Cashed up and in control

For better or worse, times of financial uncertainty encourage people to reassess their financial options.

For some superannuants, that might be as simple as adjusting allocations, but for others, the greater control and flexibility inherent in self-managed superannuation funds (SMSFs) might be enough to entice a more significant change.

This year’s uncertainty has come in the form of one of the worst financial crises that Australia has seen, but in the face of that, John McIlroy, chief executive of specialist SMSF administrator Multiport, said SMSF

performance was holding up and would continue to tempt those looking for a superannuation change.

“Based on Multiport numbers, SMSFs are stacking up well against the performance of mainstream funds,” McIlroy said.

“Most trustees have responded to the uncertainty by moving into cash and out of their unlisted managed funds and listed property — those sectors that have been taking a beating.

“SMSF allocations generally represent a balanced portfolio, and that being the case, they’ve been tracking well.”

Richard Gilbert, chief executive officer of the Investment and Financial Services Association (IFSA), said traditional SMSF allocations had probably left most trustees reasonably well placed.

“They’re possibly doing well because they’ve traditionally held a large portion of their assets in cash and fixed interest investments,” he said. “It really depends on the aggression that’s been applied to their portfolios.

“Some SMSF trustees will have gone to advisers and others will have been very conservative, with or without advice. But those funds with large amounts in general equities are certainly the ones that have taken the biggest hits.”

However, for Andrea Slattery, chief executive officer of the Self-Managed Superannuation Fund Professionals’ Association of Australia (SPAA), there has been little in the way of empirical evidence on SMSF performance, with indications that they are more than holding their own.

“This is the first time that the market has been in this position,” Slattery said.

“Yet SMSF trustees are understanding their investment environment and compliance obligations much better than they might have previously.

“The only way anyone would know about a self-managed fund’s return on investment would be to examine that particular fund in detail,” Slattery said. “But data from the Australian Taxation Office (ATO) has shown that trustees are picking reasonably balanced options and, at the moment, we’re seeing no trends saying that SMSF trustees are stepping out of that.”

Ready cash

Like Slattery, Paul Little, financial adviser for Landmark Financial Management, regretted a lack of empirical SMSF data but said he wouldn’t be surprised if the self-managed sector of superannuation was acquitting itself well in the current environment.

“Traditionally, self-managed funds hold a high proportion of their assets in cash compared to retail and industry funds,” he said.

“In this instance, that allocation may have been held simply because they haven’t got around to moving it. But regardless of whether it’s been a conscious decision, a strong preference for cash has been a good option under current circumstances.”

Irrespective of how SMSFs have performed compared to their mainstream counterparts, these are undoubtedly the toughest times any trustee has had to face. Yet a tendency for SMSF trustees to be older, more experienced investors might have meant fewer panicked decisions.

That experience could even have been the difference between SMSF account balances stumbling or remaining firm, but according to Little, trustees’ reactions depended on how many periods of volatility they had been through before this one.

“Panic is probably too strong a word because this has been a significant market downturn, even compared with previous downturns,” he said. “And generally that’s meant that a number of SMSF trustees have been re-educated about what diversification really means.

“In my experience, most SMSF trustees tend to be undiversified and pretty focused with respect to their fund’s allocations,” Little said.

“Over the years, the dog stocks within equities portfolios are sold off and the winners are kept. The portfolio becomes increasingly concentrated and this creates a rather large exposure to losses if the stocks kept are those being hammered.

“But the difference at the moment is that everything is being hit. The disadvantage isn’t as noticeable.”

Craig Day, technical services manager for Colonial First State, said it was too early to tell whether the challenges of 2008 had impacted either the strategies or day-to-day running of SMSFs.

“Most volatility occurred in the second half of 2008, so we will need to wait until audits are completed in June and July,” he said. “But the response from most SMSF trustees seems not to have involved significant changes to their long-term strategies.”

Day said he had not seen panic from SMSF trustees.

“The trustees of SMSFs tend to be control oriented,” he said.

“Asked what they find most difficult, most trustees will point to the compliance and administration aspects of running a self-managed fund rather than investment or investment strategy.

According to Day, SMSF trustees tend to understand the finer points of investment markets.

“So for any cash they may have had leftover, whether from Simpler Super’s $1 million dollar ‘window of opportunity’ or otherwise, trustees are tending to hold off from investing it.

