Are you good enough to run your SMSF?

PORTFOLIO POINT: How good or bad was your performance as an SMSF investment manager last year? The number to beat was 3.35%.

With money continuing to pour out of pooled superannuation funds into self-managed super fund accounts, there is obviously a growing view that running your own fund is the way to go.

There are now close to 470,000 SMSFs across the country, holding almost $420 billion in assets on behalf of around one million Australians. There’s no doubt that running your own fund gives you far greater investment flexibility but, let’s face it, do you really know what you’re doing? Are you good enough to win the investment race and generate decent returns?

The last financial year was living proof of the old adage “If you can’t beat them, join them”, because if your return was 3.35% or less you may as well do just that and stick your funds back into a pooled fund, or take a passive investment approach in your SMSF. That’s the average return that you could have got had you handed management of your SMSF’s investments to low-cost index funds, based on a “balanced” investment strategy for the 2011-12 financial year.

(SMSFs are not just about investments and many trustees use SMSFs for other reasons, including estate planning and holding particular investments, but investment returns are an important part your role as trustee.)

But, I’m afraid the odds are that you didn’t, if you’re a typical SMSF trustee. As Australian shares are generally the largest holding of most Australian SMSFs – and Eureka Report readers tend to be no exception – the year to June 30 is one that will have been disappointing for most.

If the Australian market hadn’t slumped in the last two months of the financial year, SMSF trustees would all have a little more spring in their step. However, Australian shares were the worst performing major asset class of the last 12 months (see below). International shares were the next worst. Property’s performance – domestic and global – straddled their long-term averages.

Financial year 2011-12 was, without doubt, a year where the cautious were rewarded. The more defensive you were, the better your SMSF’s returns would have been.

There were numbers in safety. Cash and fixed interest ruled the roost.

Eureka Report has had a strong focus in recent years on the diversification values of fixed interest as an asset class. And, to put it bluntly, if you didn’t have fixed interest in your portfolio for the year to June 30, 2012, your results would have been anaemic at best.

I’ve been writing this annual review column for a few years now (for the previous years, click here  and here, to show you the sort of returns that you should have been aiming for in your SMSF.

Below are the returns you could have achieved, if you had taken a passive approach to investment within your SMSF. Arguably, these are the figures you need to approximate, or beat, to justify your decision to run your own super. However, they don’t include platform fees charged by most non-SMSF providers.

As in previous years, I am using the returns of low-cost index fund provider Vanguard, whose wholesale managed funds charge fees of between 0.15% and 0.4% (and it has reduced its fees further from August this year) for its “wholesale” funds. The “average” active fund manager charges around 1%.

And the returns of the individual sector funds (after fees) were:

• Cash Reserve Fund: 4.5%
• Australian Fixed Interest: 12.13%
• International Fixed Interest (hedged): 11.52%
• Australian Property Securities: 10.67%
• International Property Securities (hedged): 6.79%
• Australian Shares: (-7.27%)
• International Shares (hedged): 0.28%

What proportion of these numbers you picked up depends on your asset allocation, which should be determined, in part, by your risk profile. (For a simple risk profiling tool, seach for the “risk profile questionnaire” at www.castellanfinancial.com.au .)

The following asset allocation table is the result of completing that risk profile.

Table 1: Asset allocation across risk profiles

Click to enlarge

As a SMSF trustee, you are the investment manager. You can choose to be overweight, or underweight, in any asset class you like. That’s your prerogative. The point of the above table is to give you an approximation of where your money would have been had you left it with your previous industry, government, corporate or retail fund.

So, if you plug in the performances for each asset class, what does that performance result come up with?

Amongst other things, it shows that a combination of Australian shares and cash would not have been a good combination this year. As in the last two years, with cash having a return of 4.5% and Australian shares returning (-7.23%), those who have only cash and Australian shares would have likely finished up with a negative return.

Table 2: Returns from risk-profiled returns

Click to enlarge

*The percentages in these tables under the various asset classes are the weighted returns, based on the weightings in Table 1. For fixed interest and property, the weightings were 60% Australian and 40% international.

For the third year in succession, the mantra of proper diversification would have added to your returns.

