SMSFs in a high-risk cash gamble

Many Australian self-managed super fund (SMSF) trustees are wedding themselves to mediocre investment returns by having a high percentage of their funds in cash and term deposits.

New data from the Australian Tax Office shows that SMSFs collectively hold more than $157 billion in cash, equal to 25 per cent of the $635bn in total assets held by DIY fund trustees at September 30, 2016.

But in being ultra-conservative, foregoing the much higher investment returns generated by other asset classes, those with large cash holdings are effectively jeopardising the longevity of their retirement savings.

With record low interest rates, the median return from cash in 2016 was a paltry 2.1 per cent compared with a much higher 11.65 per cent return from the Australian share market in the year to December 31. In other words, $100,000 invested into cash would have returned just $2100 over the last year compared to $11,650 from the same amount invested in the share market.

While the proportion of SMSF money in cash and term deposits has fallen gradually – down from 32 per cent to 25 per cent in the four years to the end of the third quarter last year, which is the most recent data available from the ATO – the discrepancy in returns of that period is stark.

About 10 per cent of SMSFs are entirely in cash and term deposits, while a quarter of funds have more than 50 per cent of total holdings in the asset class.

The ATO data shows those heavy in cash and term deposits are likely to be smaller funds, with diversification expanding as the value of SMSFs increases, most noticeably for funds beyond the $200,000 mark.

Of course, SMSF trustees should have a small percentage of funds allocated to cash, especially those in retirement phase needing liquid funds to make regular pension payments.

Many SMSFs remain unguided

Analysts had expected a bigger wind-down in cash holdings since the latest round of monetary easing began in 2012, with the official cash rate dropping from more than 4 per cent to its current 1.5 per cent level.

Jason Dunn of Anne Street Partners Financial Services said the ATO data showed many SMSFs remain “totally unguided” in their investment decisions and have a “huge amount” of their assets invested in cash.

“While cash serves a key purpose in a SMSF, it's important to strike the right balance of defensive and growth assets dependent on your situation and stage in life. The reality is that you need to be prepared to provide for your own retirement. Australian women now live to an average age of 84.5 and for men 80.4, ABS statistics show.”

According to data group Canstar, the best an SMSF can get for a term deposit presently is 3.2 per cent invested for five years, with interest paid annually. As such the invested cash balance only benefits from compound interest every 12 months.

By contrast, the All Ordinaries Accumulation Index (which includes dividends in determining total annual returns) has averaged about 10 per cent annually for the past four years.

The key for investors currently heavily invested in cash and term deposits is to weigh up the desire for certainty over the need for higher investment growth and income. Those with large cash holdings are often achieving returns that barely match inflation, meaning their funds will be severely eroded over time and are unlikely to last through retirement.

Home bias still unhealthily strong

Meanwhile, the updated ATO figures show SMSF trustees also remain very light on international shares compared to their ownership in domestic companies, although those weightings have thus far not been costing them money.

In terms of shares, 31 per cent of SMSF holdings were in listed Australian shares at the end of the September quarter, while listed international shares accounted for a paltry 0.6 per cent of all holdings (the figures do not take into account domestic and international shares held in managed funds.)

The sharp equity markets divergence is put into context when considering the Australian share market represents only about 2 per cent of the value of global markets.

Brokers Morgans last week íssued a warning on the issue.

“Home bias is an obvious concern, with direct (SMSF) equities investments 98 per cent skewed towards domestic stocks. We think this lack of diversification within the Australian equity market poses a risk to domestic investors,” the broker wrote in a note.

Morgans said the Australian economy was “facing challenging headwinds that have the potential to drag on growth over the medium term”.

“Current profit growth in the domestic market is forecast by Bloomberg at a modest 7 per cent in FY17 and 5 per cent in FY18 driven by a turnaround in resources. On a relative basis Australia looks to be a laggard across global markets,” Morgans said.

However, interest is growing in the international shares space. The September 2016 figure of 0.60 per cent (or just $3.66 billion) is an improvement on the proportion of holdings from the four years prior – 0.37 per cent (or $1.59bn).

And over the 12 months to September 30, 2016, the value of holdings in listed international equities rose 13.3 per cent against an increase in overall net SMSF holdings of 8 per cent. (The value of Australian shares also rose by that 13.3 per cent, however).

Source: Australian Taxation Office

November and December saw strong positive momentum for InvestSmart's International Equities Portfolio.

Europe was the best performing market for December, rising 7.4 per cent, while the US market gained 3.9 per cent, and Japan and emerging markets returned 3 per cent and 2.9 per cent respectively.

Getting allocations right – cash versus growth assets, like equities, and international equities versus Australian equities – will be increasingly important in 2017.

While SMSF trustees have been losing with cash compared to benchmark equity indexes, past returns are no guarantee of future performance.

Meanwhile, diversification between Australian shares and international holdings is as important as ever given our market's strong weighting towards the major banks and mining stocks. Good diversification is vital.