Too many investors who set out to do it themselves end up doing not very much at all. David Wright explains.
In many ways, the name self-managed superannuation fund – or SMSF, as they are often referred to – is a misnomer, because a massive number of this fast-growing superannuation segment are not managed at all. That is, the underlying investments in the fund are not properly managed and monitored.
There are a number of reasons for this, including:
• Many SMSFs are set up by accountants for legal structure and tax reasons;
• Penetration of the SMSF market by investment advisers and fund managers remains quite low;
• There seems to be a misguided understanding that running a “self-managed” superannuation fund means managing a portfolio of direct Australian equities;
‘The result is that many SMSF investment portfolios are “left” invested in cash’
• Member investment apathy is also prevalent in SMSFs;
• Some SMSFs are set up with questionable motives of investing in “related” property or collectibles (art, wine et cetera);
• Ongoing management of the assets of the fund becomes too onerous for the trustees/members.
Each of these is explored in more detail below.
One of the most common reasons that the underlying assets of SMSFs are not well managed is that SMSFs are often established by accountants for their clients for taxation and/or legal structure reasons. While this is often a valid reason to establish an SMSF, the assets of the funds are then often left without investment advice, as this is not the skill set of many accountants.
As with most professions, many accountants are reluctant to “share” or refer their clients to a financial adviser for fear of losing the relationship with the client. The result is that many SMSF investment portfolios are “left” invested in cash, either without a specific investment strategy or in breach of their investment strategy.
Despite being one of the fastest-growing segments of the superannuation and retirement income market, the SMSF segment has been, and remains, a market that has not been well penetrated by the financial advisory or funds management industry. The reason for this is related to the above point: the establishment of SMSFs is predominantly the accounting profession’s “domain” – but the implementation, management and monitoring of the investment portfolio are not performed by the accountant. As a result, much of the investment that takes place in a “self-managed” superannuation fund is exactly that – self-managed by the member or members of the fund.
For whatever reason, self-managed super funds seem to be synonymous with an investment strategy that involves investment in direct Australian equities. And that’s it! That is, there is little if any diversification into other asset classes. In addition, the underlying stocks are often selected, managed and traded by the super fund member or members, after sourcing their own research from a retail share trading website or a full service broker.
While it is this control and interest in investing that attracts some superannuants to establish and manage their own SMSF, it often leads to a less than optimal investment strategy and approach that perversely doesn’t maximise the superannuation amount for the trustee/member.
In addition, while superannuation commonly represents the largest asset outside of the family home, many SMSF trustees/members are as apathetic about the underlying investment as public, industry or retail fund members receiving Superannuation Guarantee (SG) contributions into an industry or retail default fund. Only it can be worse in the case of an SMSF, as the underlying investment is often just cash, rather than a default diversified “balanced” fund option that is likely to produce a more attractive level of return and capital growth over the longer term.
Unfortunately, some SMSFs are established for questionable purposes, including funding or partly funding a business property related to the fund’s members; or funding the members’ interests in collectibles such as art, wine or coins. While there are rules governing investment in these types of assets, this alone does not guarantee a sound investment portfolio for the fund’s members.
Finally, running an SMSF in a compliant, well-managed manner is no small undertaking in that it involves ongoing administration, investment management and monitoring and annual financial statement preparation and audit. Even many of those people who establish an SMSF with a genuine interest or intention to be actively involved in managing the investment of the fund can find it more onerous than they anticipated, and lose interest over time. As a result, the fund’s investments are not actively managed.
The lack of proper management of many SMSF investment portfolios is a massive issue as it may well lead to a funding shortfall of many funds such that trustees/members run out of money in retirement and have to resort to the Government Age Pension. As an example, the high level of cash holdings in many SMSF portfolios will not deliver the required return to adequately fund many SMSF members’ retirement incomes. This may not have been the case if the assets of the fund were invested appropriately and managed properly over the life of the SMSF.
So what are the alternatives?
The starting point of any sound investment strategy is determining the appropriate asset allocation for the required level of return, married with the risk profile of the investors. This is a principle of portfolio construction that very few SMSF trustees/members have any knowledge about; yet it is incredibly important, as it is the asset allocation of the portfolio that will determine around 80 per cent of the portfolio’s investment return.
Not only that, the strategic asset allocation (SAA) of the portfolio may need to be changed over time as the members get older – or as their circumstances change – to make sure they are adequately funded for retirement. This requires professional investment advice, at least periodically, to see if the SAA remains appropriate for the members’ investment objectives.
It is important that SMSF members understand that the term “self-managed” does not mean, “no managed”. That is, there is no reason why managed funds cannot play a part in the investment strategy and process in SMSFs. In fact, the difficulty of investing directly in international assets (equities, property securities and bonds) and alternative assets should mean managed funds are more actively used in SMSF portfolios than they are. In addition, for those SMSF trustees/members who find it onerous managing a portfolio of domestic direct equities, hybrids or fixed interest securities, investment in managed funds also makes a lot of sense.
For those who want investment in direct assets but want those assets to be professionally managed, there is now a selection of separately managed accounts (SMAs) or individually managed accounts (IMAs) where investment managers will manage the direct assets for the SMSF for a management fee similar to that of a managed fund. The main difference is that the asset is held directly by the investor (SMSF), which can bring taxation and portability advantages.
Finally, the emergence of exchange-traded funds (ETFs) certainly presents a better investment option for many SMSFs than sitting in cash. ETFs can offer a cheap, index exposure to a broad range of asset classes from which a well-diversified investment portfolio can be built.
The SMSF market is one of the fastest-growing segments of the superannuation/retirement industry. As such, the financial services industry, the Government and regulators need to dedicate significant resources to ensuring we educate and service SMSF trustees/members properly regarding their investment strategy and portfolio, or many will be left disappointed with underfunded retirement income.
David Wright is a director of Zenith Investment Partners – www.zenithpartners.com.au
