SMSFs rise to meet new challenges

The unfolding SMSF story is an interesting one, according to Damon Taylor. The sector has enjoyed significant growth and success in recent years and is here to stay, but how will it respond to proposed changes?

There is little doubt that the self-managed funds sector of superannuation has made some significant strides in recent years.

Love it or hate it, the sector now enjoys an enviable position in terms of funds under management, industry acknowledgement, and apparent popularity.

But while it is easy to point to superannuants’ desire for control as the reason for such a trend, principal and head of superannuation audit and consulting for WHK, Chris Malkin, believes that position has been brought about by a combination of factors.

“It’s certainly not confined to the desire for control,” he said. “I’d say there’s probably a bit of uncertainty as a result of Europe and the impact that that has on the marketplace in Australia, but I also think people in the very large funds have probably been a little bit sceptical about their returns over a long period of time.”

“So [it is] the fact that they hold such a view, combined with their own expertise and the ability for a self-managed fund to diversify away from managed investments into property and direct share investments,” continued Malkin. “It means they feel that they can do it as well, if not better, and probably contain the fees a lot as well.”

“There’s no one reason here; it’s definitely a combination of factors.”

But while Malkin is of the view that self-managed super fund (SMSF) sector growth goes beyond control, Peter Hogan, principal of Plaza Financial and director of the Self Managed Super Fund Professionals’ Association of Australia (SPAA), said control was commonly held to be the number one reason.

“When you look at all the surveys of trustees of self-managed superannuation funds, control is clearly the number one issue that they cite for setting up a fund,” he said. “But that arises for a number of different reasons, and what’s happening in the market has traditionally been a catalyst for people setting up their own funds.”

“It’s almost like an inverse reaction; the worse the markets do, the more self-managed super funds are set up.”

Beyond control, Hogan said an increase in the number of self-managed super fund trustees holding onto their accounts into retirement had also been a factor.

“There are also more people hanging onto their SMSF into pension phase now than there were in the past,” he said. “A lot of people found the whole prospect of running an income stream out of their SMSF quite daunting, particularly when they have to start registering for tax and deducting tax and remitting it to the tax office, and so on.”

“It was a complex procedure, but it’s less so now, with pensions for over 60s being tax exempt, and generally – provided that the fund is 100 per cent in pension phase – it can be a fairly straight forward exercise these days,” Hogan continued.

“Estate planning opportunities and abilities in that space may also be part of the reason, insomuch as you can be quite specific about who you leave your money to in the event of your death.

“That is clearly another advantage available in SMSFs, and just one more part of their overall attraction.”

Yet while the attraction of an individual being in control of their own retirement destiny is clearly telling, one would hope that the SMSFs can attribute their success to improvements in the sector’s overall running as well.

Fortunately, Hogan believes the sector’s professionalism has grown in line with its superannuation industry market share.

“The quality in terms of the work that’s being done for SMSF trustees has indeed improved,” he said.

“The ATO [Australian Taxation Office], for example – while they’re still saying that there are professionals out there who haven’t done as good a job as what they should have done for their SMSF clients, they have a much greater confidence in the financial planners, the accountants, the auditors, and in the work that they’re doing in this space all together compared to ten years ago.

“There is a higher level of competency in terms of the financial advice and the assistance being given to trustees of self-managed super funds, certainly.”

Alternatively, Graeme Colley, superannuation strategy manager for OnePath, said that based upon the evidence available, there was still room for significant improvement.

“I think the only objective view you can get on this is what the ATO is saying,” he said.

“I was on the SMSF working party for this, and the ATO was indicating quite clearly that there were professionals out there that weren’t conducting audits of SMSFs, and the way in which the funds were conducted was very ad-hoc and very haphazard.

“Now if that’s indicative of a portion of the self-managed fund market, then the competencies of financial advisers certainly need to be improved, particularly on the margins,” added Colley.

“So yes, overall, the competency of financial advisers to this sector has improved, but it still has a way to go.

“And you’ll probably see that pan out over the next few months once we start to see the legislation for auditors, accountants, financial planners and to see whether it will actually require another bit of a jump to improve the competency of those professionals further.”

However, the important point to be made, according to Hogan, is that there are always going to be opportunities for improvement.

“That’s just the nature of the beast,” he said. “At the end of the day, this is a very complicated area, and it does require people with a good understanding of what it is that they’re doing and their role in the area.