Having international shares in your portfolio would have added to your overall performance. Though international only managed to eke out a positive return of 0.28%, it would have helped to balance out the impact of the negative return from Australian shares.

But speaking of three-year returns, I’ve compiled the list of returns for three years also.

And the returns of the individual sector funds (after fees) were:

• Cash Reserve Fund: 4.34%
• Australian Fixed Interest: 8.35%
• International Fixed Interest (hedged): 8.63%
• Australian Property Securities: 11.92%
• International Property Securities (hedged): 27.31%
• Australian Shares: 5.28%
• International Shares (hedged): 13.03%

Over three years, you have been missing serious returns by not being diversified internationally, particularly in the areas of shares and property. International property has returned more than 27% compound over the three years to June 30. International property has doubled over that time.

Plugged into the same asset allocation table, you get the following results for the various risk profiles.

Table 3: Three-year risk profile performances

Click to enlarge

And looking at average three-year returns of around 9% puts the performance of last year with Australian equities into perspective.

But that’s not to say that anyone should automatically pile into international assets now. In fact, for anyone with a contrarian bone in their body, it could be argued you should be doing the opposite of that.

I’m a bit contrarian by nature. While I’m glad I’ve had weightings to international shares in recent years, I will personally be overweight Australian shares in my equities allocation for the foreseeable future within my SMSF. (But that’s not a recommendation for you – you should seek advice tailored to your personal situation.)

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are highly complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking.

• Generational differences make a big impact on the attitudes, priorities and aspirations of self-managed super fund investors, according to a new report from Macquarie Bank and the SMSF Professionals Association of Australia (SPAA). The report found that while investors of all ages and generational groups share the same reasons for starting an SMSF – more control and choice over investments – the needs of different groups for advice and services vary greatly. SPAA chief executive Andrea Slattery said SMSF investors are highly engaged with super and want their funds to perform well. “As this report has shown, the advice industry can make their role even more effective by tailoring their approach to the stage of life the investor is in,” she said.
• The ‘SMSF Generations Report’ also found evidence self-managed super balances might not be as overweight in cash as previously thought. Macquarie Adviser Services director Gary Lembit discussed the findings of the report at the 2012 SPAA State Technical Conference in Melbourne today, and said there was a high level of seasonality to cash holdings in SMSFs. “[The data] shows how misleading it is to take a cash reading at June 30. It helps us to dispel some of the myths that super funds are overweight cash,” he said. He said the variability was due to the high number of small business owners with SMSFs, and the tendency for cash to come “in big lumps at odd times of the year” for those investors.
• Cash allocations in self-managed funds are generally growing, however, according to the recent Multiport SMSF Investment Patterns survey. Cash holdings – which include both term deposits and ‘true’ cash – increased by almost 4% in the June quarter to 26.8% of overall allocations, up from 22.8% in June 2011. The survey also found a decline in the use of managed funds, consistent with a similar finding in the SMSF Generations report. In equities, holdings of Australian shares decreased from 39% in June 2011, to 35.8% in the most recent quarter, and found the most commonly held company by dollars invested was Fortescue Metals Group. This was followed by BHP, Westpac, Commonwealth Bank, ANZ and NAB, which are also the top five index constituents by market cap.
• Half of Australia’s Baby Boomers expect to run out of money in their retirement, according to RaboDirect. The online bank’s savings and debt barometer found the generation expects to retire with about $400,000 in super, or half of what they needed. Rabo’s Renee Amor said more needed to be done to address the shortfall. “Our most recent barometer shows that even if baby boomers doubled their superannuation balance between now and retirement, they would still only have approximately half of what they need,” she said.
• Many SMSFs may be under-claiming valuable tax deductions, according to SPAA. Technical director Peter Burgess said recent discussions suggested many SMSF trustees were not taking advantage of legal tax deductions. He explained these related to the proportion of a general administration expense that is attributable to gaining or producing the fund’s assessable income, which was affected by an Australian Taxation Office decision in May. The amount of tax saved could be in the hundreds of dollars per year for funds in certain situations, and Burgess said SPAA urged people to check tax calculations programs and processes to ensure deductions were claimed.