Providing financial advice to SMSF trustees

SMSF trustees are an unpredictable bunch, writes Tim Hewson. He sifts through recent research that assessed the attitudes of these independent investors.

Increased professional standards for financial planners may well be an outcome of the Ripoll Inquiry, but there are still questions arising about how advisers will be perceived by one of their most valuable client groups.

Looking at the results of the latest Raboplus research into DIY investors, it’s clear that self-managed superannuation fund (SMSF) trustees still want and need a helping hand when it comes to meeting their investment expectations and trustee obligations.

This group continues to turn to a range of independent advisers given the increased complexity of superannuation, so any legislative changes arising from the Ripoll recommendations — particularly the emphasis on a fiduciary duty of care that puts the clients’ interests ahead of the planners — can only be a positive thing for trustees.

Despite the market conditions, SMSFs continue to flourish.

In 1999 there were roughly 200,000 trustees, and now, a decade later, that number has surged to 750,000.

Their typical profile reveals a fairly diverse demographic, with a bias towards professionals and the self-employed. Ninety per cent of funds have two members or less.

Essentially, the SMSF structure allows individuals to be both trustee and beneficiary in a tax concessional environment — although regulators sometimes find this notion a little challenging.

There are several developments under way with big potential effects. Firstly, the Henry Review may well flag further changes to tax breaks and superannuation, and the recent findings of the Ripoll Inquiry are likely to ripple through the advice industry with much tougher standards.

But the idea that trustees should take more responsibility (rather than less) for their investment decisions and actions still stands.

When Raboplus ran its DIY investor research in May last year, we not only gleaned fresh insights into the minds of trustees on a number of issues, but also identified a few potential gaps in their thinking.

For instance, as many trustees grow older and approach retirement, we would expect a change in their investment behaviour to account for the need to protect their retirement savings (along with the increased risk and volatility of the past two years).

At the very least, we would expect investors to become more defensive in their investment strategies, but our survey results indicate otherwise.

Looking at the year ahead, SMSFs told us they would like to increase their growth assets, with the three preferred investment types being shares, cash and property — in that order.

SMSFs are also more likely to consider managed funds while general DIY investors have thought more about cash and fixed interest.

Shares rather than property are back in favour with SMSFs, although they remained cautious at the time of interview.

This was against a fairly fresh backdrop of lessons learned from the global financial crisis, which had provided powerful reasons for portfolio reconstruction.

Changes to short-selling rules, margin lending, hedge funds and stock borrowing were also affecting the retail investment market at the time.

And yet, very few SMSFs undertook major changes in their portfolio mix between 2008 and 2009 despite indications in our research that they would if they could.

Our research found that only one in three SMSFs were happy with their current investments — down from 40 per cent in 2008.

But there was a strong resistance to trying something new or changing their approach with less than one in five willing to do so — so what’s going on?

We know that investors who suffer a certain level of loss tend to become more inert in their decision-making, and yet if these SMSFs want to exercise greater control over their investments, they’re certainly not willing to walk their talk.

This is the territory that the regulators wish to carefully patrol. They have long questioned whether SMSFs are being set up by the right people and for the right reasons, and one can see why this debate continues.

The key questions remain about a trustees’ understanding of their obligations, and the basics of developing and implementing an appropriate investment strategy.

Many funds are still failing to document their strategies appropriately — possibly because of their lack of knowledge or the lack of time spent reviewing their portfolios.

In our survey, only one in four SMSFs in 2009 reported any enjoyment in investing (a 10 per cent decline from 2008). This is interesting when you consider these trustees were keen to initially have control when they set up their super fund.

The value of advice

Initially SMSFs threatened to make advisers redundant, but the reverse appears to be true.

Our research indicates that SMSFs are more likely to take advice than non-SMSF investors, and any further tax deductibility on that advice will presumably be a plus.

Limited or specific advice under a fee-for-service structure may be more suitable for these investors.

Indeed, our study showed that 44 per cent of trustees had consulted an adviser in the past 12 months, with 30 per cent involving an adviser in their investment decisions and 42 per cent using an advisor as their main source of information (after their partner/spouse).

Other survey results

Trustees have adjusted their return expectations down over the past 12 months, but are still more aggressive than the average DIY investor (down 16 per cent from 13.1 per cent in 2008 to 11.1 per cent in 2009, versus a reduction of 25 per cent from 12.2 per cent to 9.2 per cent).

Most interesting is that at the time the survey was conducted, SMSF trustees still expected to earn double-digit returns. But how?

Outside of super, cash still has their highest allocation (29.2 per cent), but this is still lower than non-SMSF investors (35.2 per cent) making them more aggressive in their non-cash allocations.

External to super investments, SMSFs also have a higher allocation to investment property, managed funds, bonds and structured products than non-SMSFs, but lower equity and cash allocations.

So have they been busy rebalancing their portfolios?

Inside SMSFs, compared to 2008, there’s been an increased allocation to shares — typically more aggressive than with non-SMSFs — and a reduced allocation to managed funds and bonds.

The key reasons for SMSFs making changes in their portfolios are based on the drive for better returns, while over half of non-SMSF investors said they changed their portfolios due to market volatility.

The reliance upon cash continues, but the majority of respondents were likely to consider equities (62 per cent) while keeping their eyes on long-term returns and fees.

We also asked investors how they would behave if they had a clean slate and an extra $500,000 to invest. SMSFs said they would increase their allocation to all other investment types, and would decrease their total allocation to super.

These investors also told us that any reallocation would be made to higher risk investments, such as shares.

This could be at odds with industry thinking about age and risk profiles, and how this desire for more risk (and reward) fits into the conventional planning model.

However, SMSF trustees still appear to have faith in the value of advice when you look at the current uptake rates, and given their predilection for direct investments, they may well gravitate towards advisers who think outside the square.

Only time will tell.

Tim Hewson is the investments manager at RaboPlus.