The findings ASIC has released in the last week, showing that most self-managed superannuation funds (SMSFs) fail to comply with the best-interests duty and other legal obligations, point to a broader issue relating to how these funds and the investment advice industry classify investments and construct portfolios.
I believe there is a major flaw in the way investment portfolios are constructed that comes from a bias towards listed securities. This is possibly because they can more easily be included in managed funds that pay commissions and can be accessed through a wrap investment platform.
The flaw in the way investment portfolios are constructed relates to the asset classes that are often included in a model portfolio, which SMSFs use as an investment framework. These asset classes include: cash, fixed interest, Australian shares, international shares and property.
Listed property does not equal direct investment
My big problem with the last asset class on this list is that the financial services industry has counted listed property securities as a property investment. In my investment world, listed property securities have not exhibited the traits of a property investment; they are a sector of the sharemarket and should be classed as a listed security.
A fact sheet the Property Council released recently highlighted this problem – it shows advisers are confusing listed property with direct and clients are allocating to listed under the guise of a property allocation. To make things worse, unlisted property trusts have outperformed listed property securities and Australian shares.
The Property Council’s fact sheet states that the five-year annualised return for the PCA/IPD Unlisted Retail Property Fund Index is more than 20 per cent. Compare that with the MSCI Australian Core REIT Index, which returned about 13 per cent, and the MSCI Australian 200 Index, which returned about 11 per cent.
It’s no surprise to me that the problems ASIC highlighted in its recent review of the SMSF sector relate to property; the report found that people are being encouraged to set up an SMSF with the narrow purpose of investing in property.
The reason why it is not a surprise either. It’s because those advisers who put their ability to earn commissions ahead of their clients’ interests had to look for somewhere else once the ban on commissions relating to financial products was removed – and that somewhere else was in property.
That said, the problem I am highlighting has nothing to do with super funds that have been set up purely to flog development properties and earn commissions for the advisers, and everything to do with a bias towards listed investments.
An odd definition of ‘balanced’
Further, another area where I believe super funds, fund managers and advisers have done a great disservice to clients and investors is the interpretation of the balanced investment risk category.
The Collins online dictionary defines balanced as, “having weight evenly distributed; being in a state of equilibrium”. Unfortunately, the financial services and advice industry has an un-balanced view of what a balanced investor will tolerate with regard to risk. Many balanced investment portfolios can be up to 80 per cent allocated to volatile equity assets.
I also disagree with the methodology some advisers use to determine a client’s attitude towards risk. I believe a client’s tolerance for risk has to do with their age and how much they have in investment assets, not some pseudoscience questionnaire with questions biased towards a high exposure to listed securities.
I’m more of an advocate of the goals-based approach to portfolio construction, in which the younger someone is, the less they have in retirement assets, and the greater number of years they have until they retire, the greater the percentage they can allocate to growth investments; while the older someone is, the more they have in retirement assets, and the less time they have until they retire, the more they should have a balanced investment allocation.
By balanced, I mean that no more than 50 per cent of the portfolio should be allocated to the far more risky and volatile equity sectors. Until the financial services industry can change its attitude towards portfolio construction, and what should be included in each asset sector, clients will have a possible cause for action due to not being properly diversified over the various asset sectors.
Max Newnham is in public practice, specialising in small business and retirement tax planning. He is an SMSF specialist and advises on portfolio construction and investments.