Should pension fund investors take profits now?
With the Australian and US share markets more than 20 per cent higher than 12 months ago, will they rise further? Or is this week's pullback in the US markets a sign of things to come? Clearly the risks for investors are now much higher.
A spurt of optimism about the boost to the US economy from the Trump policies to cut company tax substantially and advance infrastructure spending is driving the US market. Even with the Federal Reserve raising interest rates, corporate profits and domestic investment will be boosted by lower company tax.
The uncertainties are when the lower tax rates will begin and whether the benefits of the policy changes are already reflected in current share prices. Other factors, including whether the rebound in commodity prices will be sustained, will influence the movement in Australian share prices.
The question of whether or not to take profits is now important especially for pension fund investors affected by the $1.6 million cap applying from July 1, 2017. Even though the legislation allows investors to avoid capital gains tax on assets forced to be moved into accumulation accounts, realising gains before the changes apply can have attractions.
The problem is that there's no way to replenish the pension account balance after July 1 if the fund assets fall in value after that date. The highest-risk situation for pension fund investors will be if asset prices are at high levels at June 30, 2017. The possibility of a subsequent fall in the value of the pension fund then increases.
Indeed, the higher the value of pension fund assets are at June 30, the more difficult it will be for retirees to ensure that their capped pension fund assets will be sufficient to fund a comfortable retirement. The main way to reduce this risk will be to restructure fund assets by taking profits before June 30 on assets that may be fully valued or likely to fluctuate in value.
Investing the pension fund in lower-risk assets has been made more difficult by the continuing low yields on cash and fixed-interest securities. The hunt for yield to pay minimum pension requirement has led to higher levels of investments in shares, property and alternative assets whose values can be volatile. The sustainability of future income streams will be crucial to portfolio composition discussions before the introduction of the changes.
Where substantial assets are involved, it can be beneficial to have separate funds to operate pension and accumulation accounts. This allows more flexibility in investment decisions, particularly with respect to protecting the pension fund from loss of capital.
The good news is that restructuring portfolios is facilitated by strong markets such as they are currently. Taking profits is much less painful than realising losses.