Secret lessons from DIY funds

With almost 1 million Australians involved in SMSF superannuation funds, it is remarkable how little analysis there has been on the growing power of this constituency of investors. Now the global broker Credit Suisse has stepped up to the mark with an examination of the sector, which throws up some very useful results.

It seems institutional investors have finally realised that the SMSF sector is at a tipping point, where it is a significant driver of market direction. Moreover, the broker has uncovered some secrets of the sector which it sees as a pathway for wider investment success.

The research, titled Rise of the Selfies, is a fascinating insight from those on the outside looking in, trying to guess what it is SMSFs are doing and why, and then seeing how they can leverage these investing patterns.

What’s made them come to the startling discovery that SMSF investors need to be watched? For one, they’ve realised that SMSFs have about $220 billion invested in Australian shares, which makes up about 16% of the capitalisation of the Australian sharemarket (up from 12% in mid 2009).

Further, SMSFs are tipping in about $2 billion of new money into equities each quarter ($8 billion a year).

When it comes to selecting stocks, Credit Suisse has put SMSFs decision-making process into four categories.

1. Tier 1: These stocks will be owned by most SMSFs. And the criteria, roughly, are high dividend yields, with a history of dividend growth, franking credits, are large caps, and are companies they comfortably understand. Into here goes the major banks and Telstra.
2. Tier 2: Yields aren’t quite as big, but are still large companies, such as Woolworths, Coca-Cola Amatil, Wesfarmers and A-REITs (Australian real estate investment trusts). They might have been put into tier 2 because they cut their dividends and therefore got dumped by many SMSFs.
3. Tier 3: Top-50 companies that don’t fit into the first two.
4. Tier 4: Speculative stocks, “like bombed-out large caps and small cap miners”.

All up, that four-way split is a pretty fair breakdown of how stocks are selected by SMSFs, given my experience, if you accept that the findings have to be reasonably broad generalisations. Banks and Telstra are favourites and almost certainly will be forever. Unless they break the rule of paying high, rising, franked dividend yields.

For all investors, what was particularly interesting following the release of this report is what Credit Suisse did next. Fortified by the knowledge it had established of DIY fund investing patterns in Australia, the broker then suggested clear and pragmatic investor initiatives. In essence, there were four ‘actions’ to be taken:

1. Credit Suisse is no longer going to recommend the shorting of banks or Telstra. There’s no point fighting the weight of money that will presumably always follow those “tier one” stocks.

“There is clear demand for these companies as long as they can continue to grow their dividends. We have previously been short Westpac in our stock allocation.

“But given the bank is a Tier 1 stock, we have come to our senses and step out of the way of these considerable flows.

“We will revisit a potential short in the big banks or Telstra when they could be about to break their implicit contract with SMSFs and cut their dividend. We don’t think this will be the case in the near term.”

2. The second lesson Credit Suisse says it has learned is to put more weight on dividend yields and dividend growth and less on price-to-earnings ratios and earnings-per-share growth.

SMSFs don’t care as much about such criteria as “professional investors”, nor do they care as much about issues such as ‘weighting’ (where fund managers try to reflect the market capitalisation of certain stocks in their own portfolios).

“Perhaps the rise of the Selfie is a reason why high-yielding stocks have done unusually well at this stage of the market cycle. Selfies were not as important during similar stages in the past.”

3. The third lesson is to buy what SMSFs are likely to turn to next. That is, find the stocks that will soon, or eventually, fit the “high, rising and franked dividend yield”. Credit Suisse suggests Rio Tinto could go in this bag – if not into tier 1, then tier 2.

4. The last lesson is actually a major criticism of SMSFs. “Selfies are retarding growth in Australia. Perversely, they control much of the equity that could be used for new investment, but are demanding dividend increases instead.”

Credit Suisse said SMSFs aren’t interested in financing growth and this should be a frustration to politicians.

“If companies are not investing, then policy makers will have to do more of the heavy lifting ... companies will be too busy keeping their powerful investor base happy.”

Risks to SMSFs

From Credit Suisse’s discussions with its panel of advisers, the researchers also outlined the major risks for SMSFs. And these risks are probably the most helpful advice.

The dearth of quality bonds in Australia means SMSFs feel forced into equities to get yield, particularly when interest rates are low. As a result, they are inappropriately invested as they lack the diversification that bonds would provide, if they could be convinced to invest in them.

The advisers interviewed by Credit Suisse said that trustees are just as prone as any other non-professional to suffer from panic attacks that lead to selling and buying at the wrong times.

Credit Suisse said that SMSFs also seem to have investment return assumptions that are simply too high. They have benefited from massive returns in shares and property in the last few decades and are expecting those returns to continue.

And, finally, the influx of “unprofessional advisers” was noted by the interviewed advisers. Like bees to a honeypot, some new advisers are arriving on the scene with no other purpose than to strip SMSFs of fees. They outlined that geared property spruikers were the biggest danger here.

Stock price bubbles

So, essentially, the stockbrokers are on to us. Or a good portion of us.

How will that pan out? Well, if enough of them wake up to how SMSFs invest, they may add to what they claim is the distortion of the market being created by Selfies.

If SMSFs love banks and there will always be fresh money coming in to the banks, then more institutional investors, or stockbrokers, might start pushing more money into those stocks. It certainly couldn’t do any harm to the share prices of banks if these clowns stopped shorting them.

But SMSFs will, eventually, probably need to realise that their humble investment strategies could become more mainstream. And that could lead to bubbles.

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 Castellan Financial Consulting and the author of Debt Man Walking. E: bruce@castellanfinancial.com.au

• Recent ATO figures show how SMSFs are being responsible when using their superannuation savings in retirement, says the SMSF Professionals' Association of Australia. The percentage of benefit payments from SMSFs increased to 72% in 2012 from 64% in 2008, with the average benefit payment at $99,000. "Hopefully, these numbers are another nail in the coffin to the myth that SMSF members take their super as a lump sump as soon as they can and then go on to the aged pension, "says Graeme Colley, director of technical and professional standards.
• WAM Capital has partially attributed its 118.9% increase in operating tax before profit for the first half of 2013-14 to SMSFs. The company said self-funded retirees had taken up more than 40% of its issued capital for the period, investing over $130 million in the company. “This reflects the considerable growth in the SMSF sector,” said chief executive Geoff Wilson.
• More women are using SMSFs than males, according to a Goldman Sachs survey. In a survey of over 600 investors, the broker found 30% of females investing were using SMSFs, compared to 25% of males. Women also were using financials advisers more at 46%, above 37% of men.