Guarding super's panic button

PORTFOLIO POINT: As an SMSF trustee, super investment risk is ultimately within your control, but you need to be prepared to shift in and out of asset classes.

Using extreme examples to try to prove a point rarely does anyone any favours.

Former Treasury Secretary Dr Ken Henry’s comments about super last week were a clear demonstration of the above.

Dr Henry, author of the government’s Henry Tax Review (released in 2010) and now a government adviser and director of National Australia Bank, last week stated that a 59-year-old in 2007 considering retirement would have lost nearly 50% of their super by the time they retired a year later, if they had been invested in a “high growth” super fund.

That’s undeniably true and anyone with a vague interest in super knows that.

But everyone in “all growth” funds (super or non-super) would have lost about half of their money by the time the market bottomed in March 2009, as growth assets (shares and property) slumped globally.

The 59-year-old wouldn’t be alone. Here are some other examples of people who would have done equally poorly over the same period:

• A 29-year-old who had invested $20,000 in the stockmarket would have seen their money shrink to $10,000;
• A 44-year-old who invested $100,000 into a high-growth fund would have ended up with $50,000;
• In the Dr Henry example, a 59-year-old who had $300,000 in super would have had a fund worth $150,000 the next year; and
• A 74-year-old who had their last $150,000 in a super pension would only have had $75,000 a year later.

Are these four options of equal weight in terms of disasters? Absolutely not.

Of these four examples, which ones are a concern?

It matters little that the 29-year-old has lost $10,000. He’s lost roughly a couple of months’ salary. The 44-year-old has lost $50,000, but she’s in the peak earning period of her life and has time to make it back. (The great disaster would be if the experience scared her off investing for life.)

Obviously, Dr Henry’s 59-year-old has been seriously impacted. But the same question applies: what were they doing with all of their money in high-growth assets if they were considering retiring in a year? This situation should also be rare and would only happen by (potentially uninformed) choice on behalf of the member, or potentially bad advice.

Regarding the 74-year-old, you’d have to question how many people would be in this position. It should be extremely rare.

Risk and proximity to retirement is an important concept to grasp. It’s one that SMSF trustees are probably more aware of than the broader community, but is still requires constant revision.

The closer you are to retirement and the more you’ve built up in super, the less you should be risking on a plunge in markets. Shares and property, which are considered growth assets, are the two most volatile investment markets.

Cash and fixed interest are “defensive” assets. Fixed interest has a capital component and can move around with the strength of the economy/government/company, but tends to move around a lot less than shares and property.

The older you get, so investment theory goes, the less you should have invested in shares and property. One theory states that whatever your age, that’s the percentage you should have in cash and fixed interest.

A 59-year-old, therefore, should have around 59% of their super invested in defensive assets, say some textbooks. It’s an imprecise theory. But it points out that the older you get, the more defensive you should become of what you’ve built.

The broader point of Dr Henry’s speech was that Australian super funds are too heavily invested in property and shares (including international assets).

Australia is seriously underweight in the area of fixed interest, particularly in Australian bank paper and corporate bonds, he said.

This was partly responsible for Australia’s banks borrowing offshore to fund lending commitments here. And that, in itself, created major problems for our banking system, he said.

"When the global financial crisis hit, our national balance sheet, featuring substantial super fund investments in foreign equities and substantial bank borrowings from offshore, contained something with the character of a distressed margin-lending scheme," Dr Henry said.

Australian super fund members, including most SMSFs, lost a lot of money in the crash that started in November 2007. For a start, 80% of Australians are invested in balanced funds in their super. And even with 40% or so of their money sitting in cash and fixed interest, balanced funds went backwards.

Liquidity was a problem, most notably in the direct mortgage and property fund sector.

Naturally, fund managers have since reported that Australians have been dialling back on the risk. They’ve taken matters into their own hands and have actively moved away from previous choices – or choices that were made for them by automatic selection of the default balanced option – and decided to take a lower-risk route.

(An alternate argument is that they’ve acted after the horse has bolted and those members will miss any medium to long-term upside.)

Hopefully, there aren’t too many 59-year-olds sitting out there with 80-100% of their money sitting in property and shares. But if they are, it should be because they understand the risks they are taking and have a longer-term time frame.

But Dr Henry’s point is an argument that needs to be further discussed in the investment community and by all investors at large.

On average, the funds labelled as “balanced” by APRA-regulated funds have somewhere between 55 and 70% of their money in growth assets.

In Europe, pension funds tend to have 50% or more of their assets in cash and fixed interest.

As SMSF trustees, you don’t have a fund manager making those decisions for you. But you do control the panic button. Unlike major super funds, you can shift immediately into and out of asset classes.

Be aware of your SMSF’s 'investment strategy' (for a column on those requirements, see Time to review your strategy) when deciding to make asset allocation changes.

While investment control is partly why you chose to be an SMSF trustee, getting an understanding of unfamiliar asset classes can be difficult.

Fixed interest is the least understood of the four major asset classes. People understand cash, property and shares. But less than 10% have any real concept of what fixed interest is. It’s far less volatile than property and shares and should, over most periods, well outperform cash.

Dr Henry’s words, while aimed at Australia’s fund managers, contain a lesson we all need to keep in mind.

The ATO says it is going to review all SMSF trustee and member details over the next few weeks in order to bring registration records up to date. It said in an email that this could mean some trustees receive an education pack including details on the role and responsibility of a trustee from the tax office for the first time. Concessional contributions made in one financial year but allocated to the next should not be counted for the year they were made in, the tax office has confirmed. The ATO released an interpretive decision to clarify the situation and added that the contribution should be taxed in the year it is made – meaning members could get a double-whammy tax deduction for contributions made for the current and upcoming financial years. Until now, SMSFs have been relying on minutes from a meeting in 2009 to interpret how this situation should be dealt with. SMSF advisers will be happy the compulsory introduction of the Future of Financial Advice (FoFA) reforms has been delayed by a year, says SMSF Professional Association (SPAA) CEO Andrea Slattery. The reforms will be voluntary and not formally applied to the industry until July 1, 2013. Slattery says that given other major changes happening in the industry, such as the changes to the SMSF accountant exemption and beginning of auditor registrations, deferring the start date is a sensible approach and will give people time to introduce the new rules to their practices. SMSFs contesting non-compliance notices in the Administrative Appeals Tribunal (AAT) are likely to lose with only one appeal ever being successful, says DBA Lawyers principal Daniel Butler. He says the AAT at least gives SMSFs an outlet in which they can contest tax rulings and forces the ATO to discuss its decisions, but with so few precedents of funds winning their appeals, it’s difficult to know what was “the key to their success”.

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 advised to consult your financial adviser.

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