Is it time SMSF trustees reconsidered their cash holdings?

The decision of most investors to hoard cash for the past few years was no surprise, but as Damon Taylor reports, the SMSF investment story might be starting to change.

Having witnessed months of investment market uncertainty, it seems the majority of self-managed super fund (SMSF) trustees have sought safety within their fund’s asset allocation.

Indeed, stories of high cash holdings, a preference for term deposits and flights to quality in listed markets are all too common, and yet for Patrick Giddy, principal at Crowe Horwath, there are signs that the self-managed super fund investment story may be starting to change.

“Undoubtedly, the hoarding of cash has been prevalent but with cash rates having been so high, it’s no surprise that trustees have wanted to take advantage of that security and peace of mind,” he said.

“For our clients, unless it’s warranted to be taking market risk, we’ve certainly had that heavy weighting to defensive assets.

“Yet what we’ve done in-house here is look to utilise the bond market more,” Giddy continued.

“In fact, the bond index has done 11 per cent for the last 12 months to 31 July, 8.6 per cent over three years and 8.1 per cent over 5 years.

“Now don’t get me wrong – with cash at 4.57 per cent, that’s still pretty good, but 11 per cent versus 4.6 per cent?”

Capital appreciation aside, Giddy said that such figures could not help but be compelling, and had therefore prompted a number of SMSF trustees to reassess their options.

“So as interest rates have been coming down, I think a lot of investors are now having this dilemma of having had their money in term deposits where they’ve had 6 per cent, 5.5 per cent, 5 per cent,” he said.

“But those rates are getting closer and closer to 4.5 per cent, so the question before all SMSF trustees is ‘what’s the alternative?’”

Also seeing a gradual shift in the SMSF investment landscape, Eric Quak, SMSF development manager for Russell Investments, said that while trustees were still nervous about equity market volatility, many realised that falling interest rates could be a game changer.

“For many SMSF trustees, cash and term deposits are still an obvious choice when it comes to that investment market safe haven,” he said.

“However, with reductions in interest rates, I think trustees are beginning to look elsewhere for their income needs.

“For many, it’s time to start dipping a toe back into the market and so the yield to be gained from a diversified equities portfolio is proving to be that first step,” he said.

Of course, for Giddy, the ideal situation has SMSF trustees looking at both options.

“There comes a tipping point where a Westpac term deposit is paying you 4.5 per cent for three to six months and you compare that to your grossed up dividend yield for Westpac shares of probably 10.4 per cent,” he said.

“So that’s over double the return and I think you get to that tipping point where people are now prepared to take on a bit of stock market risk to compensate them.

“They might not be going all in, but they’re certainly prepared to put a bit more of their toe in the water.”

SMSF advice: scaled or holistic?

Yet if the investment and asset allocation status quo is changing for SMSF trustees, so too are the sector’s advice needs.

Though always self-directed, trustees are now well aware of what they want when it comes to advice, and for Aaron Dunn, managing director of the SMSF Academy, it is not a full service financial plan.

“As SMSF generations have gone along, financial literacy has improved, and I think that’s where we’re now starting to see even more self-directed trustees,” he said.

“But in that self-direction there’s also an acknowledgment that they will look for advice and assistance as and when they need.

“The old full engagement model where an adviser will manage the whole strategy, investment piece and so forth simply isn’t as common anymore,” Dunn continued.

“As the sector’s become more established and had younger entrants, there’s been this shift, and I guess this move to a coach-seeker trustee.”

What those trustees then relied on, according to Dunn, was triggers that would prompt both action and advice.

“So if they want to buy a property and structure a buying arrangement, if they’re moving to retirement and want to look at a transition to retirement plan, if they get an inheritance and want to figure out whether they put it to debt or tip it into super; these are all life events or events with respect to the fund where they will go off and seek specific advice,” he said.

“There’s this whole range of triggers, and so the challenge for the advice industry lies in understanding what those triggers are, and more importantly, how to make the most of that opportunity when it presents itself.”

Echoing many of Dunn’s comments, Quak said that irrespective of their financial advice needs, control was the constant priority for SMSF trustees.

“So if an adviser’s service proposition is to go in there and look to provide that full service only, if they’re looking to take control away from the trustee, then I just can’t see that type of adviser flourishing,” he said.

“For me, it’s more of a coach-seeking mentality where the trustees have set it up because they want control – a say in their retirement savings.

“They’re happy to work with an adviser to get that outcome, but it has to be on their terms,” Quak said.

Alternatively, while Giddy said that SMSF clients were undoubtedly better educated and better prepared, that fact did not remove the need for holistic financial advice.

“We do have a lot of clients coming in who want one-off, specific advice now,” he said.

“So an example of that might be starting a pension or transitioning to retirement, and they’re after one-off advice around the pros and the cons of that, what they need to be aware of, and so forth.

“And most clients are appreciative that we have certain compliance obligations and so they’re happy to pay fee-for-service for what is essentially that time cost,” Giddy added.

“That said, if an adviser can offer the full service – ie, holistic advice that can cover the full spectrum from structure and strategy to investments, insurance, estate planning and possibly lending, I think that’s still attractive for a lot of clients.”

According to Giddy, the issue lay in what questions were prompted by that initial, one-off piece of advice.

“So it might be as simple as a client coming in with a SMSF and saying ‘I want to start a pension – should I or shouldn’t I?” he said.

“And it evolves from there because I think clients often underestimate what’s involved in running a self-managed super fund from the compliance side and the actual investments side.

“But whether it’s seeing an adviser as a sounding board once every six months or getting what is essentially a full service financial plan, I don’t think entirely self-directed trustees are as commonplace as people think,” Giddy continued.

“They may think they’re self-directed, but they’re generally receiving help in some way, shape or form.