“Even to simply start an SMSF, you initially have lawyers involved in putting together the trust documents, you’ve got financial planners with the investments, you’ve got your accountants with annual accounts and the audits, and so on,” Hogan continued.

“So it’s not just a single adviser structure that you’re dealing with and, in that sense, it’s pretty important that everyone involved in running the fund is doing their part appropriately.”

But whether you believe that the running of the SMSF sector is where it needs to be or feel that it continues to cause concern, a certain amount of change has already been flagged in terms of service provider requirement and competency.

As Colley has already alluded, the Government has made clear its intention to raise service provider professionalism. Top of the list are auditor registration and independence, and the removal of the accountants’ licensing exemption, but the question remaining is how the sector is likely to respond.

For Malkin, however, the sector’s response is not a concern.

“I think the sector will respond very positively but, more importantly, I think it has responded very positively to date,” he said.

“As far as auditors are concerned – which is my area of interest – I welcome the increasing competency requirements of approved auditors, and I welcome the policing of the standards required within the Australian auditing standards, and of course the application of a lot of the competency requirements put on by the accounting profession – particularly the ICAA [Institute of Chartered Accountants in Australia] and CPA Australia.”

“There’s enough rigour in all of that in order to satisfy the regulator,” Malkin continued.

“I also believe that the further restricting of accountants is not a good thing, because I think properly professional and qualified accountants – and again I would reference CPA Australia and the ICAA as being the two major bodies – have disciplines that are very sound.”

Also speaking to auditor independence specifically, Hogan said that there had already been strong moves by firms in setting themselves up solely as SMSF auditors.

“So that’s all they do, and it’s with a view to having that work referred to them,” he said. “And with the accountants that are referring the audit to them, it’s being done on the basis that they’re independent of the financial advice that’s being given.

“So in the past, accountants have been reluctant to refer any client to someone else to undertake a function due to a concern that that person might actively try to take over more work from that client,” Hogan continued.

“But now what we find is that we have purely audit firms that can do audits without having any interest in any of the client’s business outside of that space.

“And that’s been a response to that whole issue around independence.”

Hogan also predicted that the proposed registration of auditors would cause a number of current providers to move out of the SMSF space completely.

“They will just see that the amount of time and effort and work involved in maintaining that registration is not going to make it worthwhile to do,” he said.

“That potentially means that there will be fewer auditors available to audit funds, but on the other hand, the auditors who do continue on in that area will certainly be people with a higher degree of capability in doing that work.

“It will be a win for the industry overall, because what we need is exactly that – that higher degree of competency.”

Changing tack to the proposed removal of what the Super System Review dubbed an artificial licensing exemption for accountants, Hogan said that the carve out that accountants currently had, while partially effective, hadn’t actually given them the scope that they needed to give an appropriate level of financial advice.

“It seems to me that the position they found themselves in, where they could say that someone should be in a self-managed super fund for certain reasons but couldn’t give them any advice about whether they should move any of their existing accounts across or about what level of contributions they should make or investment strategy and so on,” he said, “that position made it awkward for them to operate anyway.

“So as to the question of whether the requirements come down to having a full licence or whether there’s some other interim license arrangement for accountants, there's been nothing formally announced in that way so it’s still a case of ‘wait and see’,” Hogan continued.

“We’ll have to see what the solution is that they finally come up with, whether it’s that accountants who wish to give financial advice in this area will need a full AFSL [Australian Financial Services Licence] or be an authorised representative of someone with a full AFSL or whether there’ll be some in-between licensing regime – it’s just hard to say at this stage.”

“But what you may well find is that regardless of the result, accountants who are interested in operating in this space will license themselves to whatever the law requires in order to give advice in this space - those who genuinely want to operate in this space will just do what's required.”

According to Andrea Slattery, chief executive officer of SPAA, the simple reality for SMSF service providers generally is that an understanding of the SMSF advice piece well is vital.

“And they have to have the knowledge and competency to back that up,” she said.

“SPAA is all about raising competency, accrediting people to at least an undergraduate level of experience and having specialists in the market that clients or consumers in the market can seek out to get the right kind of financial advice.”

“Providers should endeavour to get their own personal recognition in their knowledge in this area and should seek accreditation,” Slattery continued.

“They just need to become more competent, get recognition and provide their clients with a very professional service.”

Yet in the wake of the Super System Review and the Government’s Stronger Super reforms, it seems clear that the frameworks surrounding SMSFs are set to improve. That area of development is in line with the sector’s overall growth but what of asset allocation?

