Interest rate rises fuel market volatility

Interest rates are up, investment returns are down

Despite hopes central banks would pause or reverse interest rate hikes, continued high inflation has reaffirmed their commitment to battle the rising cost of living.

Between July-September 2022, the Reserve Bank of Australia raised interest rates by 0.5% three times. This was followed by another rise of 0.25% this month (October).

In the US, the Federal Open Markets Committee met twice, raising interest rates by 0.75% on both occasions.

Apart from putting more pressure on mortgage repayments across Australian households, interest rate hikes have also negatively affected share prices due to the increase in the cost of business and reduced value of cash flows.

The global share market index (hedged in Australian dollars) returned minus 9.01% in September and minus 5.57% for the quarter.

Fixed interest assets have also seen negative returns, despite being considered a ‘safe haven’ asset when equity markets sell off.

This is because lower interest rates increase the market price of fixed interest securities, and central banks have historically lowered interest rates to support the economy when share markets have declined.

However, this year, central banks have been forced to continue to increase interest rates to fight inflation, resulting in negative returns for the fixed interest asset class.

As a result, the fixed interest global index (hedged in Australian dollars) returned minus 3.5% in September and minus 3.87% across the quarter.

Market volatility and your super

We invest your super to help it grow throughout your working life. Like most other investment types, your super balance will fluctuate based on market-wide forces, including market volatility.

How much volatility affects your super largely depends on how much of your super balance is invested in growth assets, such as shares.

For example, if you’re invested in our Growth option, then history suggests you might expect higher returns (on average) over the long-term but are likely to experience more short-term market volatility compared with our Conservative option.

Put simply, the more you have in ‘higher-risk’ investment options (such as our Growth and Shares), the more market volatility will impact the value of your super on a day-to-day basis.

As always, which investment option you should be in depends on how long your super will be invested, your goals, and your risk appetite.

Our quarterly performance

Following the drawdowns in September, most of our investment options were down for this quarter.

Our Balanced (MySuper) option returned minus 0.56% for the quarter, compared with minus 0.38% for the Conservative option.

While short-term negative returns are disappointing, it’s important to remember that super is a long-term investment.

Over the last ten years, our Balanced (MySuper) option has returned an average of 7.61% per year.

Given the persistence of recent market volatility, we’re confident our investment strategy is well placed to continue growing and protecting your super in the medium to long term.

How we grow and protect your super during volatility

In financial markets, the price of a share or fixed interest security is the value a buyer and seller agree upon before exchanging the asset.

In this sense, there is no ‘fixed’ price for a share or fixed interest security. The price will change depending on what the buyer or seller thinks about the asset’s prospects based on public information.

So, a buyer won’t pay a higher price for a share if there’s public knowledge of bad news ahead, such as an expected interest rate increase. This means the asset’s fair value (the share price) will drop. Importantly, this happens before the expected bad news is actually announced.

Because prices change based on new information, the right time to de-risk portfolios is rarely after the release of bad news. Instead, investors need to be forward-looking and reposition the portfolio before such developments.

In times of significant economic uncertainty (like this year), market expectations change rapidly. This means prices are highly volatile.

To ensure we can continue growing and protecting your super, we have two strategies to manage volatility: diversification using alternatives and active investment management.

Our first approach is to diversify across a range of asset classes that have different exposures to risks, such as inflation and interest rates.

Our pre-mixed investment options have allocations beyond a simple combination of shares and fixed interest. They also include alternative asset classes that have performed relatively well across 2022, such as infrastructure, direct lending, private equity and property.

To demonstrate the benefits of broad diversification, the graph below shows a 12-moth comparison between our diversified Balanced option and a classic ‘60/40’ portfolio, which invests 60% in equity and 40% in fixed interest.

The 60/40 approach has long been adopted as a simple but effective way to diversify risk exposures to manage retirement accounts. However, it has sustained more than triple the losses of our Balanced option across the last year.

Our second approach is active investing, which involves applying a forward-looking risk management process to actively reposition the portfolio.

Over the last six months, we’ve been doing this to position the portfolio more defensively than its strategic asset allocation.

Some steps we have taken induce:

• Reducing exposure to emerging market shares, which tend to be more sensitive to economic downturns, particularly when the US dollar is strong.
• Putting in place an underweight to developed market shares relative to our strategic asset allocation benchmark.
• Further reducing our exposure to international credit risk.
• Reducing our exposure to interest rate risk through a ‘short duration’ tilt in our fixed interest portfolio.
• Redeeming our investments from risky hedge funds and reallocating the funds to more defensive asset classes.
• Significantly increasing our allocation to cash to strengthen our liquidity position and provide the opportunity to exploit any market dislocations that arise.

By repositioning and de-risking our portfolio, we can better protect your super saving and position ourselves to take advantage when markets start to stabilise or recover.

Worried about your super?

It is natural to feel uneasy when interest rates rise and volatility is high. That's why we're here to help.

If you're thinking about switching investment options or are unsure which option is best for you, please get in touch.

You can also book a one-on-one chat with an expert Superannuation Adviser. They can offer helpful, straightforward advice to ensure your super is working for your situation. This service comes at no additional cost – it's part of being a Spirit Super member.

To get in touch or book an appointment, call 1800 005 166 or submit an online enquiry.

Past performance isn’t a reliable indicator of future performance.