SMSF popularity surges as superannuation returns slump

The last time superannuation returns turned negative there was a rush to establish SMSFs, and there are signs that the current downturn has done nothing to diminish their popularity.

Choice of Fund, Simpler Super and a newly competitive marketplace has undoubtedly served to increase the effectiveness of superannuation as a retirement savings vehicle. But more than that, and perhaps more importantly, these changes have achieved an increased consumer focus.

Across the board, Australians are more engaged with their super.

Flexibility and control are the order of the day and despite declining investment markets, Graeme Colley, technical manager of Super Concepts, believes self-managed super is well placed to provide that and in weathering the market storm.

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“In the past, there has been industry criticism levelled at the amount of cash held within self-managed super funds (SMSFs),” said Colley.

“And certainly, if we look at the latest round of statistics released by the Australian Taxation Office (ATO), the estimates are that more cash has been put into self-managed funds as a proportion of total assets.

“But that cash could be the result of contributions or dollars being pulled out of equities,” Colley continued. “On average, SMSF trustees aren’t acting any differently to the larger, mainstream super funds.

“Most SMSF portfolios represent a balanced fund and that means their performance has been similar.”

Pauline Vamos, chief executive officer of the Association of Superannuation Funds of Australia (ASFA), said comparing self-managed funds to larger retail, industry and corporate super funds was no easy task.

“The problem is that we don’t really have any up-to-the minute information on how they’re doing,” she said.

“Some SMSFs will have engaged in the market, so their success will have been dictated by stock selection.

“But ultimately, performance will depend on what the portfolio contains,” Vamos added.

“Some funds will be looking fine. Others will be hoping for a rebound.”

Alternatively, Andrea Slattery, chief executive officer of the Self-Managed Super Fund Professionals’ Association of Australia (SPAA), said while she had no proof, there had been suggestions that many SMSFs were currently in positive territory.

“We are currently conducting research, but initial analysis by both Rainmaker and Investment Trends [has suggested] that self-managed funds have had similar, if not better, performance than other super sectors,” she said.

Slattery also pointed to analysis released by both the Australian Prudential Regulation Authority (APRA) and the ATO as evidence the self-managed sector has good reason to be confident.

“APRA has suggested outperformance by SMSFs in seven out of the nine years to 2006,” she said.

“And data released by the ATO in 2006 showed that in terms of investment performance, most self-managed funds had characteristics similar to those evident in larger funds.

“So if APRA believes the larger funds have been acting responsibly, there is certainly indication that SMSFs have been acting appropriately as well.”

Referencing survey data collected in May of this year, Mark Johnston, principal of research house Investment Trends, pointed to a number of findings that helped to build the SMSF performance picture.

“Investment Trends do a big study of SMSF investors each year and a number of things came out of the data we collected in May,” he said.

“Firstly, SMSF trustees were reasonably okay with their fund’s performance.

“The feeling being shared by trustees was not one of panic,” continued Johnston. “In fact, 66 per cent of our survey respondents felt that the current period’s volatility would have no impact on their ongoing strategies.

"Add to that the 25 per cent who were looking to buy and a similar figure for those deciding to wait for the market to settle.

“Trustees acknowledged that yes, they had suffered losses, but most saw them as paper losses only.”

Yet while the picture of self-managed super confidence painted by Johnston is similar to that suggested by both Colley and Slattery, he admitted that gauging SMSF returns accurately, and in isolation from trustee sentiment, was more difficult.

“The issue is that our results are based on a trustee’s own assessment of their returns,” he said. “So while the average estimated return was around 14 per cent, we put a number of caveats against that.”

Johnston said valuation of falling shares was one such caveat, with many trustees failing to appropriately value the equities they intended to keep over the longer term.

“And we also feel that some trustees will have been surprised when it came to calculating their actual returns,” Johnston continued. “Because there is no doubt the index fell significantly in June.”

Evidently, judging performance in the self-managed sector is something easier said than done. Alternatively, SMSF confidence seems to be certain and the reason, according to Johnston, is that most trustees have seen this kind of volatility before.

“Generally speaking, trustees of self-managed super funds are older investors who have seen market cycles before,” he said. “So as new money flows in, most is accumulating as cash or being moved to term deposits.

“It’s very much a measured, ‘wait and see’ approach.”

Colley said while he could see many of the lessons learned during previous uncertainty being remembered, much in the sector had changed.

“If you look at the periods of volatility in 1999 and 2000 for example, there were around 100,000 self-managed funds as compared with nearly 400,000 today,” he said.

“They were very different sorts of animals back then, seen more as tax vehicles and tax sheltering vehicles than anything else.

“The same is true today, but SMSFs are more the retirement vehicles they were intended to be,” Colley continued. “So with more than 200,000 SMSF start-ups in the last two years, operating in a declining market is an entirely new experience for many trustees.

“They’ve seen good economic conditions but now they’re having to face tougher times.”

