While the proponents of SMSFs argue they have more than adequately weathered the global financial crisis, Damon Taylor reports the critics continue to have their doubts.
In recent years, superannuation has become an industry of diversity.
Australians can take any approach imaginable to their retirement savings in choosing to set and forget, to exercise super fund choice or simply to adjust their investment allocations. And for those wanting to exercise yet greater control and flexibility, there are self-managed super funds (SMSFs).
Yet while SMSFs are hardly the new kid on the block, they remain an evolving sector.
The Australian Taxation Office (ATO) continues to highlight compliance trouble spots and service providers have only recently found solutions specific to SMSF needs, yet the sector’s growth has remained strong. So what then are SMSFs evolving towards?
Financial crisis
Speaking of how SMSFs have weathered the global financial crisis (GFC), Graeme Colley, vice chairman of the Self-Managed Super Fund Professionals’ Association of Australia (SPAA) and technical manager of SMSF administrator Super Concepts, said the lessons learned by SMSF trustees had been little different to those learned throughout the super industry.
“What we saw happening earlier this year were increases in the cash allocations held by SMSFs,” he said. “But whether that was due to the drops in equities valuations that everyone saw or due to a material cash increase, that much of it remains unclear.”
Colley said as market conditions gradually improved, he could see SMSF trustees making cautious moves back into equities markets.
“But the last 12 months have taught SMSF trustees to really pay attention to investment strategies and the benefits diversification can give in the long run.”
In his role as a service provider to the SMSF sector of superannuation, Kurt Groeneveld, managing director of Supercorp Australia, said a strong preference for cash and relatively balanced portfolios had served SMSFs well through the financial crisis tumult.
“We recently did a review of the approximately 2,000 funds we do administration for,” he said. “And for the most part, we saw asset valuations down only around 14 per cent from where they were the year before, the year ending June 2008.
“The anecdotal evidence is that SMSF performance has stacked up pretty well and I think there are identifiable trends in the ATO data to back that up as well.”
Measuring success
However, not all parties within the superannuation industry believe SMSF performance is quite so cut and dry. Warren Chant, principal of research house Chant West, said he did not know how anyone could measure the investment performance of SMSFs accurately.
“There are around 400,000 of them for a start,” he said. “Obtaining allocation and performance data for them is beyond difficult and, realistically, I’d be surprised if there was any substance to anecdotal information indicating good performance.
“Look, I have a DIY [do-it-yourself] fund myself,” Chant continued. “And it has a reasonable amount of cash as well as property that hasn’t been valued recently.
“So if SMSFs are overweight in those two areas, it may well be the case that they’ve performed better than most, but there are a lot of [cases] of trustees investing 100 per cent of their fund’s balance in direct equities where the story has been nowhere near as positive.”
And for Chant, it is that lack of statistical data that presents the biggest problem in measuring SMSF performance,
not only for external parties, but also for the members themselves.
“It is absolutely a problem,” he said. “Members aren’t necessarily getting monthly or even quarterly performance reports on their fund.
“People in SMSFs aren’t receiving anywhere near the same level of data as those in larger industry funds or master trusts, and that can be an issue.”
Pauline Vamos, chief executive officer of the Association of Superannuation Funds of Australia (ASFA), said she saw similar issues in stacking up SMSFs against their mainstream counterparts.
“It’s very hard to know how they’ve been performing because ongoing SMSF performance isn’t transparent,” she said.
“We know that the average return for the year ending June 2008 was 11.8 per cent, but that’s as much as we know, and that is an issue in and of itself.
“But having said that, SMSFs are an entrenched part of the super system,” Vamos continued. “And the financial crisis has shown trustees, all trustees, how very hard it is to predict the behaviour of investment classes and how important a role diversification can play.”
Defying expectations
However, if there is one SMSF stereotype, it is that when times are tough, the number of set ups spike. Yet recent ATO statistics indicate that this kind of uptick did not eventuate as a consequence of the global financial crisis.
Growth was strong without exceeding the boom numbers experienced in the 12 months to 2007 and, according to Vamos, that fact was not surprising.
“I’m not at all surprised by the drop in new establishments,” she said. “And the number one reason for that is people knew [by] pulling money out of one asset class and putting it into another they were crystallising their losses.
“They knew or had been informed of the consequences of such an action and consequently didn’t move their investments or make moves towards a self-managed fund.”
Vamos said people looked to set up SMSFs because they had determined that doing so was the best option for them.
“They’re looking for greater investment control, much reduced fees and better returns,” she said.
“But many will also be aware that the Cooper Review (the Government’s Super System Review to be chaired by Jeremy Cooper, former deputy chairman of the Australian Securities and Investments Commission) may mean substantial changes and tightened regulation.
“Many people will stay put until they have all the information before they look to set up a self-managed fund.”
For Groeneveld, the sheer magnitude of the global financial crisis downturn meant any predicted spike in SMSF numbers did not eventuate.
“I think the reason we didn’t see any sort of uptick was that there was such a broad downside across the board,” he said.