“They’re waiting for market stability and they know the dangers of knee-jerk reactions,” Day said.

Little added that while every fund’s portfolio has stumbled, another lesson being relearned by SMSF trustees was the difference between liquid and illiquid assets.

“Trustees have realised that volatility is the price you pay for liquidity,” he said. “And as a number of people have been hitting that liquidity crunch, they’ve come to realise that the illiquid parts of their portfolio really aren’t doing their intended job.

“They’re simply not generating enough return. There’s nothing wrong with illiquid assets, but you have to be aware of their constraints and you have to be aware of the necessity of higher returns.”

Little said that illiquid assets needed to produce superior returns to liquid investments because they were more difficult to sell in market downturns.

Steady hands

For Gilbert, anecdotal evidence points to a tendency by SMSF trustees to regroup and go back to their advisers.

“Most are sitting and waiting for the market to get better,” he said. “They’re drawing on their cash and fixed interest and leaving their equities allocations alone until they improve in value.

“The trustees of SMSFs may have seen market downturns in the past, but the lessons learned this time around will definitely be longer lasting,” Gilbert added.

He believes it will be a while before we see aggressive, high risk portfolios again.

“All investors, and perhaps SMSF trustees in particular, are likely to be very careful moving forward,” he said.

According to Slattery, SMSF trustees will not have to look very hard to find advantages in having endured the challenges of 2008 and in enduring those 2009 will surely bring.

“It’s only my personal opinion, but when anyone has travelled through the highs and lows of a market downturn they gain experience,” she said. “And that experience cannot help but assist with their decision-making in the future.

“People may be more

conservative or more risk-taking in the years ahead, but they are bound to be better armed with that experience behind them.”

For those SMSFs that have experienced significant losses despite the level of experience behind their trustees, McIlroy said much of the blame could be placed at the feet of poorly performing property funds.

“Going back to December 2007, I would have said the typical SMSF portfolio held assets very akin to a balanced portfolio,” McIlroy said. “But the ones that have fallen off their perch have been those in which trustees have used listed and unlisted property funds; funds that have had their index drop more than 50 per cent over the past 12 months.

“It was an area many trustees were advised to weight heavily due to the good income they provided. But in the midst of this financial crisis, they’ve dropped away significantly and have placed those SMSFs that maintained their allocations in a much worse position.”

McIlroy added that from his perspective, the SMSF stereotype of a marked preference for direct investment in Australian domestic equities and property continues, and only time will determine whether that preference is advantageous in the current circumstances.

Agreeing with McIlroy, Little said SMSF trustees continued to be hands on, taking full advantage of the flexibility and control available within their superannuation arrangements.

“SMSF trustees tend to be hands on,” he said. “But within their ranks there are three distinct camps.

“The first group have chosen a SMSF as their retirement vehicle [because of] a preference for direct property investment,” Little said. “The second group prefers to be more hands on and enjoys the control they would not otherwise be able to exercise.

“And the third group has started their self-managed fund due to a concern over fees.”

Little said it was this third group of self-managed super trustees that is struggling with their direct investments the most.

“That third group is learning that fund manager fees are there for a reason,” he said. “Investment is easy when markets are buoyant, but the job gets much harder in times of crisis.”

In spite of Little’s concern, Pauline Vamos, chief executive officer of the Association of Superannuation Funds of Australia (ASFA), said she did not worry about SMSF trustees adhering to the sound investment strategies that would see them through tougher times.

“When you look at the number of self-managed funds within Australia’s superannuation industry and look also at the significant proportion of assets that those funds represent, then you’re looking at a relatively small number of people with a great deal of money,” Vamos said.

“People in that position can afford to obtain proper advice. And that is largely because they have investment strategies that are linked to their overall wealth position.

“For them, a SMSF is part of their entire wealth position, including assets they might have outside of super,” Vamos continued. They’re not likely to risk it on poor decisions or poor advice.”

SMSF service gap?

But not everyone in Australia’s superannuation industry shares Vamos’ confidence that SMSF trustees are obtaining advice.

Investment strategy and trustees’ understanding of their compliance obligations remain in question, and advice, taken up appropriately and to an adequate degree, seems to provide the answers.

McIlroy suggested that the problem might lie in a lack of providers offering specialised SMSF advice.

