What's ahead for SMSFs?

The SMSF sector has cemented its place in the superannuation industry over the past few years. Damon Taylor looks at the issues facing SMSFs and the debate that will determine the shape of their future.

It doesn’t seem that long ago that self-managed super funds (SMSFs) were a strange and unusual beast. Rare as a natural consequence of low levels of retirement savings, they were a vehicle restricted almost entirely to individuals of high net worth and, to some extent, they retain that perception.

Yet in a world where many superannuants are demanding control and flexibility, SMSFs have become a staple of Australia’s superannuation industry and according to John McIlroy, chief executive officer of specialist SMSF administrator Multiport, the manner in which they handled a financial crisis that had the world on its knees underlines why these structures continue to turn heads.

“At Multiport, we conduct a regular survey of the SMSFs we administer with a particular emphasis on their investment trends,” he said. “So if you look at our recent data (December 31, 2009) and even going back further to December 2008, you can see strategy changes that I expect have yielded some pretty good results.”

Pointing to figures from Multiport’s December 2008 survey, McIlroy said allocations to cash and term deposits had been quite high at 28 per cent, with equities allocations only slightly higher at 32 per cent.

“But those figures changed in March,” McIlroy said. “Our average SMSF now has an allocation to cash of around 21 per cent whereas shares have risen to 43 per cent.

December 2008 may have been about moderate risk and allocations that were more conservative than balanced but over the intervening 12-month period portfolios have become more growth oriented,” he continued.

“Add to that the fact that share portfolios are quite concentrated in the Australian market’s top 20 stocks and I’d expect that their performance would have been pretty good across 2009. It certainly would have compared well with most benchmarks.”

Interestingly, Craig Day, technical services manager for Colonial First State, said that while select statistics were available, it was difficult to get an accurate gauge of SMSF performance.

“It’s a bit of a great unknown,” he said.

“There are 400,000 funds out there and they have different methods of valuation compared with APRA [Australian Prudential Regulation Authority] regulated funds, so it’s difficult to get a handle on it. The Cooper Review seemed to show outperformance based on tax returns but the question is whether they are comparing apples with apples,” Day continued.

“We’re not necessarily seeing all costs being taken into account and we’re certainly not seeing the same valuation methods. Proper analysis of SMSF performance is still very much a work in progress.”

Asked whether he had seen SMSF trustees make any particular asset allocation mistakes in the last 12 months, Day said that his main concern was actually in the amount of cash being held.

“Again, it’s hard to put a finger on exactly how much cash is actually being held,” he said.

“The ATO [Australian Taxation Office] suggests 30 per cent where the research houses suggest 15 per cent. Either way, it’s still a high level to be holding and it will definitely have an impact on their long-term performance.

“Investment strategies are another concern,” Day added. “In my experience, trustees may have a piece of paper with a broad strategy on it but are they really targeting what they want to achieve or just investing on an ad-hoc basis? Such things may only be making a small difference right now but they can add up over the longer term.”

SMSF popularity

Putting performance aside, there is undoubtedly a perception that when times are tough, SMSFs grow in popularity. Yet despite having endured some of the toughest times ever, McIlroy said SMSF growth had remained steady.

“If we look at the figures over the last five to six years and if we take out the aberration that was 2007 and the Government’s $1 million contribution window, then SMSF growth has been quite consistent,” he said.

“In 2009, the number of new set ups was anywhere between 1,800 and 2,200 per month and those figures remained remarkably constant.

The global financial crisis certainly didn’t scare people away from starting up a SMSF but, by the same token, I wouldn’t say that it drove people away from retail and industry funds either.”

Taking SMSFs away from investment markets and looking at them as a structure for retirement alone, Day said the super industry had to expect continued growth. “2009 was essentially business as usual for self-managed funds,” he said.

“They haven’t really missed a beat, but taking it away from investment markets, people generally have higher balances now, simply because they’ve had the SG (superannuation guarantee) for longer.”

Day continued. “Many will continue to use SMSFs as their superannuation vehicle of choice and, with technology and the administration solutions it can provide getting cheaper and more accessible, there isn’t any reason why SMSFs won’t see continued, if moderate, growth.”

Peter Townsend, principal of Townsends Business and Corporate Lawyers, said in terms of raw numbers, SMSF growth had gone from 3,000 setups per month several years ago to between 1,000 and 1,500 per month right now.

“The numbers have dropped back slightly but I think that’s been due to the natural play of the market,” he said. “It’s like anything new — you get the aggressive early users, the more mature longer term players and then there’s everyone else.

