Glossary

 

SMSF Glossary of Terms

library-488677_640This SMSF Glossary of Terms is designed to help Self Managed Super Fund (SMSF) investors gain a better understanding of the terms commonly used in Investment performance measurement and benchmarking. Many of the terms will be found throughout our site.

 

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Accruals

An accrual is an allowance for income earned but not yet received at a point in time, and  expenses incurred but not yet paid.

See also: Treatment of accruals.

Adaptive Asset Allocation (AAA) approach

An Adaptive Asset Allocation (AAA) approach is one where the investor makes a deliberate decision not to set any Target Asset Allocation for their fund.

Investors using this approach follow perceived investment opportunities, without any regard for asset allocation.

See also: Strategic Asset Allocation (SAA) approach,
and Tactical Asset Allocation (TAA) approach.

Asset

An asset is something a fund owns, or partially owns.

This can include a debt which is owed to a fund, in certain circumstances.

If fund assets have been used to purchase a property via a trust structure, then the property, or the portion owned by the fund, should be included as an asset of the fund.

Note: Any corresponding debt owed by the fund would be treated as a liability.

Asset Allocation

A fund’s Asset Allocation is the level of exposure to each of the Asset Classes.

Asset Allocation approach

In the same way that there are different investment approaches available to investors,  there are also different Asset Allocation approaches.

A fund’s Asset Allocation approach is a 1st order decision about whether to attempt to stick to a neutral asset allocation, or whether to simply follow perceived investment opportunities without consideration of asset allocation.

Two approaches to asset allocation, which are at opposite ends of the spectrum, are the Strategic Asset Allocation (SAA) approach and the Adaptive Asset Allocation (AAA) approach.

To know which group of SMSFs to compare against over a measurement period, it is necessary to know whether the fund was using an SAA approach, a TAA approach or a AAA approach during the period, and if the asset allocation approach changed during the period.

Asset Classes

Asset Classes are broad categories of investment types.

These are typically broken down into Australian Shares, International shares, listed property (property trusts listed on a stock exchange), direct property, Australian fixed interest, International fixed interest, Cash and “Other”.

“Other” may include Infrastructure, hedge funds, and some of the less common holdings in a SMSF such as Art, wine, or taxi licences.

See also: Sub-asset Classes

Asset Weighting

See Asset Allocation.

Balanced Funds

A fund that combines components of Australian shares, International shares, property,  fixed interest and cash as well as other types of investments in a single portfolio. Generally, these funds stick to a target asset allocation.

Note: The term “Balanced fund” is really a marketing term. There is no fixed definition of what mix of asset classes a Balanced Fund should have. Typically they have 60 – 70% in Growth assets, but some Industry funds actually have around 85%.

This makes comparisons of performance between “Balanced funds” somewhat problematic.

The industry would be better served to create uniform terminology such as G60, or G80 to indicate 60% Growth assets, or 80% Growth assets respectively, to help investors better understand what they are investing in. To date, this has not happened.

Benchmark

A Benchmark is a standard or point of reference against which things may be compared or assessed.

Benchmark Portfolios

A Benchmark Portfolio is a hypothetical investment portfolio against which other portfolios may be compared or assessed.

For example, if a fund consisted of 100% Australian shares, over a period, then it may be appropriate to use a benchmark of the top 300 Australian shares, for that period.

Even if the fund actually only held shares in the top 10 companies, they had the option to choose any of the top 300, so it could be argued that their decision to only invest in the top 10 will be a reason for any out-performance or under-performance compared with a  benchmark consisting  of the top 300.

Similarly, if a fund consisted of a specific proportion of various asset classes during a period, we could use the same proportion of the various indicies relating to each asset class, to form an appropriate Benchmark portfolio.

The return of a benchmark portfolio over a period, is the return from the composite of the indicies over the measurement period.

The return of a benchmark portfolio is the return that investors, taking that level of Asset Allocation risk, were entitled to.

Benchmarking

The action of comparing or measuring something against an “appropriate” benchmark.

The key word is “appropriate”.

Example: A fund which contained 60% Growth assets for 2 years and 6 months, before increasing to 100% shares in the next 6 months, should not be benchmarked against a share market index over 3 years, just because that was the asset allocation at the end of
the 3 year period.

Cash

We will define cash as bank deposits of up to 90 days.

Cash Plus

A Cash Plus fund is a managed fund which invests mainly in genuine fixed interest investments, but with some other riskier investments such as mortgages,shares or property, with the aim of delivering a higher return than cash.

Cash-flow

The transfer of value into or out of a portfolio. By convention, an inflow is considered as positive, and an outflow as negative flow.

Defensive assets

For the purpose of designing benchmarks for SMSFs, we will define Defensive Assets as those assets which are held solely in cash and genuine Fixed Interest investments.

Exchange Traded Fund

A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold.

