Smart Investor: making the right investments in DIY Super

Smart Investor, April 2011

DIY Super report – Investment

It’s been clear for years that the premise of the self-managed super fund – taking charge of your own investments – has captivated the Australian public. SMSFs are, according to the Australian Prudential Regulatory Authority, the largest chunk of Australia’s superannuation industry: bigger, in asset terms, than industry or commercial funds. But making the leap to doing things your own way is only the start of a process that requires your attention for decades to come.

Building the right asset allocation, and matching it to your risk profile – indeed, working out what your risk profile is in the first place – is anything but straightforward.

That much is clear from the various studies that have attempted to work out where self-managed super fund investors are putting their money. Investors vary widely in their approach and rarely come out very close to the professionals. Consider these two surveys, one from Multiport, the financial advisory group, which surveyed the 1,350 SMSFs the group administers – who, between them, deploy $1.2 billion of investments; and one from Russell Investments, which surveyed 1,331 consumers, including 431 SMSF trustees and 258 high net worth individuals without SMSFs, as well as 599 professional advisers.

The Multiport survey found that SMSFs had a 42.6% allocation to Australian equities, 11.8% fixed interest, 21.9% cash and short term deposits, 15.7% property (12.4% of it direct property), 7.3% international shares and 1.8% alternatives.

The Russell survey came up with 42.6% for direct Australian shares, 23.1% in cash investments, 9.4% in managed funds (it’s not clear what asset class this included but likely mainly Aussie equities again), 5.6% direct residential property, 4.6% direct commercial property, 3.6% other fixed interest, 2.5% listed property trusts, 2% direct international shares, 1.6% unlisted property trusts, and the remaining 5% elsewhere.

Doing their own thing

Clearly there is some divergence in these findings, which is not surprising, since SMSFs are anything but a homogenous group: they reflect individual enthusiasms, and individual legacy investments. But some themes are very clear: a heavy skew to Australian equities, much of it direct (in the Multiport survey, of the 42.6% in Aussie equities, 36% was in direct shares and just 6.6% managed funds); a staggering dearth of investment in international equities; a very heavy cash allocation; and an equally heavy holding in property with a big tilt towards direct, unlisted holdings. Compare this with a mainstream super fund and you begin to see the difference. The balanced option at AustralianSuper, one of the biggest industry funds, today has 34% in Australian shares and 20% in international shares – in both cases at odds with typical SMSF allocations – as well as just 5% in cash, and 18% in alternative investments such as private equity and infrastructure.

The two survey fundings reflect some commonplace remarks from advisers, who say that trustees will often bring an investment property into their fund without realizing how heavily skewed their portfolio therefore is towards property. Another common theme is the high cash holding, a hangover from the financial crisis: Russell said many respondents knew they were overweight cash but were waiting for the right investment opportunity.

Additionally, both surveys find precious little use of managed funds: all told, 20.5% of SMSF fund holdings in the Multiport survey went into funds, and just 9.4% in the Russell one. Evidently, investors want to go it alone. In keeping with this theme, Russell says SMSF trustees are twice as likely to rely on their own research process than the services of a financial advisor. And one quarter of those who don’t seek advice go on gut instinct.

That’s not particularly healthy, and trustees are often shocked by the effort involved in investment management after setting up a fund. And perhaps things are changing. An industry is growing up among groups that do not seek to gain control or custody of SMSF assets, but do seek to advise on how it is invested.

The tough side of going it alone

“I’ve noticed over a long period of time that the initial driver for many people to set up self-managed super funds is that they’re disappointed with their fund managers,” says Charles Leyland, founder of Leyland Private Asset Management. “They think the solution is that they can do a better job. So they set everything up administratively, and get their fund up and running, but then are faced with a blank piece of paper and nobody to help them manage their affairs. Then it dawns on them that there’s quite a lot of work involved in researching companies and allocating capital efficiently – and that’s when they come to us.”

Similarly, Implemented Portfolios is an example of a company that has grown based on advising self managed super funds. “SMSF investors want to have individual ownership of assets, and they want control, but that doesn’t mean they don’t want professional assistance,” says Charlie Haynes at Implemented Portfolios.

“There is a whole new industry growing up about trustee education,” says Haynes. “People are getting more into coaching, assistance and advice, because it’s a complex area. You don’t want to go off and gamble in your retirement.”