“We’re reasonably bullish about SMSFs though,” added Townsend. “They’re not for everyone; but for people who want to control their own money and to have a material focus on their superannuation, [SMSFs] can be worthwhile.”

Townsend said the statistics put forward by Jeremy Cooper in Phase III of the Government’s superannuation system review had indicated that SMSFs had done quite nicely.

“And from that I think there was a definite sense of people wanting to lose their own superannuation monies rather than paying someone else to do it for them,” he said.

“So long as Cooper doesn’t raise the bar too high for SMSF trustees, I can’t see any reason why their popularity won’t continue. That isn’t to say that they will turn into a behemoth that will dwarf other sectors of superannuation, but I think it’s long since been proven that they’re a superannuation vehicle that’s here to stay.”

Minimum account balances

But while self-managed super might have long since cemented its place as a worthy and attractive option to mainstream funds, there continues to be question marks around whether they are always being set up for the right reasons and with the right amount of preparation. Minimum account balances are one such question mark.

The common notion when setting up a SMSF is that potential trustees should have a minimum superannuation account balance of $200,000. But is that enough, particularly when considering things like wholesale investment and the cost of administration?

Day conceded that in many circumstances it was a difficult question.

“When you look at the costs involved with SMSFs then they are clearly an expensive structure to run with a small account balance,” he said. “But in saying that, you have to take into account people’s right to exercise choice.

“Cost isn’t and cannot be the only consideration,” Day continued.

“There may be other more pressing concerns or overriding considerations for potential trustees that make a SMSF right for them, and at the end of the day, I’d rather see people being educated on what is necessary to run a SMSF than seeing them be limited based on a balance.”

For his part, Peter Fry, principal of chartered accounting and financial planning provider Peter Fry and Associates, pointed out that $200,000 simply represented a starting point for conversations.

“As a practice we use $200,000 but SMSFs are strategy driven, not dollar driven,” he said.

“If the strategy is suitable then a client can set up their own self-managed fund and make it worthwhile with even less. And when it comes to wholesale investment and access to wholesale funds, I wouldn’t say that was a problem either,” Fry continued.

“SMSFs with small balances can access them through wraps if need be. $200,000 is used for simplicity really — it’s a rough crossover point for comparisons between SMSFs and an industry or retail fund, but not a lot more.”

With particular knowledge of the administrative burdens involved in running a SMSF, McIlroy said he was similarly opposed to any notion of there being a minimum account balance for a SMSF to be worthwhile.

“People’s circumstances are different,” he said. “A small business owner may start a SMSF with $150,000 but intend to pump it up over the next several years.

"There are also a number of immigrants from the United Kingdom who may setup a SMSF and want to build up their balances incrementally due to some of the immigration legislation currently in place,” McIlroy continued.

“And there is any number of these sorts of stories out there. Any sort of minimum balance is pretty ridiculous because SMSF suitability will always depend on a trustee’s individual situation.”

Compliance

Yet having navigated the global financial crisis, the next thing on SMSF trustees’ radar has to be the superannuation system review currently being undertaken on behalf of the Government by Jeremy Cooper.

Indeed, much of the review’s focus on the self-managed sector of superannuation seems to revolve around compliance and any increased risk that SMSFs might pose, and for McIlroy, that focus is understandable.

“Unfortunately, compliance has been and will continue to be a significant concern,” he said.

“And part of the reason is that this sector of superannuation has a lot of different service providers in auditors, accountants, administrators, financial planners and so on and there really aren’t any barriers to entry.

"Someone could be a hairdresser yesterday, they could go and buy a piece of software today and then set themselves up as a SMSF service provider of some sort tomorrow,” McIlroy continued. “It really is that simple.”

And in terms of a compliance solution, McIlroy said he would be a huge proponent of SMSF service provider standards.

“If there were standards for service providers, if they had to manage registration with some sort of approved body, then I think that would be of great benefit,” he said.

“It would mean that service providers across the board would have a better knowledge of the industry and it couldn’t help but lift general compliance as well.

"Naturally, there’s the option of educating trustees instead but, with limited resources available, I think the industry would be better served focusing on 10,000 service providers rather than 770,000 trustees.”

Talking about whether compliance was something the SMSF sector now had under control, Townsend pointed out that self-managed funds and, more importantly, their trustees would never be perfect.

“The compliance character of this sector could certainly be improved but I don’t think we need to go overboard in that regard,” he said.

“The stats show that there were only 99 funds out of 410,000 that lost their complying status in 2008-09 and only 2 per cent of the sector received negative audit reports. So for a sector that’s been hammered for being non-compliant in general, I’d say they’ve done particularly well.”

