fund we use for this asset Class in TIC Super.

Cash basics

Cash plays an important role in an investment portfolio. You can use your funds to manage cash flows into other asset classes and you can also access your funds for day to day living expenses.

Typically, cash investments aim to provide income, liquidity and stable returns. Cash management trusts and funds usually invest in a range of short-term money market investments (that usually mature in 12 months or less) and provide the potential to earn higher returns than normal bank accounts and term deposits.

Cash investments can include term deposits, money market securities and cash management trusts. Term deposits usually offer higher returns than traditional bank accounts to compensate for the longer investment term. Usually, the higher the interest rate on offer the longer you need to lock your money away and the higher the risk.

Cash has the lowest risk of all asset classes. In fact, the 90 day treasury note interest rate is often the yardstick for a risk-free rate of return in Australia. The short-term nature of cash investments makes them less volatile than other types of asset  classes. While it is unlikely that the value of your capital will fall, most cash investments do not provide a capital guarantee. There is also the risk that your capital will not keep pace with inflation, and will lose value in real terms.

The level of income from cash investments varies as interest rates move up and down. Interest rates typically rise with inflationary expectations. It also depends on the types and maturities of securities held.

You can access cash investments directly via bank deposits, debentures and bank bills or indirectly via cash management trusts and managed funds. Managed funds provide a way of accessing a diversified portfolio of securities, which can include securities with different issuers, maturities and credit ratings.

In TIC Super the cash allocation is currently managed by one of Australia’s largest banks.

Fixed interest basics

Fixed interest investments can be issued by the Commonwealth Government, state governments, semi-government authorities, banks and other corporations, both locally and overseas, to raise capital for projects.

The main types of fixed interest securities are:

1. Government bonds - issued directly by a government and are explicitly guaranteed. For instance, in Australia the Federal Government issues commonwealth securities to help pay for major government projects;
2. Semi-government bonds - not issued directly by a government but might have a direct or implied guarantee. For instance, state governments and other entities that have a government guarantee, (like the World Bank), issue bonds to support their financial needs or to finance public projects; and
3. Corporate bonds - issued by large public companies to fund expansion and other major projects. Corporate bonds differ in two important ways to government bonds - yield and credit quality. Generally, corporate bonds are thought to have a higher level of risk than government or semi-government bonds, so they typically offer higher interest rates.
4. Hybrids - have characteristics of both equity and fixed interest securities. Convertible bonds, for example, commence as bonds but can be converted into equity at a future date. These types of securities have higher risk than government or corporate bonds as they are less secured. This means they come further down the repayment line if the issuer defaults on the loan.

Fixed interest is a low to medium risk investment suitable for investors with a timeframe of three years or more. While fixed interest doesn't deliver the highs of shares or property trust investments, it tends not to suffer the lows that these investments can in more volatile times.

Fixed interest investments usually have longer investment terms than cash investments. Australian bond maturities range from one to 10 years while US bonds can extend up to 30 years.

Investment in both international and Australian fixed interest securities has two major benefits for investors. It increases diversification, which lowers risk, and it provides opportunities for enhanced
returns without resorting to lower grade, higher risk debt. The international bond market includes over 3,000 securities compared to around 300 in the Australian market.

In addition to providing a regular income stream - an important feature for many investors - fixed interest can provide a stabilising effect during periods of share market volatility.

In TIC Super the fixed interest allocation is currently managed by the TIC Currency Fund – Capital Guaranteed Option as it provides a capital guaranteed investment with the potential to earn greater than the inflation rate.

Property basics

Australians have had a long love affair with property. According to an Australian Bureau of Statistics report property assets account for almost sixty per cent of mean household assets*.

Property is a long-term investment with higher risk than fixed interest investments but lower risk, historically, than shares.

Direct residential property offers steady rental income, tax breaks (via negative gearing and depreciation) and capital appreciation. At the same time, it can have a number of drawbacks. It takes time to buy and sell: building a diversified property portfolio is an expensive exercise; your property exposure is limited to one sector; locating and keeping good tenants can be difficult and there is always ongoing care and maintenance. There is also the risk of capital loss and lower rentals during times of oversupply.

A managed fund for residential property can provide many of the benefits of direct property investment without the effort or the problems listed above. The main benefits of managed funds are that you can invest in properties you would not be able to access directly yourself and you can hold a diversified portfolio of properties for a relatively small initial outlay.

Investment returns can include income in the form of rent received from the underlying properties and capital growth (or loss) from changes in the value of the properties. Property trusts can also offer tax advantages to investors in the form of tax deferred income distributions.

