Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 354

Bear markets are good for portfolio makeovers, not only bargains

Notching up record after record, financial markets are continuing to deliver unpleasant reminders of just how unprecedented the global pandemic crisis is. One recent record is the speed of the S&P/ASX 200 Index’s sudden slide to bear market status (defined as a 20% decline in pre-tax value from peak to trough). This slide took a mere 14 days in March, the quickest in the index’s history, easily eclipsing the next worst market slide of 55 days which signalled the onset of the GFC.

Source: Bloomberg, Parametric 31 March 2020. For illustrative purposes only. It is not possible to invest directly in an index.

Portfolio management in a crisis

A sophisticated approach to managing equities through this crisis period, as any large super fund will tell you, focuses on two things: first, avoid being a forced seller, and second, be well-positioned to take advantage of buying opportunities (which have been hard to find in recent years).

Despite fearmongering about the liquidity of large super funds in these extraordinary times, my conversations with super fund clients have been focused on the latter—tactical buying opportunities—not the risk of a debilitating run on funds and becoming a forced seller of equities. This suggests that, at least for these funds, liquidity is being well managed and will not be an issue.

Beyond the bargain-hunting opportunities for super funds (and other investors), there is a bigger opportunity available when bear markets hit—to give the whole equity portfolio itself a structural ‘makeover’.

As funds become larger and more sophisticated, they look to migrate their equity holdings from pooled investment funds housed in a legal trust structure (for example, ETFs and unlisted managed funds) across to separately managed accounts (discrete mandates) which give super funds direct ownership of the equities in their portfolios.

Pooled investment funds have their place as they are easy to use, ‘off-the-shelf’ ways to invest in equities. They shield the investor from much of the complexity and compliance burden of equity investing, which are instead borne by the product provider or pooled fund manager. But trends in the APRA-regulated super fund sector suggest funds are favouring more transparency, tax efficiency and customisation in equity investing.

The package of benefits that can be delivered in a separate account equity investment structure (with the right managers) but not through pooled funds includes:

  • specific ethical screens and values-driven investing
  • centralised portfolio management (CPM)
  • innovative fee structuring
  • tactical portfolio ‘tilting’
  • efficient transition management
  • after-tax investing
  • better assessment and management of portfolio risks, and
  • custom stakeholder reporting.

The window to restructuring a portfolio

Ironically, the strong returns on equities over the past decade (Australian, developed and emerging markets) have created a problem for super funds wanting to restructure their equity holdings—the capital gains tax liability they would incur in redeeming their investments from a pooled equity fund to seed a new separate account.

This kind of restructure can be done tax-free under US law, but not under Australian law, so beware literature from the US, which misleads Australian investors on this issue.

Consider a super fund wanting to transfer its $500 million equity portfolio from equity unit trust holdings into a separate account. The units have appreciated 25% since their acquisition, and 90% of the units are long-term holdings, with the remainder acquired in the past year. In isolation (and without tax-managing the transition), the fund faces a $10.5 million tax bill to restructure, or over 2% of portfolio value. While the restructure would deliver many benefits, the up-front tax bill is hard to swallow and a reason to delay the move and persist with what the fund believes is a sub-optimal structure.

Which brings us to the bear market conditions suddenly upon us. For super funds and others encumbered with ‘legacy’ investment structures and their embedded tax, now is an important window of opportunity for much more than just bargain-hunting—to re-cut the numbers to see just how much lower the tax cost of a move to their desired ‘future state’ for equity investing would be.

It is far more likely right now that the tax cost of a ‘portfolio makeover’ to move equities to a separate account structure would be immaterial or easily outweighed by the benefits. In our example above, the fund might even find that the current market value of its units in the equity trust has dipped below the original $400 million acquisition cost, which would actually deliver a windfall tax benefit if the fund seized the opportunity to restructure now.

While this ‘portfolio makeover’ opportunity represents a rare piece of good news for those navigating current market conditions, the cautionary lesson for super funds given the ASX bear market’s sudden, dramatic arrival is this: that predicting the market turnaround and speed and shape of the recovery (V-shape; U-shape; Nike ‘swoosh’?) will be fraught with difficulty.

The opportunity to not just find equity bargains, but migrate to a best-of-breed equity investment structure, is one to seize now, in case it vanishes just as fast.

 

Raewyn Williams is Managing Director of Research at Parametric Australia, a US-based investment adviser. This material is for general information only and does not consider the circumstances of any investor. Additional information is available at parametricportfolio.com.au.