“Potential SMSF trustees accepted that they couldn’t necessarily have done any better than their existing super funds, so the dissatisfaction that occurs when markets are down didn’t happen to the same extent.
“But now, as we’re coming out of that and it’s starting to look as though SMSFs have fared pretty well, I’d expect take-ups to continue.”
Alternatively, Chant said while SMSF growth had been impressive, he did not believe it would be open ended.
“At Chant West, we’ve been on the record saying that there’s been a tremendous amount of growth in DIY [do-it-yourself] funds,” he said.
“And from our perspective, there are three reasons to consider a DIY.
“The first is a desire to pick stocks and managers,” continued Chant. “The second reason is if you want to own property within your super fund outright, and the third comes in the form of material estate planning advantages.
“But forget about any notion of $200,000 being the minimum account balance. Unless you have $1 million put away, you shouldn’t even be thinking about it.”
Chant pointed out that while $200,000 might be little more than an arbitrary figure, such a low balance had some very telling implications on superannuation investment and, ultimately, on the provision of retirement savings.
“On point one from before, at such a low balance you can’t get into the wholesale fund space,” he said. “And that means you’re paying retail prices.
“So if, for instance, you have $250,000 and you want four managers, you’re talking about $60,000, a pop and you’re going to be paying retail fees.”
With respect to his second reason for starting up a SMSF, Chant asked how many properties members of a SMSF could purchase for less than $500,000, let alone $200,000.
“If we’re talking about Sydney or Melbourne, then not a lot,” answered Chant. “And even then, you can’t be getting 100 per cent of your superannuation investment from one property.
“Obviously, estate planning benefits are very specific to the individual, but over time, I wouldn’t be surprised if these turn out to be very telling factors in terms of DIY fund growth,” Chant continued. “Administration, auditing requirements and compliance requirements all start to look rather stupid and burdensome if you’re only talking about $200,000.”
Service providers
Another common theme when talking about SMSFs is perhaps a lack of specialised service providers to support this segment of the super industry, however, this shortage is something Groeneveld sees providers responding to in greater and greater numbers.
“When it comes to service provision, there are some interesting drivers at play,” he said. “I think the change in commissions bias for financial planners will make them en masse more service savvy.
“They’ll look to service their clients better and possibly look to self-managed funds more where they wouldn’t have previously,” Groeneveld continued. “Also, accountants are starting to look at SMSFs more to drive workflow.
“We’re certainly starting to see a lot more activity and I think those two sectors are a large part of that.”
Asked whether he saw any gaps emerging in SMSF service provision, Groeneveld pointed immediately to the SMSF sector’s wider knowledge base.
“There continue to be significant knowledge gaps when it comes to SMSFs,” he said. “There are still a lot of accounting firms with fewer than 20 of these funds on the books and a lot of them are struggling to keep up.”
Sharing Groeneveld’s concern over a lack of SMSF knowledge, Colley said the technical side of things needed a substantial push.
“We’re still seeing referrals from people with a significant lack of technical knowledge,” he said. “These are issues that should be relatively simple for SMSF professionals and yet it’s apparent that the know-how simply isn’t there.”
Interestingly, Vamos’ take on the gaps in SMSF service may itself be a solution to the knowledge-gap issues identified by both Groeneveld and Colley.
“From our perspective, the biggest gap is in the lack of short, cost-effective courses for SMSF trustees,” she said.
“There’s some great information out there from the ATO, SPAA and so on, but no short-form course particular to trustees where they can go online and understand the responsibilities and obligations inherent in running a self-managed fund.
“ASFA’s working on that at the moment though and it’s a gap we’re hoping to fill.”
Trustee approaches
Beyond the question of what gaps may exist in SMSF service provision is the question of what approach trustees are best advised to take. A one-stop-shop style of advice and service seems logical on the face of things but, according to Vamos, there are advantages in enlisting the aid of specialists.
“There are probably three basic services for a SMSF,” Vamos said. “The first is in its initial set up, its governance and ongoing auditing, the second has to do with transaction administration and the third is the investment side of things.
“SMSF trustees may have an all-in-one provider for those services or they may use specialists in administration, in compliance, in investment and in accounting,” Vamos continued. “There is no right or wrong approach, but if a SMSF trustee leaves everything to one provider, there is the chance of increased regulatory risk.
“Multiple parties enable checks and balances that a single party cannot provide.”
Advocating neither approach, Groeneveld said there was no reason why a range of parties could not be a good solution for a SMSF trustee, provided good communications were maintained at all times.
“And by the same token, a one-stop-shop style of service can work well so long as it isn’t biased by one service element,” he said. “SMSFs are like any business — you don’t want to be well across one side of things at the expense of another.”
Yet for Groeneveld, the far bigger issue is SMSF management.
“We’re still seeing a kind of shoebox management where everything is done at the end of the year and that kind of approach has to change,” he said.
“The fact is, with contribution caps and pension requirements and all the rest, there are so many pitfalls that if a fund isn’t being professionally monitored throughout the year, trustees can fall into huge traps.