“But is that so surprising? They shouldn’t expect to be able to do it all because they’re often not experts in it all,” he said.

The changing role of a trustee

Of course, if there is one criticism levelled at SMSF trustees that makes no allowance for their level of expertise, it is that their focus on control and flexibility comes at the expense of having the rest of their superannuation house in order.

Indeed, Australian Taxation Office (ATO) regulations in effect from 1 July 2012 and outlining SMSF trustees’ roles and responsibilities seem to speak to this point and, for Giddy, the announcement was significant.

“What’s interesting is that there were a number of new measures introduced which you might have thought were a bit self-explanatory,” he said.

“For instance, as a trustee you’re now required to conduct a review of the fund’s investment strategy on a regular basis.

“That review needs to reflect the purpose and circumstances of your fund and its members and it needs to be documented,” Giddy continued.

“Now, if you’ve got an adviser, that’s happening automatically through regular meetings, but for pure DIY, self-directed funds, they need to be aware that it’s no longer an annual, ‘tick-a-box’ type exercise.”

Of particular note for Dunn was the ATO’s requirement that SMSF trustees consider insurance as part of their fund’s overall investment strategy.

“Insurance is an interesting one, because as of July, an SMSF investment strategy has to give consideration to insurance on behalf of its members,” he said.

“On the face of it, this is because most self-managed super fund members have been underinsured, but to some extent, they were also a significantly older generation of members.

“So while SMSF members have typically had a very very low uptake of insurance cover, whether it be death, total permanent disablement (TPD) or some form of salary continuance, we’re seeing this change now and it’s about making sure that these sorts of things are top of mind,” he said.

On the topic of insurance, Giddy was quick to point out that considering insurance did not necessarily mean obtaining insurance.

“The ATO announcement specifically said that as a trustee of an SMSF, you’re required to consider insurance for fund members as part of the investment strategy,” he said.

“And while that doesn’t mean that insurance has to be included in every fund, it does mean that the investment strategy needs to show that the matter has been appropriately considered.

“So taking the matter a step further, a lot of clients come in and still have their death and TPD cover outside their self-managed super fund and they’re paying for it with after tax dollars,” Giddy continued.

“Now there can be valid reasons for why that may be the case, but from a cashflow perspective and paying for it with pre-tax dollars, it can often make sense to hold that death and disablement cover through the fund.”

But regardless of how insurance is obtained, the clear question mark for the ATO is whether such matters are being attended to appropriately.

For Dunn, the impetus for improvement has been placed firmly on SMSF professionals.

“If we go back to when the Cooper Review was taking place, there was a pretty big push from outside the sector to enforce mandatory education on SMSF trustees,” he said.

“And while Jeremy Cooper and the panel decided against it, they did recognise the need to increase competency within the profession.

“Now, that’s already starting to unfold in terms of the Future of Financial Advice [Future of Financial Advice] reforms and what it’s going to mean for accountants in terms of licensing, auditors in terms of registration and so on,” Dunn continued.

“But the idea is that these are requirements that will raise the bar professionally.”

Dunn pointed to SMSF administration as the perfect example.

“So in administration, people are taking a more regular approach rather than relying on trustees to dig out the shoebox once a year,” he said.

“They’re looking to make sure their clients understand that they, as administrators, can’t do anything at the end of the year if your contributions are more than the cap.

“So across the sector, the business models are changing and the hope is that flows on to trustees as well,” Giddy said.

Yet for Giddy, the fact that trustees’ obligations and responsibilities had been pointed out at all could not help but suggest that, from the regulator’s perspective, certain SMSF basics still required work.

“It’s definitely interesting that the ATO has come out and specifically addressed a number of these issues,” he said. “It does, after all, suggest that maybe not all trustees are handling these things as well as the regulators would like.

“And I guess that is the concern from our side as well,” Giddy continued. “When clients want specific advice on just one particular matter, then maybe not everything’s being looked at.

“With your own fund, you’re the trustee and the buck effectively stops with you,” he said.

Of course, it is that very fact – the reality that the members of an SMSF can invest, insure, plan and control their retirement savings to maximum effect – that makes this sector so appealing.

Not threatened by MySuper

Even in a MySuper environment where industry funds and retail master trusts work to increase the choice and flexibility available within their options, Quak said that SMSFs could not help but provide the lead.

“For those individuals who have chosen to establish an SMSF, and many have done so for that control reason, I think the sector will continue to flourish,” he said.

“And to be honest, I don’t see Stronger Super having any sort of material impact on its growth.

“MySuper may bring an entirely different marketplace, but from my perspective, if the client can take control of their superannuation, they’re probably going to do so irrespective of what other products may come to market,” Quak said.

In the same vein, Giddy said that while self-managed superannuation was not for everyone, it was ideal for those superannuants with the time and interest to take advantage.

“It’s the ultimate in flexibility when it comes to strategy, structure, investments, estate planning, insurances, so I can see no reason why that won’t continue to be the case,” he said.

“I suspect, though, that with the amount of money pouring into self-managed super funds, it will continue to come under a lot of scrutiny from the regulators and probably from future governments as well.

“And rightly so; people need to have their house in order,” Giddy said.

For Dunn, though industry and retail funds would inevitably build more choice and flexibility into their superannuation offerings, the SMSF experience would always stand apart.

“And I think that’s what people are starting to understand and see the power of,” he said.

“It’s not just about being able to invest in shares and being able to invest in property and so forth, because at some point the industry and retail funds will offer that.

“It’s the ability to have control at the top,” Dunn continued.

“It’s having the trusteeship of the fund and making the decisions around that for the betterment of that member group.

“That’s the peace that the industry and retail environment will never be able to offer.”