“There aren’t enough SMSF trustees taking up advice, but I think in the current environment many trustees are a bit sceptical about how much value an adviser can add,” he said. “But even if they’re not using a financial adviser on a day-to-day basis, Multiport’s experience has been that they should still be looking to people to get second opinions.

“The feedback we’ve been getting from trustees is that they’re tending to question the value of paying 1 per cent to 1.5 per cent per annum to a financial adviser, particularly when they’ve experienced negative returns,” McIlroy said. “And perhaps that’s due to a gap in the advice services offered to SMSFs.”

Historically, Day said SMSF trustees relied heavily on advice from accountants, but added that he could see a preference for a more rounded advice package emerging.

“Up to 50 per cent of self-managed super trustees are now obtaining financial advice,” he said. “And that’s been for two reasons.

“In the first place, financial advisers are targeting the self-managed sector of the super industry. They’ve realised that it’s a growing sector and are therefore very interested in making it a growing part of their businesses as well.”

Day said the second reason came down to the new requirements that have been placed on financial advice and its independence.

“Accountants are well aware of the new rules and requirements and the need to be more careful. And it’s left a gap that can be filled by financial advisers,” he said.

“At the end of the day, most trustees are aged between 45 and 60. But there’s only a very low proportion currently in retirement.

“We’ll see that transition to retirement in the next 15 years and at that point, we’ll see most, if not all, trustees seeking advice.”

Pointing again to gaps in the advice package offered to SMSFs, McIlroy said SMSF trustees could use advisers all the time or not at all, but there was very little in the way of a middle ground.

“If a SMSF trustee uses an accountant then they may be getting advice on the compliance side of their fund,” he said. “But they won’t be getting financial or strategic advice.”

According to McIlroy, there are three components to running a SMSF: the investing that many trustees do themselves, the compliance and the strategy, which includes tax management, estate planning, contributions and so on.

“That last part is the area in which giving advice is most difficult and if their advisers aren’t experienced, SMSF trustees will be missing out,” McIlroy said.

Given the statutory requirements placed on SMSFs and their trustees, Slattery said there should be ample opportunity for trustees to obtain advice.

“SMSFs have two statutory requirements in an auditor and an actuary,” she said. “If trustees don’t lodge their own returns, then they must also use a tax agent. And if they don’t maintain their own investment strategy, then they must look to a financial planner.

“Add a lawyer to that and there’s effectively five points of advice,” Slattery continued. “Obviously SPAA encourages the use of specialist SMSF advisers for the assistance they can provide in making better decisions with the right skills.

“Yet in those five points of advice, trustees could already be getting the advice they require.”

SMSF growth

Irrespective of advice or performance, the growing popularity of SMSFs seems to have assured the sector of a long-term position within Australia’s superannuation environment. And even in times of financial crisis, anecdotal evidence points to SMSF growth remaining strong.

Day said SMSF setups certainly seem to have increased over the past few months.

“It seems to be a long-term trend,” he said. “The trigger being poor returns from people’s mainstream super funds and dissatisfaction with the fees they’re being charged.”

Sharing Day’s view, McIlroy agreed that market downturns had a habit of producing people who thought they could do a better job investing their retirement savings than their mainstream super funds and asset consultants.

“Multiport has definitely seen an uptick in SMSF setups,” he said. “It’s really a repeat of the experience the industry had following 2001’s market hiccup.

“Rightly or wrongly, people have that view.”

Strongly disagreeing with Day and McIlroy, Slattery said history had shown SMSF growth to be very even in recent times.

“If you go back and look at the sector carefully, if you look at all the openings and closings that have taken place, the growth has been very evenly spaced,” she said.

“There are times in the year when ATO data will show

spikes — in May/June and December/January — but if that growth is averaged out over the year, then there should have been less setups in the good times.

“In fact, during those times SMSFs have opened at a similar rate. At the moment we may have a slight increase in the number of openings, but the industry is seeing that same increase in the number of SMSFs closing. It evens out.

“It’s been very even net growth and it shows that the anecdotal evidence is perhaps not as correct as the evidentiary information.”

Looking beyond the financial crisis afflicting all superannuation account balances, Day said he saw few reasons why SMSF growth should not continue.

“People are becoming more interested in their superannuation as they see the tax benefits that it provides,” he said.

