In defence of the SMSF investor
- On 09/03/2017
Although the SMSF segment only holds 1.1 million (4%) of the 29.7 million superannuation accounts, they represent about 30% of the assets within the superannuation system with around half of these assets in the retirement phase.
The number of SMSFs continues to rise, albeit at a lower rate. Rice Warner projects the market share of this sector to contract slightly over the next 15 years (Rice Warner’s Superannuation Market Projections Report 2016) due to lower contributions (more stringent legislative caps) and the outflow of pension payments of those already retired.
The high share of assets held in this segment by a minority of superannuants results in a disproportionate public focus on SMSFs, whether that be to provide SMSF members with information and news to help them manage their accounts or, more frequently, criticism from other areas of the industry on why SMSF members are not suitably qualified to act as their own trustees!
This criticism usually focuses on three claims:
- SMSFs are expensive to run, and fees paid are too high relative to APRA funds.
- SMSF trustees are not professional asset managers and do not diversify their asset allocation.
- SMSF members cannot beat the professional managers when it comes to investment performance.
In this Insight column, we unravel each of these issues in turn.
Fees for SMSFs vary greatly based on the size of the fund, the investment strategy, the amount of administration that the Trustee is willing to undertake themselves and the level of advice that has been provided. In a report to ASIC¹ Rice Warner estimated a minimum balance of $200,000 – $500,000 was required to make SMSFs cost effective relative to APRA regulated funds.
Our estimate for the total fees paid by SMSFs in the 2016 financial year is 0.99% of assets. This is inflated by including the estimated cost of interest margins on bank deposits as a fee whereas interest margins are excluded in calculating fees for APRA-regulated funds. The average SMSF fee is still lower than the market average for all APRA-regulated funds, showing that the sector has generated some scale benefits from aggregation of administration and software platforms. It should be noted that small SMSFs incur relatively high fees whereas many larger self-directed funds not using financial advice have fees as low as 10 basis points.
The aggregate asset allocation of SMSFs has clear biases towards domestic shares and cash when compared to APRA regulated funds. However, it should be noted that estimates of Australian Equities are overstated by the fact that many SMSF members utilise Exchange Traded Funds (ETFs) or managed investment trusts to get international exposure – a recent report by Class estimates total SMSF holdings of $11.4 billion in ETFs², more than 40% of all ETF holdings.
Another important consideration is that half of SMSF money is in the retirement phase. Our analysis of the asset allocation for members of APRA-regulated funds in the retirement phase suggests that they hold similar allocations to defensive investments such as cash to meet pension payments. Some of the cash held by SMSF retirees is placed in Term Deposits as a nest egg.
Table 1. Asset Allocation
Perhaps the best indicator of whether SMSFs deliver value is how they perform.
Our analysis of APRA vs. SMSF returns (based on APRA and ATO statistics) shows that SMSF funds collectively have outperformed APRA-regulated funds since 2005, with average compound returns of 8.0% p.a. and 6.2% p.a. respectively. Further, SMSFs outperformed in 8 out of 12 individual years for the period considered. The margin would be greater if fees were deducted from returns!
In our opinion, much of this performance can be attributed to asset allocation, patient long term investing and tax optimisation at the member level. Of course, past investment performance is no guide to the future. However, sensible investment strategies are likely to continue to produce good results over long periods.
Rather than criticise SMSFs, perhaps the rest of the superannuation industry should be challenged to emulate them.
Table 2. Annual Investment Performance – Rice Warner analysis of APRA and ATO statistics
¹ Cost of Operating SMSFs, Rice Warner, 2013 http://download.asic.gov.au/media/1336058/cp216-RiceWarner-cost-of-operating-smsfs.pdf
² Class SMSF Benchmark Report – March 2016, available from https://www.class.com.au/insights-ideas/class-smsf-report/