External cash flow

When considering a total portfolio, an external cash flow is a flow of cash and/or securities (capital additions or withdrawals) that is investor initiated. Examples of external cash flow are contributions and withdrawals. Expense payments and taxes are also considered as external cash flow.

Fixed Interest

A fixed interest investment is one where the return on capital comes mainly from income. Although there can be variability in the value of the investment in the short term, there is little chance of “equity like” volatility or default. Examples of Genuine Fixed interest
include: Government Bonds, Debentures and Corporate notes.

There is a secondary market for most fixed interest investments, and it is possible for such investments to reduce in value over a period.

Hence, it could be argued that the term Fixed Interest is an unsatisfactory term, as it leads many investors to think that their initial capital value is fixed – ie/ cannot be reduced.

Fixed Interest funds

A “Fixed interest fund” is a managed fund which invests in various types of fixed interest investments.

Fund Balance

The fund balance at a point in time is the net Assets of the fund at that time. That is – gross assets less liabilities, such as property loans.

Gearing

Gearing refers to an investment loan taken by the fund to purchase an asset such as direct property.

The Gearing level (%) is equal to the Loan Value ($) / Gross assets ($) at a point in time.

Growth Assets

For the purpose of creating benchmark portfolios for SMSFs we will define Growth Assets as:

“Everything apart from Defensive assets.”

Note:  We will include hybrids, infrastructure, hedge funds, and preference shares as Growth Assets. As the source of income from these investments are from both income and growth, there is some “equity like” risk associated with these investments at times.

Gross Assets

A fund’s Gross Assets at a point in time is the total value of all the assets, using the valuations in the last set of accounts, or any more recent market valuations if available, before subtracting any loans (liabilities).

Growth funds

A managed fund that combines components of Australian shares, International shares, property,  fixed interest and cash as well as other types of investments in a single portfolio. Generally, these funds stick to a target asset allocation that reflects a higher exposure to “Growth assets” than a Balanced fund.

Note: The term “Growth fund” is really a marketing term. There is no fixed definition of what mix of asset classes a Growth Fund should have. Typically they have around 80% in Growth assets, but some have 100%.

This makes comparisons of performance between “Growth funds” somewhat problematic. It is similar for Balanced funds.

The industry would be better served to create uniform terminology such as G60, or G80 to indicate 60% Growth assets, or 80% Growth assets respectively, to help investors better understand what they are investing in. To date, this has not happened.

Hedge funds

An aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark).

Hedge funds tend to use an Adaptive Asset Allocation approach. Unlike a Balanced fund, they have no mandate to stick to a target asset allocation, and they are free to pursue perceived opportunities as they arise.

The term “Hedge” here should not be confused with  “Currency Hedging”.

Hedging

Hedging refers to “Currency Hedging”. It is a risk management strategy which reduces the impact of currency movements on international shares or bonds.

Note: It is common for fund managers to offer both a hedged and an un-hedged option with their international share funds. They can experience very different returns at times.

Holding

A Holding is a fund asset. It is a specific investment, such as Shares in BHP, or a term deposit with NAB.

Hybrids

A single financial security that combines two or more different financial instruments. Hybrid securities, often referred to as “hybrids,” generally combine both debt and equity characteristics. The most common type of hybrid security is a convertible bond that has features of an ordinary bond but is heavily influenced by the price movements of the stock into which it is convertible.

Income

The cash flow generated from the assets in the fund.

Index

An Index is a hypothetical portfolio consisting of all the holdings in a particular asset class, or sub-asset class.

For example, the S&P/ASX 200 consists of the largest 200 companies listed on the Australian Sharemarket.

Index Fund

An Index fund is a managed fund with a mandate to attempt to deliver the returns of a particular asset class or sub-asset class.

To do this, fund assets are invested across all holdings which make up the Index, and the fund managers have to track the changes in the underlying constituents of the index.

Infrastucture

The basic physical and organizational structures and facilities (e.g. buildings, roads, power supplies) needed for the operation of a society or enterprise.

Large Superannuation funds would typically invest a portion of their funds in Infrastructure. However there is no industry conformity about whether funds should treat infrastructure as a Growth asset or a Defensive asset.

Infrastructure is largely an income producing asset, but at times can experience equity-like volatility.

Internal Cash flow

All cash flow that is not external cash flow. Examples of internal cash flow are portfolio transactions such as purchases and/or sale of assets, and income received from assets.

Investment Approach

An “Investment Approach” is the way a trustee chooses to access the various asset classes.

For example, a trustee who wishes to invest in Australian shares may choose to:

  • Select individual shares, and regularly turnover their portfolio;
  • Select individual shares and maintain their portfolio for some time;
  • Select shares on the basis of income and franking credits only;
  • Purchase a relevant Exchange Traded Fund.

