Along with his good news for shareholders in last week’s CBA interim report, chief executive Ian Narev gave some additional views that could cause SMSF investors to pause.
In an interview with the AFR’s Chanticleer columnist (Tony Boyd), Narev said the biggest threat to CBA’s booming results were several “known unknowns” – essentially things which we know about, but which we don’t know when or if they might occur.
He said these included: a freeze of global funding markets; a significant slow down in China; stagflation in Australia and the bursting of the housing bubble. While he dismissed the prospect of these events, he disclosed that the CBA had run a stress test, which showed that it could survive a scenario that included unemployment almost doubling to 11.5% and house prices collapsing by a third.
Even if the CBA could survive such a scenario, other institutions and investors might not, especially if it was accompanied by rising interest rates.
Could disaster happen?
Pessimists who believe in reversion to the mean say it’s inevitable that there could be a nasty end to the growth in China and housing prices. Optimists hope they’re wrong and that markets continue to behave.
But there’s something called sequencing risk – a fancy term for losing money at the most inopportune time, such as when retirement investments are at their peak after a lifetime of saving. With more and more SMSFs paying pensions, trustees need to do an occasional stress test on their portfolios to see whether funds in pension mode need a different strategy to accumulation portfolios (where members may have decades left before retirement, allowing them to take a more risky approach).
Like the banks, perhaps investors also should consider the potential effect on their portfolios from events like a housing bubble bursting or China fizzling out. They may believe these scenarios are unlikely. They may conclude they can’t escape the full effects of such a disaster. They might rely on the undoubted strength and reputation of Australia’s Big Four banks. But, whatever their exposure to the banks, they still might consider their overall asset diversification policies.
The housing market – whether it is a boom or a bubble – depends on interest rates, employment levels, consumer confidence and the availability of funds from lenders. It now also relies on strong demand from Chinese buyers. Clearly, the government would be loath to see banks raise home loan rates or slow down housing lending. But at some stage, if inflation starts rising, this could involve a tricky balance of interest rate policies.
Run the stress test
Investors’ traditional answer to such uncertainties is diversification – as long as we don’t see a crisis like the GFC, which briefly affected most assets.
Bonds and fixed interest securities produce capital losses when interest rates are rising. Equities and property aren’t always a guarantee (especially if financed by loans) and holders need to be prepared for potential large (if temporary) capital losses.
Cash is a safe haven in the short term, but anything other than short-term inflation can wreak havoc with pensions’ purchasing power. For absolute safety, inflation-linked government bonds – currently offering a real return of some 1.7 percentage points above inflation over 10-years-plus – may be a solution outside the box.
The bottom line is that sometimes there are few places to hide if things go bad, and the difficulty in timing a move into a complete ‘safety first’ setting will deter most investors from making drastic changes.
But that doesn’t mean investors, like the banks, shouldn‘t spend some time asking those “what if” questions – even if they decide to continue with a slightly modified version of their current policy of relying on bank securities and deposits.
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