“SMSFs have to be actively managed and, for that to happen, a psychology change needs to take place.”
Financial advice
Still within the realm of SMSF service provision is the topic of financial advice. In most, if not all cases, the members of SMSFs have been attracted to them for a vested interest in investment, yet there is continual concern over whether SMSF trustees have the right strategies in place.
Fortunately, Colley sees most SMSF trustees sticking to the plan.
“That’s the story from most financial advisers,” he said. “The majority of people stuck with their investment strategy and made very few changes.
“They may have pushed contributions made through the GFC directly to cash, but otherwise they stuck to the plan.”
Vamos said she had met a lot of SMSF trustees and that a lot of them had the time, energy and background to soundly monitor their own superannuation investment.
“So there’s no financial advice issue there,” she said. “Others do seek outside help, but for them it’s more about understanding what questions they should be asking, what value they could be getting from a financial adviser and what they should be paying for that service.
“Realistically, it doesn’t matter what sort of fund you’re a member of, the advice proposition is the same for everyone.”
Chant’s SMSF advice story is somewhat different: seek financial advice but be aware of account balance realities.
“When you set up your own DIY fund, if you’ve got 80 per cent in property and 20 per cent in cash, you don’t need much advice,” he said. “But for those members and trustees interested in picking shares and managers, or for estate planning needs, they’d be wise to leverage the knowledge and experience of a financial adviser.
“You’d be crazy not to, but bear in mind how your account balance stacks up,” Chant continued. “If someone’s in the $200,000 boat, and a lot of people are, I’d be surprised if they’ve received a huge amount of service and advice in the last 18 months.
“It comes back to economies of scale.”
The reality, according to Chant, is simple.
“If a SMSF trustee is paying 1 per cent of their account balance to a financial adviser, so $2,000 in the case of a $200,000 account balance, how much advice will they receiving?” he asked. “The smaller the account balance, the less economical it is for the financial planner.
“And there are a lot of people in this boat — it’s a high price to pay for so-called flexibility.”
Compliance
If service and advice are the first two horses in the SMSF trifecta, compliance is the third. The industry’s regulatory bodies have continually flagged by both word and action that they are watching SMSF trustees closely, and Colley expects such scrutiny to continue.
“I’d think that the scrutiny we’ve seen to this point would have to be there for quite a while yet,” he said. “When you see some of the cases coming into the courts, you have to wonder why people have appealed in the first place — the breaches are that serious.
“As things stand, the ATO keeps highlighting the difficulties it’s finding in SMSF compliance, and while the number of trustees not heeding the commissioner remains a minority, that ATO watch is likely to continue.”
Similarly, Vamos said the compliance issue for SMSFs related to criminal action rather than systemic compliance breaches.
“The main issue for self-managed super is that it’s an attractive area for organised crime,” she said. “Because there are regulatory gaps, we have issues with people looking at SMSFs to operate illegally.
“There aren’t any name checks, for example,” Vamos continued. “So anyone can come along and set up a SMSF called First State Super or something else along similar lines.
“Abuse is where the regulation must be focused because these are retirement vehicles that have to stay safe.”
In terms of what sort of actions on the part of SMSF trustees and the super industry would reassure the sector’s regulatory bodies, Colley said the industry was already on the right track.
“Higher leverage points are certainly an area likely to give the regulators a degree of confidence,” he said. “The more organisations there are out there specialising in SMSF compliance, the more confidence there is likely to be in the total system.”
Adding to Colley’s list, Vamos suggested that using education as a gateway could also provide a strong starting point.
“Constant oversight by the ATO has to continue, but trustee education can go a long way,” she said. “If trustees understand their responsibilities, their obligations and, ultimately, what they’re getting themselves into, we automatically eliminate a lot of the accidental compliance breaches.”
Looking not just at compliance but at the future of SMSFs, Groeneveld said both education and scrutiny had to be a good thing.
“SMSFs have come a long way — in most cases they’re a very conservatively run, well thought-out investment vehicle,” he said. “They’re characterised by independence and flexibility and that gets people nervous.
“Strong and constant regulation is vital, but I’d urge people to look at the SMSF track record,” Groeneveld continued. “They’ve just come through one the worst periods of financial crisis ever and they done so quite nicely.
“That sort of performance should speak for itself.”
Alternatively, Chant said DIY funds had done reasonably well until February 2009 due to their high weightings towards cash and unlisted property.
“The key issue for them moving forward will be when to move back into a more normal asset allocation,” he said.
“Generally speaking, it isn’t difficult to move into and out of cash, but trustees will need strong financial advice to pick the right moments.”
For Vamos, there is no doubt that the self-managed sector of superannuation will continue to be a key part of the retirement income system.
“For certain people it will continue to provide a credible and optimal retirement solution,” she said. “But it’s like many areas of super in that it has experienced growth that wasn’t anticipated.
“And the onus is on both the SMSF sector and the wider super industry to ensure that solution continues to best provide for people’s retirement needs.”
