Servicing the DIY sector

In a year of regulatory upheaval in many areas of the financial services industry including superannuation and the Future of Financial Advice (FOFA), the self-managed superannuation fund (SMSF) sector remains relatively unscathed.

The Financial System Inquiry (FSI) touched on the SMSF sector in two areas: limited recourse borrowing arrangements (LRBA) and the concessional tax treatment of earnings and contributions.

Regulation of the SMSF sector landed on the Australian Taxation Office's (ATO) lap in 1999, and the sector has since burgeoned to 545,334 SMSFs, and over one million members. Of the $1.85 trillion invested in superannuation, $560 billion is in SMSFs.

Regulatory reforms, increased focus on specialisation, technology advancements, and the evolving nature of trustee types present the perfect opportunity for financial advisers and planners to re-evaluate their business structure to meet the challenges and embrace the opportunities ahead in the growing SMSF sector.

Different people/Different needs

Even in an area like SMSFs, where many trustees say they are self-directed, they are still looking for expert input from financial advisers to make their investment decisions.

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But the advice needs of SMSF investors are not homogeneous, which means advisers have to tailor their advice to individuals. This presents a real opportunity for advisers to cater to the self-directed market, even if it is to provide guidance.

While some are looking to maximise growth, others want to protect existing assets and income against market crashes. Around 35 per cent of respondents to an Investment Trends/Morningstar survey said they want a balance of capital and managing risk.

According to Morningstar, trustees are looking for advice on choosing investments, second opinion or validation of their decisions, and technical advice.

Self-directed investors also see the appeal in using third party research and data to assist them in their investment decisions.

Investment Trends and Morningstar's ‘Investor Product Needs Report — The Importance of Advice' showed that almost 23 per cent of the 787 SMSF clients surveyed use advisers to access a wider selection of investments, while an equal amount go to advisers for a second opinion.

Over 20 per cent stopped using advisers due to poor outcomes, mainly due to the global financial crisis.

Morningstar's director of manager research, Asia-Pacific Grant Kennaway said SMSF trustees see advisers as a source of knowledge who can help them gain access to a broader range investments rather than resorting to the traditional Australian stocks and cash.

"Traditionally, SMSFs have been full of Australian direct shares and cash. They've held Australian banks, life company stocks, and had a fair bit of cash but with people looking for more diversified portfolios, access to exchange traded funds (ETFs) and listed investment companies, they are generally more interested in overseas shares or stocks and they're trying to get more global exposure," Kennaway said.

Yet investors face significant barriers that prevent them from investing overseas, which means advisers have a role in shattering these barriers to more global investment.

Around 42 per cent of the 743 surveyed feel they do not know enough about the overseas markets, while 25 per cent find it a hindrance that dividends on international shares are not franked. A small group fear exchange volatility and feel the Australian market performs better for them.

Investment Trends' senior analyst, Recep Peker, said that in 2014, 23 per cent of respondents said they prioritised ‘maximising capital growth' over the next year, the highest in the past six years.

He also said 32 per cent wanted to balance growth and manage risk, while building a sustainable income stream stood at 33 per cent in 2014, down from 45 per cent in 2011.

Kennaway said SMSF investors are keenly aware of the strong performance of the US share market and the growth in Asia, adding they are actively looking to get offshore.

But around 14 per cent of 774 respondents feel they do not have enough knowledge about overseas markets, which provides advisers with an opportunity to move into this space to lure this segment.

There are multiple areas where investors would like to receive advice but currently are not. Almost 13 per cent are seeking investment strategy advice, 11 per cent want advice on investing for a regular income, 15 per cent want advice on inheritance and estate planning, while almost 15 per cent just want reassurance their money will last their lifetime.

"I think this shows you how non-homogenous the whole sector is," Kennaway said, who added that there is an opportunity for advisers to specialise in certain areas of SMSFs.

"If you're an advice provider or a financial adviser or someone who specialises in advising SMSF trustees or you're an external provider of third party research or data, it just shows that there are a number of niches that are special: exchange traded funds, and technical areas like tax planning, longevity risk, estate planning."

Getting down to the specifics

Professional bodies face the uphill battle of convincing professionals of the need for SMSF specialisation and its role in advisers being successful in this space. While it is not the cure-all, the Future of SMSF survey by the SMSF Academy found that specialist businesses had more SMSFs and fee revenue compared to generalist businesses.

These businesses have been quicker to adopt technology and have seen the upside to automation through efficiency gains and firm profitability.

The research also found bigger firms are more willing to set up specialist divisions to service SMSF trustee clients. It showed three out of four businesses with fee revenue between $2 million and $4.99 million have a specialist SMSF offering within their firm.

Counting the accountants

When the SMSF Academy sought to find out the composition of the SMSF space, it perhaps came as no surprise that accountants dominated the sector. The Future of SMSF survey had 430 respondents, out of which accountants made up 61 per cent, representing the biggest professional category.

Meanwhile financial planners comprised only 10 per cent, while administrators (10 per cent) and auditors (five per cent) made up the rest.

Considering these numbers, it would not be far-fetched to expect accountants to be lining up at the Australian Securities and Investment Commission's (ASIC) doors to move into licensing, either limited or full.