Of course, whether we’re talking about mainstream or self-managed super, the solution to weathering those tougher times clearly lies in investment strategy.

But if comments made during this year’s Institute of Chartered Accountants in Australia (ICAA) forum on SMSFs are any indication, this is an area that continues to be a concern.

Hugh Elvy, head of financial planning and superannuation for the ICAA, said that as a starting point and a minimum, fund trustees should document both a clear investment objective and a detailed investment strategy.

“Very broad investment strategies and a lack of documentation explaining the trustee’s reasons for a particular strategy makes assessing the strategy with the requirement highly subjective,” he said.

“And this creates real problems for the auditor.”

However, Colley said these days, the ATO is far happier with the compliance aspects of self-managed funds.

“Investment strategy depends on the size of the fund,” he said. “The fact is, the strategies of larger SMSFs compete well with the strategies of the larger mainstream funds.

“Those at the lower end of the bracket probably don’t have strategies that are suited to their fund,” Colley continued. “And that is definitely an area that needs to be picked up.”

On the topic of SMSF investment strategy, Vamos said she had to trust that trustees were getting it right.

“The ATO tells us that the majority of SMSF trustees know what they’re doing,” she said. “But there will certainly be a minority out there who are feeling more than a bit stressed at the moment.

“You’ve got to look at the numbers,” Vamos continued. “With 380,000 SMSFs accounting for around 31 per cent of total superannuation assets, that means 12 million members own 70 per cent and 380,000 own 30 per cent.

“There’s a lot of dollars in these accounts, so rest assured that people are keeping a close eye on it being invested appropriately.”

Taking investment strategy one-step further, Johnston acknowledged that some of the more common perceptions of SMSF portfolios, such as investment tending towards direct equities, undoubtedly had a basis in truth.

“SMSF investors certainly favour direct equities,” he said.

“Looking at the circumstances before them at the moment, 60 per cent of our respondents indicated an intention to buy blue chip shares over the next 12 months.

“But that doesn’t mean they’re steering away from managed funds,” continued Johnston. “Generally, those investing in managed funds are using them for quick asset changes and they provide a good means of doing that.

“In the short term, trustees are looking at blue chips but with a broader investment horizon, the intention is for a wider investment menu.”

Regarding suggestions most SMSF trustees favoured direct equities over the possibly reduced transparency found within managed funds, Vamos pointed out that the underlying assets remained the same.

“Whether you’re talking about direct investment or managed investment, the underlying assets are the same,” she said. “Direct equities investment simply has no formalised management structure.

“SMSF trustees are seeking a portfolio that is personalised to them,” Vamos said. “But if they have direct equities within that portfolio, there will be a requirement for greater management.

“They really can’t afford to ‘set and forget’.”

Johnston said in some ways, currently declining investment markets have happened at a good time for self-managed super.

“The SMSF environment underwent big changes in July 2007,” he said. “And one of the biggest changes was in trustees’ use of financial planners.

“We’re now looking at 49 per cent of SMSF trustees who are seeking advice when not so many years ago, that figure was much lower.”

Johnston added that if accountants were included in the advice equation, the figure rose to 55 per cent and then to 67 per cent if stockbrokers were taken into consideration.

“Self-managed funds are simply more engaged with investment advice now,” Johnston said.

“Volatility can never come at a good time,” he continued. “But it is better that it has arrived now, when trustees have the advantage of advice.”

So within the most challenging environment seen in Australian super for nearly 10 years, and with around 200,000 new self-managed funds remaining largely un-panicked, it certainly seems that the advice advantage referred to by Johnston is making a significant difference.

Asked whether professional advice had been appropriately taken up by SMSF trustees, Slattery pointed to data released last month in a speech by Ian Read, assistant deputy commissioner of taxation for the ATO.

“Statistics through the ATO’s compliance program have shown around 85 per cent of SMSF trustees are now seeking advice,” she said.

“On top of that, every fund has to have an auditor playing the role of gatekeeper and checking advice.

“So coming from a point some years ago when only 15 to 30 per cent of trustees had the benefit of advice, that is a definite improvement.”

Slattery also noted that people needed to remember a great many SMSF trustees were themselves financial services professionals.

“So these trustees may be doing a lot of the work themselves,” she said.

“Advice capacity is an important cog in the workings of a SMSF,” Slattery continued.

“But it needs to be specialised to enable better informed, more effective decisions.”

For Colley, the take up of advice in self-managed super formed a large part of the reason behind the sector’s confidence.

“Analysis of the SMSF sector by Investment Trends has indicated that there has been a marked increase in the number of trustees taking up advice, even in the last 12 months,” he said. “And we’ve certainly found that people aren’t panicking.

“Even with the current state of the market, it’s been a much calmer time compared to what we saw between 2001 and 2003,” Colley continued. “Back then, people didn’t know where to go for help.

“Now, as a general rule of thumb, those funds utilising advice tend to enjoy returns that are 1 to 2 per cent better.”

