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How SMSFs invest

Photo of David Wanis By David Wanis

min read

Room for improvement in asset-allocation strategies.

As part of discussions around how investors can achieve the best outcomes from their portfolios, Schroders recently conducted some analysis of Australian Taxation Office (ATO) data on self-managed superannuation fund (SMSF) portfolios, looking in particular at asset allocations.

The analysis concluded that SMSF investment portfolios tend to be less efficient (higher risk and lower performance expectations) compared to those within super funds or adviser-based.

With historically low interest rates around the world, SMSF portfolios are under pressure to deliver meaningful outcomes, and we would say many trustees need to consider making some changes to improve their diversification across both the risk and return spectrum.

SMSFs have a clear bias toward Australian shares, property and cash, which under certain market conditions can lead to poor investment outcomes. Increased diversification is an easy solution and a worthwhile goal for most SMSF funds. However, this does not necessarily mean trustees should lock themselves into the strategic asset allocation model favored by so many other investors.

In our view, SMSF trustees should adopt an active asset allocation approach that considers prevailing asset valuations as well as their own investment return and risk objectives.

SMSF portfolio biases
SMSFs have a number of clear biases in their portfolio construction relative to other investor groups – driven by investment objectives, access or tax reasons.

Our key observations from the ATO data on investment make-up of SMSFs are:

  1. A preference to hold Australian equities directly (34 per cent) rather than via managed funds (5 per cent).
  2. A preference for Australian equities (39 per cent).
  3. A high allocation to property, which includes both commercial and residential (a property class not found in other portfolios).
  4. A strong preference to cash over fixed income.

The assumption is that these biases are often tax driven (for example, investments in property, unlisted trusts) but a number of them also look to be behavioural – based on what is familiar and accessible (direct Australian equities, cash) rather than what may make most sense to the investment objectives (global equities, fixed income, credit).

SMSFs also have a clear bias towards unlisted property. Given property is almost 17 per cent of the average SMSF portfolio (compared with less than 13 per cent in 2008), we assume the property allocation is relatively fixed. Hence, any increased risk to property returns from here is going to be seen in future portfolio returns – and we believe these risks are very high.

The bias of SMSF investors to Australian equities (which returned 8.7 per cent per annum over the past seven years) versus global equities, which returned 12.8 per cent over the same period, would have hurt SMSF investors. They also favoured cash (returning 3.2 per cent per annum over the past seven years) over fixed-income assets (6.7 per cent over the same period).

Comparing risk and returns
To analyse the risk and return characteristics of SMSF portfolios, we have used ATO data from 2009 to 2014 and estimated performance through to June 2016 (Exhibit 1, below). We have also provided two comparator return series to show where SMSF results sit relative to available alternatives:

  1. The Morningstar multi-sector growth category has a similar level of risk to the typical SMSF portfolio, although most multi-sector funds diversify into fixed income as well as cash. This category returned 9.3 per cent per annum versus the SMSF portfolio return of 6.5 per cent per annum (estimated) during the period June 2009 to June 2016.
  2. The Schroder Real Return CPI +5% Fund has an investment objective similar to the average multi-sector growth fund but targets a lower level of risk. This fund delivered an improved result to the SMSF portfolio (8.4 per cent per annum) but at half the level of volatility.

Exhibit 1 – Return and risk performance: 30 June, 2009 to 30 June, 2016

Chart of return vs risk

SOURCE: SMSF: ATO (2008–2014), Schroder est. 2015 and 2016, Schroder Funds, Morningstar. All numbers gross of fees. Analysis is from 2009 to 2016 as all three compared strategies have investment histories covering this period. ATO data used for SMSF fund returns available 2009–2014, and estimated returns 2015 and 2016.

The graph reinforces our core premise about SMSFs today: that they carry higher risk and lower performance outcomes compared with mainstream counterparts.

The importance of ‘smoothed’ returns
Why should an investor care about portfolio efficiency and the benefits of reduced volatility of returns from diversification?

The simple answer is that converting average asset returns into the compounding portfolio returns that build wealth depends very much on their path and volatility. A return of -50 per cent followed by +100 per cent gives an average of +25 per cent. But our starting $100 which declines to $50 and returns to $100 as impacted by those returns, gives a compound return of 0 per cent. A return of -5 per cent followed by +15 per cent may look paltry on the average (+5 per cent) but our compounded end point is a bit over 9 per cent.

That is the unarguable mathematics of why a smoother path of returns – all other things being equal – is preferred. But there is also a behavioural consideration. When faced with a large loss, many investors find it emotionally difficult to maintain an investment program and often abandon their approach precisely at the worst time.

New products helping diversification

One of the core characteristics of SMSFs is a preference to invest directly in listed securities, a tendency that also exacerbates SMSFs’ lack of diversification. However, as more investment solutions become accessible via a listed or quoted ASX structure, we predict that SMSFs will take the opportunity to rebalance away from Australian equities and cash over time.
For example, exchange-traded funds (ETFs) provide diversified exposure to developed and emerging equity markets, domestic and global fixed income, corporate bonds and property assets. These products mean portfolios with a bias to particular assets can now be easily changed.

A more recent trend is to exchange-quoted managed funds (EQMFs) which, like their ETF brethren, are exchange-quoted and settled like an ordinary share – but the underlying portfolios are actively managed rather than passively constructed.

Taking an active allocation approach
Although improvements in existing portfolios from a diversification and risk/return perspective should be encouraged, we believe the static asset allocations most people use to weight these investments can bring a whole new set of challenges.

Schroders’ view is that SMSF trustees should take advantage of their lack of constraints and exercise flexible asset allocation in pursuit of their objectives.

For example, Exhibit 2 shows how the asset allocation of our Real Return strategy, the Schroder Real Return CPI +5% Fund, compares to current SMSF positioning – highlighting potential areas for improvement or consideration by SMSF investors.

Exhibit 2 – Real Return Fund vs SMSF portfolio

Chart Schoders real return fund vs SMSF

The key portfolio differences between the average SMSF portfolio and the Real Return Fund are:

  • Growth assets. The fund has lower overall exposure to growth assets and improved diversification through global equities and foreign currency. The SMSF portfolio has a clear preference for Australian equity and property assets.
  • Diversifying assets. The fund invests in liquid and transparent assets. Within this component of SMSF portfolios are assets such as options, bonds, hybrids, futures, warrants, CFDs and ETFs.
  • Defensive assets. The fund is actively managing the fixed-interest allocation; despite our concerns about the valuation outlook we do have a small allocation for diversification and protection against a deflationary scenario.
  • Dynamic allocation. We have used the asset allocation at June 2016, but an objective-based portfolio will respond to the available opportunity and this may change in the future. As an example, in the past 12 months alone our cash weight has varied between 24 and 40 per cent.

The Schroder Real Return Fund [ASX: GROW]
In August, Schroders launched its first managed fund quoted on ASX – the Schroder Real Return Fund (Managed Fund) (ASX: GROW), based on the popular Schroder Real Return CPI+ 5% Fund.

GROW places emphasis on generating positive real returns while managing volatility and minimising frequency of drawdowns by investing across a broad range of asset classes.

GROW is one of a number of new products available via ASX that can help SMSF trustees improve the diversification of their portfolio, smooth the return journey, and ultimately achieve better portfolio outcomes.


About the author

David Wanis, Portfolio Manager, Multi-Asset, Schroders, presented a version of this paper at the Portfolio Construction Conference in August.

From ASX

Schroders is an mFund Foundation Partner. mFund allows you to buy, hold and sell units in unlisted managed funds through a process similar to buying and selling shares.

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