Yet as ASIC deputy chairman, Peter Kell, pointed out, accountants have not exactly been knocking down the door to sign up to the new licensing arrangements replacing the accountants' exemption.

Kell said that even though 10,000 accountants are expected to participate, only a tenth of this number had expressed interest so far.

He told the SMSF Association annual conference in Melbourne that the regulator had received only 105 applications so far, with only 44 receiving approval.

So will there be a mad rush at the last minute?

SMSF Academy managing director Aaron Dunn seems to think so.

But the more pertinent question on Dunn's mind is whether accounting businesses will opt to become authorised representatives in the immediate future to avoid the costs and hassle of attaining an Australian financial services licence (AFSL).

The cost of attaining a licence could be between $20,000 and $50,000.

"I think we're naturally going to see more accounting businesses work under an AFSL rather than their own AFSL because they're going to have to have their advice training wheels on for a period of time to make sure that they understand all the nuances that come with advice," Dunn said.

"Many accountants would be confident in their ability to provide the advice, but within the financial services framework they need the support at least for the first few years to get them through that."

Dunn believes as much as 80 per cent of accountants will become authorised representatives in the short term, while less than 20 per cent will venture into the self-licensed space. But this could change over time as accountants ease into the licence space.

SMSF Association CEO Andrea Slattery worries that if accountants do not start the transition very soon, they are going to leave it too late to advise on SMSF. She highlighted the confusion that exists for accountants as they try to move into unchartered territory.

"The confusion is more that they are unfamiliar with the licensing world and the AFSL world. The way their practice is set up is partnerships and professionals.

"To set up under the licensing regime with licensees and product providers and other forms of requirements under a licence, accountants need to decide what they need to continue their business in this area," Slattery said.

SMSF administrators Xpress Super and SuperGuardian CEO Olivia Long said accountants will need to think about whether they want to continue providing SMSF services, and will have to get moving on licences if they do. They also have to decide if they want to work as an authorised representative, and they need to do the research on what the licensee conditions are.

"The other option is to consider whether or not they want to use this opportunity to revolutionise their whole business offering and actually look at getting their own AFSL and expanding into other areas of strategic advice for their clients," Long said.

However, with accounting practices lacking time to keep up with administration duties, Long also believes accountants will work as authorised representatives under somebody else's guidelines, and they will outsource clients.

Be rational about it

Although the SMSF sector has been known as the "cottage industry", and disruption to the industry is still not rampant, rationalisation of service providers is happening.

Data from the ATO showed there were nearly 8500 registered tax agents servicing less than 20 SMSFs in 2013 while 3600 tax agents provided services to less than 100 funds. The average number of funds per tax agent has increased from 21 to 31 funds, while the number of agents undertaking less than 10 funds has dropped by 10 per cent.

"That will be hit hard by the accountants exemption removal," Long said.

"I would assume at those volumes that there are very few that are going to decide to continue to provide that service given the level of complexity and cost that's now being introduced to their business."

The data showed over 12,000 tax agents are currently servicing less than 100 funds, making it an ideal target market for outsourcing arrangements.

Furthermore, last year, regulatory changes seen as an attempt to lift competency levels saw ASIC cancelling 440 SMSF registrations of auditors who did not sit or pass a competency exam required to keep their registration.

Limited time for borrowing?

Taking a conservative stance on LRBAs, the FSI called for the government to reinstate the general prohibition on direct borrowing by super funds by stripping out Section 67A of the Superannuation Industry (Supervision) Act 1993. The Inquiry insists that super should be a savings mechanism for retirement income, and worries that borrowing, even with LRBAs, will multiply the gains and losses from price fluctuations of assets held in funds, and will increase the chances of huge losses within funds.

The FSI noted that over the last five years, the amount of money borrowed via LRBAs surged 18 times, from $497 million in June 2009 to $8.7 billion in June 2014.

But Dunn believes that rather than weed out LRBAs it just needs a few tweaks, adding that "you don't need to crack an egg with a sledgehammer".

He urged the government to make 67A and 67B a financial product, lamenting that this legislation lapsed under two former governments due to elections being called.

He argued that if it required somebody to be licensed to make a recommendation around LRBAs that would eliminate some of the concerns in the marketplace around issues like property spruiking and prioritising product over advice.

Curtin University associate professor in the department of taxation Helen Hodgson acknowledges that the LRBA problem has not surfaced yet, as interest rates remain low. But if that changes, she said things will become dangerous for SMSFs with LRBAs.

"Once you start to reach the retirement phase, and you have to start to pay a certain amount after the super fund, they don't have the cash flow because all of the cash flow is required to pay the loan," Hodgson said.

"At that point the SMSF either has to find another source of cash or they have to sell the property or they have to defer their retirement plans because the regulations say that you have to have at least four per cent as a starting figure to return as a pension once you go into the pension phase of the amount of your contributions."

If a trustee has property that is leveraged and not negatively geared, but they do not have any surplus cash flow, Hodgson worries that once they start making contributions and move into retirement, they have got nothing coming in to pay the required four per cent.

"I think the ban should happen because while the problem hasn't hit us yet there is a problem brewing. When it starts to happen in large numbers the Government will sit up and pay attention," she said.