 

4 Comments
David
April 24, 2020

I am a self funded retiree and I believe an intelligent individual. I understand the context of the article although I have had difficulty understanding a large amount of the terminology. As an example, "separate account equity investment structure", of the eight points I could relate (understand) two. The article has a number of similar statements. In my opinion the article could have been conveyed in much simpler terms.

Graham Hand
April 26, 2020

Hi David

We prefer to avoid articles which are too long, as readers are usually busy people. It is not always possible to explain concepts and terminology and some articles assume a level of knowledge. We have published over 3,000 articles and do not always repeat some earlier explanations.

For example, 'separately managed accounts' or similar have been covered a few times, such as:

https://www.firstlinks.com.au/top-three-ways-sma-helps-optimise-tax

https://www.firstlinks.com.au/four-drivers-growth-managed-accounts

https://www.firstlinks.com.au/5-flexible-features-managed-accounts

Raewyn has also provided other articles, as you can see by looking her up under 'Contributors'.

Jack
April 23, 2020

I agree this is a time for a clear out, but with my personal portfolio, what is especially disappointing is that many LICs which have been hopeless for years are now at even worse discounts.

Simon
April 25, 2020

If LICs were forced to offer a buyback at NTA say annually, there would be no discounts for very long. Unfortunately, it's like trying to squeeze blood out of a stone to get them to do that kind of shareholder friendly action.

 

Leave a Comment:

     

RELATED ARTICLES

A band-aid on a bullet wound

When is a share market sell-off really a crisis?

Four checks for a financial fire drill

banner

Most viewed in recent weeks

Stop treating the family home as a retirement sacred cow

The way home ownership relates to retirement income is rated a 'D', as in Distortion, Decumulation and Denial. For many, their home is their largest asset but it's least likely to be used for retirement income.

Two strong themes and companies that will benefit

There are reasons to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies should benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Welcome to Firstlinks Edition 433 with weekend update

There’s this story about a group of US Air Force generals in World War II who try to figure out ways to protect fighter bombers (and their crew) by examining the location of bullet holes on returning planes. Mapping the location of these holes, the generals quickly come to the conclusion that the areas with the most holes should be prioritised for additional armour.

  • 11 November 2021

Reducing the $5,300 upfront cost of financial advice

Many financial advisers have left the industry because it costs more to produce advice than is charged as an up-front fee. Advisers are valued by those who use them while the unadvised don’t see the need to pay.

Welcome to Firstlinks Edition 431 with weekend update

House prices have risen at the fastest pace for 33 years, but what actually happened in 1988, and why is 2021 different? Here's a clue: the stockmarket crashed 50% between September and November 1987. Looking ahead, where did house prices head in the following years, 1989 to 1991?

  • 28 October 2021

Why has Australia slipped down the global super ranks?

Australia appears to be slipping from the pantheon of global superstar pension systems, with a recent report placing us sixth. A review of an earlier report, which had Australia in bronze position, points to some reasons why, and what might need to happen to regain our former glory.

Latest Updates

Investment strategies

Are these the four most-costly words in investing?

A surprisingly high percentage of respondents believe 'This Time is Different'. They may be in for a tough time if history repeats as we have seen plenty of asset bubbles before. Do we have new rules for investing?

Investment strategies

100 tips from our readers for new investors

From the hundreds of survey responses, here is a selection of 100 tips, with others to come next week. There are consistent and new themes based on decades of experience making mistakes and enjoying successes.

Strategy

What should the next generation's Australia look like?

An unwanted fiscal drain will fall on generations of Australians who have seen their incomes and wealth stagnate, having missed the property boom and entered the workforce during a period of flatlining real wages.

Shares

Bank results scorecard and the gold star awards

The forecasts were wrong. In COVID, banks were expected to face falling house prices, high unemployment and a lending downturn. In the recovery, which banks are awarded gold stars based on the better performance?

Exchange traded products

In the beginning, there were LICs. Where are they now?

While the competing structure, ETFs, has increased in size far quicker in recent years, LICs remain an important part of the listed trust sector. There are differences between Traditional and Trading LICs.

Shares

Should you bank on the Westpac buy-back?

Westpac has sent out details of its buy-back and readers have asked for an explanation. It is not beneficial for all investors and whether this one works for some depends on where the bank sets the final price.

Investment strategies

Understanding the benefits of rebalancing

Whether they know it or not, most investors use of version of a Strategic Asset Allocation (SAA) to create an efficient portfolio mix of different asset classes, but the benefits of rebalancing are often overlooked.

Shares

Six stocks positioned well for a solid but volatile recovery

The rotation to economic recovery favouring value stocks continues but risks loom on the horizon. What lessons can be drawn from reporting season and what are the trends as inflation appears in parts of business?

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.