The stereotypes of highly conservative allocations within SMSFs persist, but according to Hogan, such stereotypes are not necessarily accurate.

“When you look at the statistics that the ATO puts out with respect to self-managed super fund asset allocations, and if you compare that to the asset allocation decisions of large funds, there’s not a huge difference between the two,” he said.

“Perhaps there’s a stronger allocation to Aussie shares versus international shares, but otherwise, the allocation to cash is probably no more skewed than for bigger funds.”

“Property is also not quite as large as you might think,” Hogan added. “Then there are investments that are problem investments, but there always will be.”

“From SPAA’s perspective, trustees of SMSFs aren’t really that different in their capacity as trustees as they are in their capacity as an individual investor.”

For Malkin, there is nothing in superannuation legislation that dictates a requirement to invest in certain products or that certain products are bad investments. 

“Yes, there are restrictions as to your ability to invest in certain products, to build some rigour around those investments and ensure you’re not getting a present day benefit,” he said, “but embedded into SIS [the Superannuation Industry (Supervision) Act] is the requirement to have an investment strategy which considers diversification and risk, and all of the aspects of any sound investment strategy, and I think that there’s enough rigour around the legislation to do with investment strategies to allow for a wide range of investments.

“Also, as far as investments for SMSFs are concerned, I think simple is best,” Malkin continued.

“So even if I had the capacity to advise clients – though I don’t, given that I’m an auditor – I would never advise them to go into derivatives that they don’t understand or instalment warrants that they don’t understand or anything complex and of that nature.”

“There’s lots of ways to skin a cat, so I would personally prefer a SMSF to be well diversified with a combination of cash, blue chip listed securities that are paying fully franked dividends and, of course, property, because I think property is still a very good investment for self-managed super funds – particularly business real property and particularly if you’ve got an exit strategy for the time at which you wish to retire.”

Also stating quite clearly that SMSF allocation stereotypes were misleading, Slattery said the most recent data available from the Australian Prudential Regulation Authority (APRA) showed that most SMSFs were actually slightly less conservative than a number of APRA-regulated default funds.

“So while people may believe that they’re generally conservative, I think they have matured, and I think all the different sectors are maturing,” she said.

“You’ll also find that SMSF trustees are able to make decisions in a sometimes more timely fashion, and they’re able to be flexible in the way in which they manage their fund.

“So the combination is that SMSF trustees will make decisions based on their personal circumstances rather than having to be in a situation where a decision has been made in bulk for you and sometimes takes a little while to turn around, particularly when you’re meeting barriers or targets that you have to set in a pooled environment.”

For Hogan, the reality is that all investors, whether trustees of a SMSF or individuals, are in the same boat.

“They will always have to make investment decisions,” he said. “And the unfortunate reality is that some of those decisions will always be better than others.”

So, on the back of already significant growth and reform which the sector acknowledges to be positive, the unfolding SMSF story is an interesting one.

And regardless of whether they become the superannuation vehicle of choice into the future (as some have so recently predicted), Malkin said he had few doubts that they would remain as popular as they are now for some time to come.

“I personally think that as long as you’ve got enough money to start a fund and you know what you’re doing with it, they’re the superannuation vehicle of choice now,” he said. “And they’re certainly here to stay.”

Similarly, Hogan said there was also little reason to think that recent years’ growth – both in terms of number of funds and funds under management – wouldn’t continue.

“That well known average of 2,000 SMSF set-ups a month, that’s been a very long-term average when you think about it,” he said.

“It’s gone back even to the days of the introduction of the superannuation industry’s Supervision Act back in 1993-1994 when it saw a decline fošr a very short period of time and then bounced back almost immediately.

“So certainly, I think the attraction is still there, and I think Cooper was right when he said that the members of SMSFs are more engaged in their superannuation savings than perhaps are members in other types of funds,” Hogan continued. “But they almost, by definition, need to be.”

The reality is, according to Hogan, if a member isn’t terribly interested in what they’re doing with the fund, how they’re investing the money or even in taking an active role, then a self-managed super fund simply isn’t the appropriate superannuation vehicle for them.

“It really is that simple,” he said. “But for those people who feel engaged, and for those who want to have that control, a self-managed super fund gives them one of any number of avenues to get involved with their super.

"It’s clearly one that’s proved to be popular so far, and so long as people are interested in saving for their retirement, I really can't see that changing."