This article appeared in the September 2010 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
By Geoff Stewart, Macquarie
Australia's Self-Managed Superannuation Fund (SMSF) sector has grown to be a substantial part of Australia's retirement income system. Total SMSF assets as at June 2010 were estimated to be $390 billion by the ATO, or around one third of Australia's total superannuation invested assets. The ATO estimates that the total number of SMSFs was slightly greater than 428,000, covering over 815,000 members, in June 2010.
SMSF growth reflects a continued trend towards personalisation of investment arrangements, which implies a strong preference for control over the assets included in portfolios and a high degree of alignment between the investors' objectives and decisions made regarding matters such as costs and investment execution.
The SMSF sector is regulated by the ATO owing to the typically confined member base, with APRA regulating the remainder of the superannuation industry, comprising larger funds and insurance entities. Data on a wide range of characteristics is collected by the respective regulators, with limitations to the ability to compare the two sectors in a number of areas, including portfolio composition.
For example, a direct comparison between the international shares exposure between SMSFs and APRA-regulated entities is not easily achieved. However, we can see from published data that the SMSF sector displays some meaningful differences from APRA-regulated superannuation entities in terms of broad asset allocation, geographic dispersion of assets and vehicles used to implement investment exposures.
Typical SMSF Characteristics
The ATO estimates that around 60 per cent of SMSF assets are invested in direct Australian shares and liquid assets (cash and term deposits) in roughly equal proportions. Around 20 per cent of assets are invested in "managed investments", broken down into 6 per cent listed managed investments and 14 per cent unlisted. Approximately 15 per cent of assets are invested in real estate assets, predominantly Australian non-residential real estate.
The remainder of SMSF assets comprise derivatives and instalment warrants, real assets such as artwork, with a small allocation (0.2 per cent) to overseas shares. Although no further breakdown is provided, we can assume that exchange-traded fund (ETF) exposure is included in the 6 per cent allocation to listed managed investments, which would also comprise allocations to real estate investment trusts and listed investment companies.
These asset allocation figures apply to the SMSF sector in aggregate, so being able to drill down to analyse SMSF assets by characteristics such as size would be quite useful. Analysis conducted as part of the recent review of Australia's Superannuation System (the Cooper Review) provides assistance here, indicating that the majority of SMSFs held either one or two asset classes only, these being Australian listed shares and cash or term deposits. We can surmise that, within these allocations, there is a high degree of asset concentration across the SMSF sector.
Applying some broad assumptions to the ATO data on how some of the broad asset categories may be invested, we can assume that the SMSF sector, in aggregate, looks something like a "Balanced" investor, with 60-65 per cent invested in growth assets and 35-40 per cent invested in defensive assets.
Size of fund also impacts how SMSFs are invested, with larger SMSFs having lower allocations to cash and listed Australian shares and higher allocations to unlisted managed investments and real estate. This suggests larger SMSFs are more diversified than smaller SMSFs and may reflect factors such as inefficiency in investment execution or lack of time acquitted to ensure the adoption of a sound investment strategy. The Cooper Review also highlighted data that showed that costs have been higher and historical returns lower for smaller SMSFs, compared to larger. These outcomes suggest that smaller SMSFs are at a disadvantage than larger SMSFs in aiming to achieve an efficient investment structure.
By way of comparison, APRA-regulated superannuation investors typically have a higher proportion of assets invested in international assets, mainly shares but also in debt and real estate investments. SMSFs typically have a higher cash allocation than APRA-regulated entities, which may reflect SMSF investor desire to structurally offset the risk of concentrated exposures in shares and property, as much as decisions to switch out of growth asset classes over the last couple of years, owing to the heightened risk environment in investment markets.
Prima facie, there is a case for SMSF investors to move towards an asset allocation with greater diversity to improve the efficiency of their overall SMSF structure. This diversity covers both allocation of assets across the typical spectrum of growth and defensive assets, in addition to ensuring a prudent number of individual assets are included within each asset class. This diversity would go some way to ensuring that a sound investment strategy can be implemented by SMSF investors which is aligned to their preference of portfolio control.
Role of ETFs
There appear to be obvious differences in the asset allocations of SMSF investors when comparing the sector to the "typical" diversified investor with long term timeframes. These differences appear chiefly to be in the areas of debt-related investments like bonds and international exposure. Defensive allocations for SMSFs appear to be dominated by cash and listed debt securities, with relatively little exposure to investments such as corporate debt securities or international bonds.
Of likely greater impact, however, is the relatively small role that international shares play in the portfolios of SMSF investors, given the overall dominance of growth assets and the fact that SMSFs are primarily wealth creation vehicles. When including international shares in otherwise-diversified investor portfolios, expected portfolio diversity improves markedly. In other words, forecast portfolio return is expected at a lower level of portfolio volatility. This is because inclusion of assets from other markets and in currencies other than Australian dollars tends to generate a smoother portfolio return. While developed world shares have not been stand-out performers relative to Australian shares over the last decade or so (largely due to the impact of two bear markets in that period), the inclusion of emerging markets has been a great benefit to diversified portfolios over the last few years.
The introduction to the ASX of ETFs covering a range of broad international share markets, in addition to regional, country and sector exposures, has been accepted by the SMSF sector as these ETFs represent tools to improve portfolio diversity with relative ease. These ETFs represent a simple exposure to an underlying pool of assets (like the US S&P 500 index) with a simple method of execution.
Likewise the addition to the ASX of a range of ETFs based on precious metals, Australian sectors and dividend-focused ETFs has helped improve the breadth of portfolios able to be implemented by SMSFs via the ASX. Examples of such portfolios include:
- a full replication of the broad global share market via ETFs
- focused exposure on the US or Chinese stockmarkets
- using broad Australian market ETFs as assets of core portfolios; and
- the use of precious metals ETFs as "safe havens" in the face of declining stock markets.
Future potential ETF range
As well as differences in the asset allocation range of the overall SMSF sector, there are improvements that can be made to the range of ETFs trading on the ASX. ETF product issuers are moving to provide a fuller menu of products to reflect the tools available to diversified asset portfolio investors. A shortcoming of the current range of international ETFs on the ASX is that they do not include hedging of movements in the Australian dollar as part of their process.
Movements in the Australian dollar may have a meaningful impact on the portfolio risk and return outcome for Australian investors. Broadening the product set to include ETFs based on bonds and a broader range of commodities (including agricultural or commodities used in industrial processes) would allow investors to implement more diverse exposures to offset growth asset allocations and produce smoother portfolio returns.
While improvements can be made to the current ETF product set, there is no real blockage to their usage in completing diversified portfolios for SMSFs. The risks around currency exposures can be mitigated somewhat through awareness of currency levels and willingness to allocate between international and domestic assets. As part of their investment process, SMSF investors should make sure they clearly understand their investment strategy, their current portfolio of assets and where it can be improved, as well as the features of ETFs. Investors should seek advice from professional advisers to improve their chances of success with ETFs.
About the author
Geoff Stewart, CFA, Associate Director, Senior Investment Analyst, Macquarie Private Wealth.
Watch the ASX SMSF introductory video to learn more about Self-Managed Super Funds. ASX Business Development Manager Graham O'Brien outlines the key trends.
Visit the ASX website for more information on ETFs.
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