Has your SMSF been missing out on offshore gains?

It's not quite “mutual exclusivity”, but Australia's self-managed super fund investors and international equities are, let's say, not well acquainted.

It's a pity. A huge shame. That's partly because, ignoring how much myself and others have banged on about it, the benefits of getting that exposure in your SMSF are still not well understood.

The message seems to be, slowly, getting through. There has been a lift in the number of SMSFs who are getting exposure to international equities. And if the volume of emails in to Eureka Report is any indication, then interest is growing further.

With the end of calendar 2014 comes further proof of why SMSFs are missing out by virtually ignoring this asset class.

I'll use my favourite comparators for topics like this (each year in July, I do a full comparison of performance that could or should have been achieved by SMSF trustees) and use Vanguard index share funds. Why? Because you can get access to them for very little and massively reduce the risk of under-performance in an asset class through indexed exposure.

The average return for the Vanguard Australian Share Fund for the year to 31 December, 2014, was 5.16%. The three-year return ending the same period was 14.7%.

When it comes to international shares, I use two comparison funds. The first is the Vanguard International Shares Index Fund (VISIF) and the second is the Vanguard International Shares Index Fund Hedged (VISIFH).

VISIF returned 15.12% for the year and 24.87% per annum for the three years. VISIFH returned 12.64% for the year and 20.91% for the three years.

Go a little longer, to five years, and the returns, in order are 6.25% versus 12.52% and 14.37%.

On performance alone, ignoring international exposure has cost SMSFs dearly over the last three and five years.

If you had split $200,000 and put $100,000 into Australian shares and $50,000 into the hedged and unhedged versions of the Vanguard international funds five years ago, the international funds would have outperformed the domestics by $52,600. The domestic index fund would be worth around $135,400, while the combined international funds would be worth $188,000.

Importantly, I'm not saying that all SMSFs should now pile into international equities. It's possible that the outperformance of the last five years has been and gone – though an extended strong run for Wall Street is expected by leading analysts (see Goldman Sachs says US stocks will win again this year, January 28). (I certainly do believe that the Australian market, comparatively, is undervalued.)

So, why won't most SMSFs go near international equities?

Arguably, for most SMSF trustees, they would have got better performance if they'd stayed with their former industry or retail funds, as they would have had automatic exposure to international assets, because of fund manager diversification preferences.

Indeed, only 17% of SMSF trustees believe they got better performance than the average super fund rates of return, according to research last year from UBS and the Financial Services Council. (That statistic alone is astonishing. Sure, SMSF trustees are, predominantly, doing it for control. But if that control comes at a significant risk of underperformance, that they are aware of, are many doing themselves a massive disservice?)

So, why are SMSFs feeling this way about their performance?

It's probably based largely on asset class performance. SMSFs are overweight Australian shares and cash. The typical balanced fund manager has an allocation that makes them relatively overweight, compared with SMSFs, to international shares and bonds.

As a result, balanced fund managers are likely to have outperformed, through holding more of the assets that performed well, for the last three and five years. The reverse was true during the GFC, when SMSFs, overweight Australian shares and cash, outperformed.

How much do SMSFs have in international assets? The average is around 6%, where the average “balanced” fund manager would have between 20 and 30%.

(There is a separate listing for “managed funds” in the ATO's data, which only accounts for about 7%, a portion of which would also be in international equities.)

SMSFs tend to have around 45% of their funds invested in Australian shares, versus around 25-30% in balanced funds.

How much in cash? SMSFs have on average 26% of funds in cash, versus just a few per cent in the average balanced fund. Balanced funds tend to also have a much higher allocation to bonds than SMSFS, which have also outperformed cash.

Eureka Report has been fielding inquiries from SMSF trustees in recent times about international exposure. “How do we get in?”

You can probably break it down into three main options.

Direct share investing: Like buying your own Australian shares, you can buy international shares directly, though it is best usually done via a stock broker. It is very difficult to get diversification with this option, as spreading your money across international shares successfully would require a large sum of money, well beyond the potential of many smaller SMSFs. (To read more about direct offshore investing, click here to see Clay Carter's recommendations.)

Managed funds: You can use both active and index fund managers here (my preference is index, for the low cost and broader exposure). These options will instantly give you diversification across dozens, probably hundreds, of companies globally.

Exchange-traded funds (ETFs): The options here are growing and are probably the cheapest from an ongoing management expense ratio perspective.

(See also: Buying overseas stocks: A Eureka guide, July 28, 2014 and Buying shares offshore: Tax issues you need to know, January 21.)

As Vanguard points out in some recent research of its own, it can be easy to build international shares exposure with two simple share market trades.

VTS is the US Total Market Shares Index ETF, while VEU is the All-World ex-US Shares index. A 50-50 exposure to assets will offer a broad spread across the world's equity markets.

(Do not take this as a recommendation. All investors should take their personal situations and circumstances into account.)

The diversification benefits go well beyond just international exposure. Australia's markets are massively overweight financials and materials. Gaining (indexed) foreign exposure will increase your relative weightings to those industries not well represented in Australia, including IT, consumer discretionary, health care and industrials.

If you haven't been exposed to international shares in recent years, it has cost you. Big bucks. Righting that wrong, if you think it is appropriate for you, is not as hard as it might seem, particularly if you are looking to index that exposure. Either do the research yourself, or speak with a financial adviser.

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 extremely complex and require high-level technical compliance.

Bruce Brammall is director of Bruce Brammall Financial and the author of Debt Man Walking. E: bruce@brucebrammallfinancial.com.au

• The number of SMSFs that have to lodge contravention reports with the ATO – where an auditor or accountant flags that the trustee has done something wrong – has fallen slightly in fiscal 2014, according to a survey by Partners Wealth Group. Some 5% of the 600 funds surveyed needed to lodge a contravention report, below the prior year's 5.3% and the long-term survey average of 6.3%. Contraventions can occur for several reasons, such as where an SMSF paid funds to an individual who was not on a pension, or where there was a problem with the way an SMSF went about lending funds to a small business. The proportion of breaches that were due to issues with borrowings by SMSFs – including issues such as SMSFs borrowing for short-term payments or acquiring property via an LRBA – rose significantly in the year, the survey found, to 23.3% of contravening funds, up from 12.5%.

• Delegates at the Association of Superannuation Funds of Australia conference believe most super fund members have an inadequate understanding of their life insurance within super, according to a poll. The survey found 73% of respondents believed more than half their members had an inadequate understanding, according to media reports.