Regulatory brakes

“Australians typically have a high level of share ownership and they like the control, so as superannuation account balances reach the point at which a SMSF is justified, a SMSF setup continues to look attractive.

“The only thing that could change that trend is a greater Government interest in SMSFs,” Day continued.

“If the setup or running of a SMSF has greater requirements placed upon it — a minimum balance, for example — then that could change.

“But unless that happens, I can see few reasons why SMSF growth wouldn’t continue and a great many reasons why it should.”

Commenting on a number of industry submissions to the Government on SMSFs, Slattery admitted they have the potential to have a significant impact on the sector’s growth.

“A number of those submissions are around barriers to SMSF entry,” she said. “They suggest, for example, requirements on minimum balances or compulsory trustee licensing.

“And if they come into effect, those barriers will have a significant impact on SMSF growth.”

McIlroy said he also saw SMSF growth continuing.

“But it should slow in the next few years,” he said. “You really need a balance of at least $300,000 to start these things and there’s only a small percentage of the population who have that.

“There really are only a finite number of people who could or should have these funds.”

So where does that leave SMSFs? Are they likely to come out of this financial crisis unscathed or having acquitted themselves well, or simply as another sector of Australia’s superannuation industry?

Day said he expects SMSFs to continue to be a significant part of Australia’s superannuation system.

“But a part of the system that has particular attraction to certain people,” he said.

“SMSFs won’t ever be the best option for everyone due to the obligations and responsibilities involved. But for those with the interest, the time, the knowledge and the balance, they will remain attractive and for that reason, remain a significant part of the industry.”

SMSF trustees still struggle with compliance issues

AS the reality of 2008’s financial crisis dawned on Australia’s superannuation industry, fund executives, trustees and members remained understandably focused on poor investment returns and struggling account balances.

Yet, even with such vital issues taking centre stage, SMSF compliance and the Australian Taxation Office’s (ATO) continued examination thereof continued to take its share of the spotlight. Technical services manager for Colonial First State, Craig Day, believes it certainly seemed to be an ongoing issue.

“The ATO began regulation of self-managed super funds in 1999,” he said. “They started with education but they are now taking a more strident approach.

“The message being delivered to SMSF trustees is that they have clear responsibilities, that they must comply with those responsibilities and that severe action will be taken against those funds with significant breaches,” Day said.

“So far, the situation seems to be improving but there is a way to go.”

From an SMSF administrator’s perspective, John McIlroy, chief executive of specialist SMSF administrator Multiport, said that Multiport took over the administration of many SMSFs with terrible compliance.

“We see issues much worse than those used as examples by the ATO,” he said.

“Of the funds we’ve taken onboard, we’d be very lucky if more than 50 per cent had an investment strategy in place.

“It’s a fundamental requirement of running an SMSF and indicative that the sector has a lot of room for compliance improvement.”

McIlroy expressed the view that compliance issues were likely to be a constant reality for the self-managed sector of superannuation.

“The sector is different from every other area of super,” he said. “Compliance in mainstream super funds is day by day but in SMSFs, the compliance focus might occur once every 12 months. And on that basis, compliance issues are bound to come up.”

McIlroy suggested the solution to SMSF compliance lay in ensuring the sector’s service providers knew what they were doing and did the best job possible.

“It’s unrealistic to think that the ATO can educate 500,000 people,” he said.

“They have to focus on SMSF trustees or SMSF service providers, but perhaps providers — being smaller in number — are the better option.”

On the other hand, Andrea Slattery, chief executive of the Self-Managed Superannuation Fund Professionals’ Association of Australia (SPAA), said there had been clear improvement in the SMSF compliance program.

“There continue to be non-complying funds,” she said. “But there is also greater governance and corporate responsibility in the programs being undertaken by the ATO.

“Actions have been taken against certain sections of the market, but overall compliance has certainly improved.”

With respect to SMSF compliance solutions, Slattery said specialised SMSF auditors would improve compliance programs dramatically.

“But if there is also an increase in specialised advice, then it enables better decisions and an increase in trustees’ information and understanding,” she said. “By extension, issues at the fund level improve as well.

“It has only ever been a significant minority of SMSF trustees that have had problems,” Slattery said. “And those are due to a lack of knowledge, a lack of good advice and the lack of a solid process.

“Problems haven’t arisen because SMSF trustees wanted to be doing the wrong thing.”

— Damon Taylor