In TIC Super the residential property allocation is currently managed by the TIC Diversified Residential Property Fund which uses the experience and investment team of The Investors Club, which has been providing residential property investment research and support to its members since 1994.
* Reference to be provided

Sharemarket basics

Investing in the sharemarket provides a way of participating in the future profits and growth of Australian and international businesses. In Australia, there are around 2,000 companies listed on the stock exchange, representing a total market capitalisation of around $1,487 billion. [August 2008. Source ASX Getting Started in Shares]

Shares are generally considered a high risk and high return investment and are suitable for longer-term investors.

Historically, Australian shares have provided long-term growth well above inflation. At the same time, shorter-term sharemarket returns have been very volatile at times.

Sharemarket investors can expect a negative return once in every five years, which is why shares are suited to longer term investors (seven years plus). Time greatly reduces, but does not eliminate, the volatility in returns from shares.

Sharemarkets move in cycles, reflecting the underlying strength of the economy, political factors, industry trends and market sentiment. On any given day interest rate and inflation expectations, company profits, dividends, economic growth figures and the rise or fall of our dollar can impact share prices.

While shares are primarily a growth asset, they can also provide a good source of income. Most companies distribute a proportion of their profits in the form of dividends. Companies that pay high dividends tend to be blue chip companies like those in the banking, insurance and retail sectors. Some companies, like those in the mining sector or newer industries like biotechnology, may retain dividends to fund future research, expansion or exploration.

Actual yields can change dramatically from year to year and vary from company to company. If company profits are not growing, dividends are likely to be stable and if profits fall, a company may have to reduce dividends. Investing in a diversified imputation or high yield style fund can lessen this impact.

Australian shares can provide tax-effective returns. Dividend imputation is the main reason Australian shares are so tax effective. Given companies have already paid tax at the company tax rate, investors can use franking credits to offset the amount of tax they pay on dividends. The higher the franking level, the greater the benefit.

Some companies pay fully-franked dividends, with the maximum imputation credit of 30 per cent (equal to the company tax rate). Other companies pay partially franked dividends where the imputation credit will vary depending on the amount of tax they have paid on their profits.

You can invest in the sharemarket directly or via a managed fund. One of the major benefits of a managed fund is that you can access a much wider range of investments than you can by investing directly yourself. Another is that your assets are professionally managed.

Index funds on the other hand, will include a broader range of securities holding all or most securities in the index. Many active Australian share funds hold between 30 and 70 stocks, out of a universe of around 200 to 300 securities depending on the index used. Some higher conviction funds hold less than 30 stocks. In TIC Super the Australian shares allocation is currently managed by Vanguard – one of the worlds’ largest index managers.

International Shares

Investing internationally can increase your diversification and give access to industries and companies not available in Australia. After all, Australia represents less than three per cent of the total world sharemarket.

Many industries are not represented or under represented in Australia. For example, the MSCI World Index has an allocation of more than 20 per cent to the fast growing information technology and healthcare sectors. By comparison, Australia has around five per cent in these sectors.

The Australian market is highly concentrated with a large representation in the financial services and resource sectors. The top 10 Australian companies make up more than 40 per cent of S&P/ASX 300 Index, with three out of the top five companies in the financials sector.

Diversifying your portfolio internationally can help to improve your return potential and potentially lower your risk. As each country experiences different economic growth rates, consumer sentiment and political issues, international sharemarkets can grow at different times and rates. Within each country there will also be industries and companies that perform better at different times. For example, the retail sector tends to perform well when interest rates are low and consumer confidence is high.

Accessing global investment opportunities

Investing in a global equity fund that tracks the MSCI World Index is one way of achieving access to many of the world's best known brands such as Coca-Cola, Microsoft, Nestle and Vodafone. These companies can be classified as truly global with customers all around the world.

International shares are considered a high risk and high return investment. As such, they are suited to investors with longer-term investment horizons (seven years plus).

International shares don't provide the same tax-effective income benefits as their Australian counterparts. Income generated from international assets is generally in the form of realised capital gains rather than dividends.

International share portfolios get their returns from two sources - the change in the value of the investment and currency returns. When the Australian dollar falls relative to overseas currencies, it has a positive performance impact for Australian investors, and vice-versa.

Fully hedged funds incorporate a currency edge to act as a buffer against local currency fluctuations. In effect, fully hedged investors receive returns equal to a weighted average of individual country returns in local currency terms. As the Australian dollar exchange impact has been removed, hedged investors can focus solely on international market movements.

Having said that there can be an opportunity-cost to currency hedging. Currency exposure can add an important diversification element to overseas investing. While US dollar denominated assets usually make up the largest component of an international equity portfolio at around 50 per cent, a diversified international portfolio can be exposed to more than 20 different currencies.