SMSFs: The unsung super heroes

Take a bow all those who have taken their money from the big funds and started their own self-managed funds.

On average, you are proving to be much better managers than the overpaid managers of big funds. And the results in the local sharemarket this week confirm the wisdom of the average self-managed fund strategy – the Australian dollar is rising along with our sharemarket.

So today I am going to set out just how you SMSF trustees are managing to perform so much better than the big fund managers, and then look at the underlying strategic reasons for that better performance.

But weaknesses also show up, and I will look at strategies to overcome some of those weaknesses in self-managed funds.

I am indebted to David Gall, the National Australia Bank’s executive general manager banking and wealth solutions, for the data.

NAB found that, on average, between 2004-05 and 2011-12 SMSFs had beaten the average APRA-regulated fund by 22.5% after paying all costs. (Australian Prudential Regulation Authority regulated funds include the industry funds, corporate funds, public sector funds and big retail funds. Self-managed funds are not regulated by APRA but by the Australian Taxation Office). NAB has been assembling the information from ATO and APRA statistics in a study that began in 2004.

The numbers indicate that a $500,000 investment in an SMSF at the start of the 2004-05 financial year would have returned, on average, $345,571 net by June 30, 2012, an increase of 69.11%, compared with the average APRA-regulated fund returning $190,100 net, a lift of 38.02%.

NAB concedes that it is now clear that SMSFs rate very well in terms of performance against the other funds, “contrary to some perceptions out there.”

Speaking to Andrew Main at The Australian, Gall noted that, surprisingly, the better performance from the SMSFs came despite the fact they have higher costs.

Over the eight-year period, the NAB survey found SMSFs incurred total costs of $59,404, or $7,425 a year on the original $500,000 investment, which is markedly more than the $42,159, or $5,269 a year, spent by the APRA-regulated fund members.

“Cheaper is not necessarily better, and trustees are actually prepared to pay for advice if they believe it’s worth doing so”, Gall says.

Why did SMSFs do so much better than the big funds? First, self-managed funds were ‘overweight’ in domestic equities—close to the best performing asset class over the period.

In 2013, SMSFs had an average 36% exposure to domestic equities, whereas the big funds had between 24% and 31% exposure.

The self-managed funds also use bank deposits, which have carried higher yields than bonds, and for investments under $250,000 bank deposits carry government guarantees. The vast majority of unlisted property in self-managed funds is linked to the trustees’ own business. This can be very rewarding to the family. If the business can stand a high rent it injects large sums into the fund.

The big funds usually have about 24% of their money in international equities, and their performance from this sector has been eroded by the rise in the Australian dollar. At the start of 2004-05 the Australian dollar was around US70 cents. NAB calculates SMSFs have only around 0.3% exposure to international equity markets. The self-managed funds have seen the international role of companies like CSL, Westfield, BHP and others as their ticket to a stake in overseas markets. However, given the vulnerability of the Australian dollar, the level of 0.3% in international equities looks too low. On an asset diversification basis, self-managed funds need to give increased consideration to international equities, particularly the US. In the short term the Australian dollar looks more likely to rise than fall, but longer term I am an Australian dollar bear. The cheapest way to gain low-cost international equity exposure is through listed investment companies like Templeton (that’s what I do).

Self-managed funds also have a big leaning towards yield stocks, which have been among the best performers. Again, there is no hurry but we are in the middle of a yield boom and longer term that boom will end when interest rates start to rise and/or banks find they must invest more in their business.

The big growth in self-managed funds has come at the expense of NAB’s MLC, Commonwealth’s Colonial, Westpac’s BT and the AMP. Industry funds have been less affected.

The big funds have waged an unrelenting campaign in Canberra trying to spook the politicians and public servants about the so-called dangers of self-managed funds. The latest performance figures will confirm that the big funds have been telling fibs.

NAB, at least, seems to have woken up to the fact that instead of joining other big institutions in conducting a fifth column war against self-managed funds, it makes much more sense to treat them as potential customers.

Big institutions should be devising low-cost securities for self-managed funds that are hard to duplicate in the self-managed fund space. A good example is international equities. Infrastructure may be another.

When it comes to fees, the average self-managed fund investor in the survey is paying some 1.5% on the original investment but closer to 1.1% on average funds over the eight years. Of the $7,425 in fees, let’s assume $2,425 goes to the accountant. Many are cheaper.

That leaves $5,000, or about 1%, on the original investment for other fees. It’s easy for me to say that is too much, but let me relate a true story.

Recently I was yarning to a trades person who has his own fund and had an adviser who made some investment mistakes. So the tradie signed up with a respected investment house for a 1% of assets in the fund fee. I told him I would not do that, especially as the investment recommendations were all leaders and not particularly original – it would be much cheaper to buy into a respected investment company to gain a stake in Australian equities.

But, nicely, he rejected my suggestion. He really wanted top advice and was prepared to pay. Clearly from the survey, many others have the same view.