 


Liability

A liability is an amount owed by the fund where the debt is associated with fund assets.

For example, if you have used fund assets to purchase a property via a trust linked to your fund, then a proportion of any borrowings associated with that property should be considered a liability of the fund, and a proportion of the property would be considered an asset of the fund.

See also: Treatment of Accruals.

Market Value

The Market Value of a holding is the most recent value of that holding.

If a holding is listed on an exchange, such as the Australian Stock Exchange, market values are readily available.

If a holding is not listed, such as with a direct property, the market value should be taken as the most recent valuation available. This will be the value in the most recent accounts for your fund, or any valuation which has been received since the last accounts were prepared.

Median Asset
Allocation

Each month, the asset allocation of a fund may vary.

By measuring the asset allocation which applied each month, the median asset allocation which applied over longer measurement periods can be calculated for each fund.

Measurement Period

A measurement period is any length of time, from a start date to an end date.

In the calculation of returns it is important to be clear about the measurement period which the return relates to.

Example: The return
for the 12 month period ending on 31 March 2008 may be quite different to the return for the 12 month period ending 30 April 2008.

Money Weighted rate
of return (MWR)

Also referred to as the Internal Rate of Return (IRR) or the  Dollar Weighted Rate of Return. This is used to measure the performance of a fund taking into account external cash flows.

This method is useful when looking at the return of a fund in isolation, however there are limitations in using MWR returns for any comparisons against other funds, or against any benchmark.

As the money-weighted rate of return factors in all cash flows, including contributions and withdrawals, the formula places a greater weight on the performance in periods when the account size is highest (hence the term “Money-Weighted”).

This would hardly lead to a meaningful comparison as a fund may have its best results at a time when the account balance was lower, and another fund would have different cash flow timing.

In order to compare returns, the impact of external cash-flows must be removed– by using a Time Weighted Rate of return (TWR).

Net Assets

A fund’s Net Assets at a point in time is the Gross Assets LESS the Liabilities.

Any comparison of fund balances must be done using Net Assets to be meaningful.

This is especially true where fund assets are used to purchase direct property through a trust, and a loan is also taken to partially fund the purchase.

Performance

Performance is a function of both risk and return. For example in a year where the share markets have had a good run, a fund with 80% shares in it would be expected to out-perform a fund with 30% shares.

To know whether a fund performed well, you would need to compare its total return over a measurement period with other funds which had a broadly similar asset allocation over the period (one measure of risk).




Rate

A measure of the change of a quantity over a time unit.

Example: 10% per year ( ie 10% per annum, or as commonly expressed, 10% pa).

Rate of Return

The return of an investment expressed as a time unit.

By convention, if the measurement period is longer than 1 year, then the rate of return is expressed as yearly (annualized), and for measurement periods less than 1 year are not annualized.

Rebalancing

“Rebalancing” a portfolio is where a trustee, who uses a Strategic Asset Allocation (SAA) approach, changes some investments in order to get the asset weighting back in line with their Neutral Asset Allocation.

For example, after the share market has gone up over a period, a fund may be over-exposed to Growth assets.

The trustee using an SAA approach will “rebalance” the portfolio back to their desired asset weighting, by moving some funds from shares to fixed interest, or cash.

Similarly, if the share market has gone down over a period, the fund will be under-exposed to Growth assets, and the trustee using an SAA approach will re-balance the portfolio back to their Neutral Asset Allocation, by moving some funds out of cash or fixed interest, and back into shares.

Return

The return of an investment, portfolio or fund refers to the change in wealth created by holding the investment, portfolio or fund over that measurement period.

NB: Unless stated
otherwise, throughout our website and reports we will use the term “return” to mean the return for a Self-Managed fund on the whole, as opposed to returns for a share portfolio within the SMSF, for example.

There are several ways of calculating a return, and these must be understood when comparing investment returns.

See also: Money Weighted Rate of return (WMR) and Time Weighted Rate of return (TWR).

Risk Free rate of return

We will define the Risk Free rate of return over a period as the return available if a fund had invested all its assets in cash of up to a 90 day duration.

Risk

There are many types of risk when it comes to investments and Superannuation, not the least of which are legislation risk and compliance risk. However, our reports will initially focus on 2 types of risk: Asset Allocation risk and Gearing risk.

Asset Allocation risk

Growth assets tend to be more volatile and have a higher probability of permanent loss of capital compared with Defensive assets.

Asset Allocation risk refers to the proportion of Growth assets held by a fund.

When comparing the level of risk between funds, a fund with a higher exposure to Growth assets during a period has taken more risk than a fund with a lower exposure to Growth assets.

To compare performance of funds over a measurement period, it can be instructive to plot the return against the level of Asset Allocation risk taken.

Gearing Risk

When gearing (an investment loan) is used, the gains are magnified in the good years and the losses are magnified in the bad years. A fund using gearing could experience more volatility and even permanent losses in some cases. A fund with a higher level of gearing (%) has a higher level of risk.