Commenting on APRA’s recent suggestion that industry and retail super funds subject transfers to SMSFs to higher levels of scrutiny, Townsend accepted that the need was there but added that it gave the impression of compliance breaches where none were in evidence.

“The suggestion itself is fine — no one minds this kind of tap on the shoulder with respect to diligence around fraud but it gives the impression that this kind of thing is common and that simply isn’t true,” he said.

“And unfortunately, that’s what the compliance debate comes down to. A lot of what is said about self managed super is simply not true and the numbers show that,” Townsend continued.

“The numbers and anecdotal evidence do show a lack of education but when that’s the case they’re getting advice — they’re getting a financial planner, they’re getting an accountant or they’re getting a lawyer. At the end of the day, they may not fully appreciate how they comply but they do, in fact, comply,” he added.

Risks

Another concern to come out of the Cooper Review and one that has long been shared by the wider superannuation industry is that of SMSFs coming with greater risks to the safety of retirement savings.

After all, there is no obligation for a SMSF trustee to engage professional services in the realms of financial advice, accounting or administration and the danger is that a member’s retirement savings could suffer as a consequence.

For Fry it is a valid point. “Not everyone has the time, the expertise or the inclination to properly manage all aspects of a SMSF,” he said.

“They may be able to do its day-to-day running when it comes to investment but when it comes to their pension phase, where a lot of expertise is required, they really should be seeking professional help and, unfortunately, not all trustees are.”

Like Fry, Day said that while most trustees were probably getting some sort of professional advice, there were a number of superannuation hotspots in which advice was vital and yet not always being sought.

“The simple argument for advice engagement is that because all funds have to be audited once a year, trustees are getting some level of professional service automatically,” he said.

“But I think the level of that service is probably questionable. There is a definite need for more trustees to be engaging more advice but when it comes to estate planning and insurances and things that aren’t investment related, that advice is critical,” Day said.

He continued: “With those in particular, if they’re not getting proper advice then there’s a real danger of their benefit being paid to a dependent or beneficiary in a manner that was never intended. “The result is greater risk not just in terms of investment but also in terms of superannuation outcomes.”

However, according to Townsend, the claim that retirement savings held within a SMSF are at a greater risk when compared to those held within a mainstream fund is one that cannot be justified.

“The fact is that SMSF trustees and members have a higher exposure to cash through the financial crisis and, as a consequence, they suffered less,” he said.

“And these are the same people who are supposedly subject to greater risks. When it comes right down to it, this is their money and they’re as focused, if not more so than the members of an industry or retail fund.

“Many people put their contributions into their super fund and then they forget about it,” continued Townsend, “but that isn’t the case for a SMSF member. SMSF members are engaged up to their bootstraps.”

Of course, beyond what may be its final result, the Cooper Review and its various submissions have already stimulated significant discussion and for Fry, it is all positive. “I think there are a number of things that may come out of it that will be positive,” he said.

“Because in some ways the negatives people are seeing have been based on why the review was originally needed and a fear from practitioners that there would be an overreaction. Obviously, it’s all speculation until the final report,” continued Fry.

“But there have been a number of well-constructed submissions and how Cooper takes those and whether he incorporates them into the final product will be interesting to see. In a lot of ways it’s a case of ‘if it isn’t broken, don’t try to fix it', so I think we’re all hoping for a balanced and measured approach.”

Less optimistic about what the Cooper Review might produce, Townsend said while the questions that had been asked were all valid, he was not in favour of unjustified change.

“So far there’s been a real sense of change for change’s sake rather than for any tangible benefit,” he said.

“And it comes back to that old line — ‘if it isn’t broken, don’t try to fix it’. Cooper’s made it clear that he didn’t take that view and in some ways it’s putting the cart before the horse,” Townsend continued.

“It’s almost a case of ‘here are the changes’ and then ‘here are the reasons for those changes’, and that certainly seems the wrong way around. Personally, I’d like to know why they’re looking to change things when the sector’s already going along nicely.”

Yet from McIlroy’s perspective, the Cooper Review is representative of a great opportunity for the self-managed sector of superannuation and one that should not be squandered.

“Thus far the review has been chucking up every conceivable issue of concern for the sector and I think that's a good thing,” he said.

“It’s giving the industry a forum and an opportunity to put forward its ideas. Judging by the funds that we look after, SMSFs are doing pretty well in the performance stakes,” McIlroy continued.

“And while there seem to be continuing problems with compliance, they’re the result of sloppy work rather than intentional fraud. At this point our focus needs to be on tidying up self-managed super, and I think that one way or another, the Cooper Review is doing exactly that.”