Yet it must be pointed out that advice is not and should not be entirely focused on maximising portfolio returns. And with Australia already facing a growing underinsurance gap, it seems reasonable to ask whether the members of self-managed funds are adequately covered.

Phil Collins, general manager — life for International Underwriting Services (IUS), said SMSFs were definitely a target market for his colleagues in the insurance industry.

“SMSFs are not a target market for us at IUS, but they are certainly of interest within the wider industry,” he said.

“Anecdotal evidence suggests that their insurance cover is lacking, but I must stress that it is only anecdotal,” Collins continued. “Unfortunately, the likelihood is that the majority of SMSF trustees are looking at other benefits and not necessarily at insurance when they commence set-up.

“Insurance probably isn’t high on the list of priorities.”

Colley said with less than $300 million devoted to insurance out of total assets of $300 billion, there was little hope that SMSF members had adequate insurance.

“The main reason for that is the age of SMSF members,” he said.

“At Super Concepts for example, the average member’s age is 57 years old and at that age, premiums are becoming expensive.

“Cost is another issue,” Colley continued. “Self-managed super doesn’t have access to the group discounts offered to the larger retail and industry funds.

“But in saying that, there’s been a lot more promotion going on in this area, so hopefully that movement will result in change.”

Irrespective of advice and investment strategy, the growing popularity of self-managed funds, particularly since the legislative changes of 2006, means their place within Australian super is assured.

In fact, according to Colley, though most industry experts would have expected a slow down in the number of SMSF set-ups, growth remains high.

“Even in the June quarter of this year, the sector was still seeing around 3,500 funds being set-up each month,” he said. “And that figure is still at or around 2,500 per month, so I don’t think the numbers are likely to decrease in the short term.”

Interestingly, Vamos said she saw SMSF growth slowing in the face of declining markets.

“I think growth has been slowing and that it’s been a reflection of nervousness,” she said.

“In this kind of market, people understand that by changing funds, they crystallise their losses.

“Doing so makes it that much harder to regain momentum when markets do rebound.”

Vamos also said the increasing flexibility available within mainstream superannuation since choice of fund could have an impact on SMSF growth.

“We’re seeing a broader range of options there now,” she said. “A broader range of insurance products, investment portfolios, fee competition, advice and reporting services.

“It’s also not unusual for people to have more than one fund,” Vamos continued. “Each superannuation sector provides a different value proposition.”

Like Colley, Johnston said he saw SMSF growth holding up well following the spike of 18,000 new set-ups in the June quarter of 2007.

“The drop outs that we expected just didn’t happen,” he said. “And there’s been another spike in the June quarter of this year, so it will be worth keeping an eye on moving forward.

“Historically, SMSF establishment actually increases during a bear market,” continued Johnston. “People who are currently members of the larger funds see their returns diminishing and they see price or the fees they are paying as an issue.

“Quite often, that is sufficient motivation to provoke a move.”

Obviously, whether the growth of self-managed super is showing signs of increasing as suggested by Colley and Johnston or slowing, as is Vamos’ belief, the sector’s popularity is clear.

But in light of compliance scrutiny by the ATO, that popularity is not the only reason behind recent media attention.

From the mainstream super perspective, Vamos said there was continual concern over the SMSF minority that failed to meet their compliance obligations.

“These may be isolated cases,” she said. “But the numbers going into SMSFs make the issues important.”

And as for suggestions of regulatory overhaul and stories of SMSF members writing to themselves as trustees, Vamos said the current regulation was entirely appropriate.

“People mustn’t lose sight of the fact that they are in a SMSF in two capacities,” she said. “As both the trustee and as the member.

“As the trustee of a fund, they have legal obligations,” Vamos continued. “So any legislation that provides for both roles is vital.

“Bottom line, SMSF trustees are wearing two hats. They need to remember that.”

For his part, Colley said he saw the SMSF sector as a relatively robust part of the industry.

“Most SMSFs are complying,” he said. “And I don’t regard the fraudulent cases being highlighted by the ATO as being representative of the SMSF [industry].

“These are funds being set up for the wrong purposes anyway.”

Colley said with regard to compliance, he could see trustee’s knowledge of their self-managed fund increasing.

“Their knowledge of SMSFs is becoming better,” he said.

“Compliance is improving and I say that because we’re starting to get harder questions.”

Looking ahead at how SMSFs might navigate the turbulent markets through to 2009, Johnston said in this kind of environment, everyone was feeling the pinch.

“I doubt anyone was adequately prepared for this level of volatility,” he said. “But with a longer-term view, it is encouraging that SMSF trustees are not being reactionary.”

Vamos said it was not surprising that Australians with wealth at their disposal want to take control of their super.

“People are wanting to take control and they are wanting to invest in assets they wouldn’t normally have access to,” she said.

“That kind of flexibility is what people like, but the industry has to ensure people know what they’re getting into.

“SMSF trustees need to understand that they are taking on every risk — governance, compliance, and investment.” SR