The cost of a standard Australian equity trade has risen by more than 10 basis points during the financial crisis, prompting super funds to think carefully about the way in which they rebalance portfolios. According to
State Street’s Transaction Cost Analysis, the average equity transaction cost in
Australia rose from 25 basis points in 2007 to 38 basis points in 2008. However the cost for a fund of not rebalancing could be even higher, according to Thomas Chevrier, head of research at State Street Associates, Asia-Pacific.
State Street recommends super funds “optimally rebalance” their portfolios amid market volatility to preserve portfolio value and create efficiencies. Chevrier said an Australian fund that was invested 60 per cent equities and 40 per cent bonds at the beginning of 2008, and did not rebalance, would have finished the year with the reverse allocation. “If you don’t rebalance, your allocation might get off track from your strategic asset allocation which your investment policy board dictates, and that has a cost – we call it the suboptimality cost,” he said.
“Maybe you’re taking on too much risk, or too little risk. Then if you rebalance, you face transaction costs, so we are boiling it down to two costs; transaction costs and suboptimality costs and it’s just a matter of looking at which one is the biggest.” Michael Putica, vice president, portfolio solutions group at
State Street Global Markets, said while transaction costs were typically easy to identify and calculate, suboptimality costs were potentially more difficult for funds to understand.
However Watson Wyatt has warned that before rebalancing, funds should first review the suitability of their existing strategic asset allocation following severely negative returns which have left many funds substantially underweight to risky assets. “Our view is that institutional funds should review their strategic policy before rebalancing, as we see a number of reasons why many funds might prefer a lower allocation to risky assets in the shortterm than their strategic policy suggests,” said Graeme Miller, head of investment consulting in
Australia at Watson Wyatt.
“While changing the choice of a strategic benchmark is not a decision to be made lightly, we think the economic, capital market and political environment is now very different to when most funds set their current strategic benchmarks. In particular, we believe that any review of strategy should include stress testing the behaviour of the portfolio in adverse circumstances.” According to Watson Wyatt’s Global Pension Assets Study, in the five years to 2008, equity allocations among the seven largest pension markets have fallen from around 51 per cent to 42 per cent, having reached a high of 60 per cent in 1998. A significant proportion of the fall took place last year.