Implemented Portfolios has found that attitudes to risk vary, and aren’t always what people think they are. “It’s different for different people,” he says. “Advisors say people come in saying they have a reasonable appetite for risk. But when you put it to them that might mean losing 20% of their assets for a reasonable period of time and taking a long time to recover, their attitude is not so strong.” It’s an attitude that has changed in recent years. “People have adjusted their attitude according to investment markets. Outcomes that were once considered unlikely have become reality in the last couple of years, particularly in the SMSF space. People who thought they were secure in Aussie banks and property trusts saw some of their trusts down 70 to 80% and the banks 50%. That sharpens people’s minds.”

Diversify, diversify, diversify

In any event, advisors like these do support the survey findings that investors tend to need to diversify. “Anecdotal evidence suggests there tends to be a high concentration in a lot of self managed super funds,” says Haynes. “The first message we have is that we seek to get diversification. There are so many resources trustees can access to get an appropriate balance across the asset classes, and also diversification within asset classes.”

“Generally, people who are looking for asset allocation advice may have particular securities they want to keep hold of,” he adds. “So there might be a correlation between their BHP shares and their Australian equity portfolios. There is certainly a lot of talk about the home bias towards Aussie equities in self-managed funds, and people may not appreciate the risks that brings into a portfolio; or direct property investments that overshadow everything else and they don’t realise the disproportion.”

One problem is that received wisdom on ideal asset allocation doesn’t reflect individual circumstances – and in a self-managed fund, those individual circumstances are the whole point. “The textbook financial planner will say something like: some local shares, some international shares, some property trusts, some cash,” says Leyland. “But that textbook doesn’t necessarily hold for super fund holders for their retirement.” For example, most people own their own family house; often they will also own an investment property or a beach house too. “They don’t think about that when they’re doing their asset allocation, but they have too much exposure to property: it’s a real risk for them.”

Running an SMSF does require a realistic view about workload and likely returns. “Some people in industry funds have a very low MER [management expense ratio] and their performance is generally in line with the market,” Leyland says. “Quite often, the effort required to get 1 or 2 per cent extra performance isn’t necessarily worth it.”

“Taking your money and putting it in a self managed super fund doesn’t guarantee a better return.”

That said, fund trustees do appear to be confident in getting what they need from their funds. Russell found that four out of five SMSF trustees are confident they are on track to achieve their target retirement income – which, in the Russell survey, was on average $1,531.76 per trustee per week.

And reported returns do support the sense that, for most people who have taken the plunge, it appears to be paying off. According to APRA, the average rate of return for large SMSF funds (those with more than four members) was 8.9% for the year to June 30 2010; the average self-reported return made on an SMSF over those 12 months is 10.7%. Running a self-managed fund isn’t easy. But it can work.

Breakout: Why do it?

In working out individual attitudes, it’s useful to understand why people set up self-managed super funds in the first place, which is something else the Russell survey tried to identify – and there is quite a divergence of reasons. The most obvious group of people to take the self-managed route is what Russell calls controllers: people who want to do things their own way. But the fact is, many in that camp have already done so. Russell reckons that the biggest potential group is instead what it calls coach seekers: a group which it considers to account for 30% of the superannuation investing population, but among whom only one in four has so far taken the self-managed route. If this group increasingly gravitates towards self-managed super, it has major ramifications for the advice industry, and further supports the growing number of businesses that give self-managed super advice without ever actually holding the funds.

Breakout: How much is enough?

People often ask what a suitable amount of money is to set up an SMSF. Russell research shows that one in four trustees have an SMSF balance of more than $1 million, and a further quarter have a balance between $250,000 and $550,000 in assets. Only one in seven said they had less than $250,000 (clearly some respondents declined to specify their amount) which cements the sense that $200,000 or thereabouts – the figure proposed by the government as a minimum for an economically viable SMSF – is the floor. In the Russell survey, the average amount considered a minimum by advisors was $241,280.

For his part, Leyland says “you still need about 200K to make it viable, when you take into consideration fees and the work involved in being a trustee and managing a fund.” But, he says, “assuming they’ve got the size, I think it’s a sensible move: it gives them flexibility. They can pick their own fund manager, or open an IMA [individually managed account], or go through an on-line broker; if they’re so inclined they can save a lot of money by managing themselves.”