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

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.

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

“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

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

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.


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