Summary: Despite impressive financial performance over time, SMSFs still face ongoing criticism and misconceptions, which can lead to pressure for an increase in regulation. Trustees also need to get appropriate advice and continue to develop their investment strategy over time. Industry insiders also warn of the importance of portfolio diversification and education about new opportunities.
Key take-out: Make sure to get specialist advice, keep learning and developing your investment strategy, consider diversifying into international markets and stay informed about new prospects.
Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.
We know self-managed superannuation funds offer their members more flexibility and control than traditional super funds, a fact which was affirmed by the Murray inquiry’s interim report (see What the Murray inquiry means for you). We also know they have outperformed other super funds over time. On average, between 2004-05 and 2011-12, SMSFs beat the average APRA-regulated fund by 22.5% after paying all costs (see SMSFs: The unsung super heroes). SMSFs have posted a better average return than APRA-regulated funds in three of the five years to fiscal 2012, ATO research shows. And savers are voting with their feet. SMSFs are growing in popularity, with the total number of members passing the one million mark for this first time this year (see A million reasons to watch SMSFs).
But SMSFs still face an uphill battle to be recognised as a significant sector. Trustees may also require specialised advice, while needing to keep up with a constantly changing investment landscape. We take a look at the key issues for SMSFs, as judged by industry insiders.
1. Seeing through industry-funded attacks
Ongoing criticism of SMSFs frustrates industry insiders, who say trustees are generally capable of making decisions about their own investments. Simon Makeham, executive director of the Australian SMSF Members Association (ASMA), notes this criticism occurs despite SMSFs’ outperformance. “One of the key frustrations is the ongoing ridicule and attempt to diminish their competencies in investing, which comes about by some of our super industry competitors – for example, industry funds and retail funds,” Makeham says. “So the only way to counteract growth in the SMSF industry to their expense is to diminish the competencies of SMSF trustees.” He says the perception that trustees are incompetent is “unfounded and unjust”.
Andrea Slattery, chief executive of the SMSF Professionals’ Association of Australia (SPAA), echoes this sentiment. She says proper recognition that the SMSF sector is working well is very difficult to achieve. The sector is constantly being attacked by people who don’t understand it, while misconceptions and misunderstandings about the sector abound, she says. Better recognition of the sector would enable the development of new products, more efficient fees and career opportunities for advisers, she says.
2. Rising regulation
The consequence of ongoing criticism is that professional bodies and other organisations lobby governments and regulators for more regulation, which makes it more difficult for people to invest, Makeham says.
Olivia Long, chief executive of specialist SMSF administrators SuperGuardian and Xpress Super, says talk of regulatory changes creates uncertainty. For example, the Financial System Inquiry raised the possibility of minimum educational standards and minimum balances for trustees. She says continual changes to the super system make it difficult for trustees to plan, adding that the question of minimum balances is raised every couple of years.
Interestingly, she says although criticism of SMSFs leads to pressure for more regulation, it does not deter savers from switching out of APRA-regulated funds. “We’ve seen evidence it hasn’t slowed down the number of people opening accounts and taking control.”
3. Getting appropriate advice
SMSFs need a particular kind of advice, Vanguard Investments head of market strategy and communications Robin Bowerman says: trusted advice from someone with the appropriate level of qualifications and specialisation, such as a SPAA-accredited adviser. Research shows SMSFs recognise they need advice but do not want advisers who only want to sell a product – they want advisers who can help with strategy and portfolio allocation, he says.
As Bowerman explains, “They’re looking for people to be a financial coach, not just an adviser who takes control of the investments, but who helps validate what the trustee is looking to do … Investors are looking for someone who’s more involved, not someone they outsource the whole job to. It’s different to the traditional model.”
Bowerman also recommends getting good advice on the administration of the fund to make sure it remains compliant with its legal obligations, while Slattery recommends getting specialist advice on the drawdown phase of the fund’s operations.
4. Evolving the fund’s strategy
It might not make headlines, but Slattery emphasises the importance of trustees understanding their investment strategy. Get advice about what your objectives are and how to service that from your investment allocation, she says. Be aware of trends, risks and the nature of your asset allocation over the short and long term.
SMSF trustees are already doing relatively well at allocating their assets and developing their strategy, as shown by their outperformance compared to industry and retail funds, she says. But it’s important for SMSFs to continue to learn and develop their strategy over time.
She compares the process of understanding and developing strategy to buying a car: a driver might buy a sports car, then have a baby and find they need an SUV. If they don’t understand which SUV to buy, they’ll end up with something unsuitable.
5. Diversifying offshore
Asset allocation is a critical decision that affects how an SMSF’s portfolio performs, Vanguard’s Robin Bowerman warns. He sees many SMSFs with around 40-45% of their portfolio invested in Australian shares and 25-30% in cash, but says exposure to international share markets and fixed income is typically lacking (see Investing around the world).
He emphasises the benefits of understanding the risk in a portfolio that’s concentrated in Australian shares, given the local market is mostly financial services and resources, and diversifying into international markets (see Don’t dismiss market risks). “People say, ‘I like franking credits.’ That’s fine – some home country bias makes sense. But do you really want to ignore the entire international market?”
Dividends are only one part of the return on shares, while the other is capital growth. He offers the example of a portfolio that includes growth from global companies such as Apple, Exxon and Nestle.
One interesting behavioural trait is that investors are often comfortable funding their lifestyle using yield, but are reluctant to sell shares and realise capital to do the same. He suggests thinking about international shares from a total return basis, rather than a yield basis. Australian dividend yields are twice as high as in the US.
6. Understanding new investment opportunities
Not everyone shares concerns about a lack of opportunities. SPAA’s Andrea Slattery warns of the opposite problem – a range of new investment opportunities that are opening up. Trustees need professional advice to understand these new opportunities, as some may be structured to benefit investors, while others may be designed to benefit the provider offering the product, she says.
ETFs did not exist 10 years ago, whereas the availability of managed funds direct to the public, instead of only through large institutions, is relatively new, she points out.
New opportunities do not necessarily take the form of new assets, but new ways of packaging those assets to investors, she says, using the example of new infrastructure investments that are being considered for retail investors, after these opportunities were traditionally only available to the big end of town. Australia’s small corporate bond market is another new opportunity.
7. Spotting spruikers
SMSFs borrowing to buy property might be in the headlines, but for industry insiders, it’s not front of mind. Slattery says few trustees are using this strategy, which is only receiving attention as it is an area of complex advice. A similar conversation occurred in the past about artworks and collectables.
SuperGuardian’s Olivia Long warns that the issue for trustees is avoiding salespeople who don’t have their best interests at heart. The sector’s funds under management total around $550 billion, leaving it open to being targeted. “It is important trustees and regulators remain vigilant and monitor activities to make sure there’s no illegal activity.”
She has seen property spruikers trying to sell the benefits of SMSFs in order to sell property, but not encouraging trustees to get independent financial advice. Trustees should always consider their situation, such as whether they are nearing retirement and will need to be able to pay a pension.
ASMA’s Simon Makeham takes the view that worries about borrowing to buy property are out of touch.
“The underlying message we get is the issue with SMSFs is there is no issue,” he says.
“Leave them alone. They’re doing quite a good job of managing their own affairs.”