Similar Funds

We define Similar Funds as funds which invested in a similar way to each other over a period.

This is measured as funds which had the same median asset allocation, over a period as each other. For example, in a particular  onth, if 60% of a fund was in Growth assets it can be instructive to compare returns against other funds which took the same level of Asset Allocation risk in that month.

Extend the same example to a 5 year period. The neutral asset allocation and indeed the actual asset allocation of the fund may vary during the 5 year period. The only way a fund can really compare its performance against other similar funds, is to compare against other funds with the same median asset allocation over the measurement period.

SMSF

A Self-Managed Superannuation Fund (SMSF) refers to a Superannuation fund with no more than 4 members and where all members are trustees or directors of the trustee company. All members in an SMSF are legally responsible for the management of the fund.

The regulatory body in charge of SMSFs is the Australian Taxation Office (ATO). Their role is to ensure that SMSFs comply with all the rules as laid down by the Government in the Superannuation Industry Supervision (SIS) Act and SIS Regulations.

SMSF Benchmark Portfolios

SMSF Benchmark Portfolios are benchmark portfolios which we have specifically designed for Self-Managed super funds, based on the way they are actually investing, according to ATO Statistical reports.

We have designed 11 SMSF Benchmark Portfolios and have used the following terminology:

“SMSF 20” means an SMSF Benchmark Portfolio with 20% in Growth assets;

“SMSF 60” means an SMSF Benchmark Portfolio with 60% in Growth assets; and so on.

The exceptions are SMSF P1 and SMSF P2.

SMSF P1 means an SMSF Benchmark Portfolio which has holds some direct property  as part of a diversified portfolio, along with shares and cash.

SMSF P2 means an SMSF Benchmark Portfolio where virtually 100% of the fund consists of direct property.

Strategic Asset Allocation (SAA) approach

A Strategic Asset Allocation (SAA) approach is one where trustees set an objective to maintain a specific asset weighting, as a “Neutral” position ( target asset allocation).

A trustee may specify a range for their asset weighting, and the actual asset weighting may oscillate around their Target Asset Allocation, but will not usually significantly vary from it.

Under this approach a trustee makes a decision to regularly rebalance their portfolio back to a particular asset weighting, primarily for risk management purposes, but the approach can also lead to increased returns at times.

Trustees using a SAA approach are deliberately not attempting to add value by predicting which asset class is about to perform well.

Sub-Asset Classes

A Sub- Asset Class is a sub-set of an Asset Class.

For example Australian Small companies and Australian Value companies are sub-sets of Australian Equities.

Tactical Asset Allocation (TAA) approach

An investor using a Tactical Asset Allocation (TAA) approach sets a target asset allocation, but from time to time makes tactical decisions to be deliberately over-weight or under-weight growth assets for a period.

This tactical decision will be one reason for any out-performance or under-performance, compared with other funds and  their customised benchmark.

 

Target Asset Allocation

Investors using a Strategic Asset Allocation (SAA) approach or a Tactical Asset Allocation  (TAA) approach choose a “target” asset allocation, based on how much risk they need to  take to meet objectives, and how much risk they are comfortable to take.

At times, the fund’s actual asset allocation will have a higher exposure to Growth assets, and at times a lower exposure to Growth assets, but the exposure to Growth assets will  tend to vary around this “target” position.

Time Unit

The time unit is any period or interval of time that has been selected for the purpose of the financial calculation to be carried out.

The selection of a suitable time unit is important as it can impact on the way a calculation is carried out.

Common time units are monthly, quarterly, half-yearly, yearly, 3 years and 5 years.

Time Weighted rate of return (TWR)

A Time Weighted rate of Return is a method of calculating the return over a period which reduces the impact of external cash flows. Any comparison between funds should be done on a Time Weighted Return basis.

For Time Weighted return measurement, the total period to be measured is broken into many sub-periods, which can cover any length of time and need not be uniform.

Note: Our methodology is to use monthly returns, and use geometric linking to calculate returns over longer measurement periods.

Total Return

The rate of return for the fund, over the measurement period, which includes the realised and unrealised gains and losses, income earned, expenses paid and interest incurred on loans.

Treatment of Accruals

Our primary objective is to allow subscribers to make a fair comparison of how they are going compared with other Self-Managed Funds.

Technically, in calculating fund valuations and returns, an allowance could be made for accruals, but as we are dealing with SMSF investors, and not professional fund managers, we are concerned that members would not use a consistent treatment of accruals, which could lead to unfair comparisons.

Therefore, in the interests of creating fair comparisons, we will not allow for accruals in our calculations of returns.

 






Valuation

The fund valuation (or balance) at a point in time is the net assets of the fund.

Gross valuations are used to calculate gearing levels.