There is no standard definition of what is a growth asset and what is a defensive asset. This makes it hard for investors to understand the risk they may be exposed to before investing, and hard to compare returns amongst investments of a similar risk. What’s your understanding?
There is a growing array of investments available to SMSF trustees. To make it easier to understand what you are getting into, it can help to start with a fundamental truth.
Investment returns can only ever come to you as income and/or growth (a positive or negative change in value).
To manage risk, many SMSF trustees aim to invest with a combination of growth and defensive assets, across things that are not highly correlated.
Here’s my definition, and I invite discussion. If the main source of returns from an asset is income, it is a defensive asset. Otherwise it’s a growth asset.
Many share investors define defensive assets as “high-yielding or blue chip shares”, and growth assets as “other types of shares.”
In my opinion, this is overlooking the fact that there is a high correlation between these two groups of shares. When the share market suffers a correction, most shares are likely to fall, even though the dividends may continue.
It would be better to define those distinct groups as “Australian defensive Shares” and “Australian growth shares”, to distinguish them from genuinely Defensive assets such as government bonds or term deposits.
Let’s consider some other asset classes, and see if you think they are growth or defensive assets.
Fixed Interest. A fixed interest investment is one where you loan your money to someone (generally a person, a bank, a government or a company). A term deposit is one type of fixed interest investment where your returns come from income only, but the term “fixed interest” confuses many investors, as it sounds as though your capital is fixed – as in “it can’t go backwards in value”.
Although government bonds, corporate notes and debentures have the potential for an increase or decrease in value, the likelihood of significant change is rare, unless you are talking about junk bonds (high risk/high return corporate debt).
The source of their returns is mainly from income, so Fixed Interest should be considered a defensive asset.
Infrastructure. An investment in infrastructure, such as a tollway, has the potential for income. It is also much more common for there to be significant losses or gains in value in this sector.
As returns come from both income and growth, Infrastructure should be treated as a growth asset.
Hedge Funds. Also known as absolute return funds, hedge funds aim to deliver positive returns whether the share market is rising or falling, though a combination of income and growth. Therefore, Hedge Funds should be treated as a Growth asset.
Nick Shugg is the chief executive of SMSF Benchmarks, an on-line service designed to give SMSF trustees better information about how their fund is going. He has worked in the finance industry for 30 years, including as an adviser for 19 of these years.