To successfully establish and grow a self-managed super fund means keeping in mind some critical steps.
By Michael Laurence
Self-managed super funds
Perhaps the biggest challenge for new self-managed superannuation funds (SMSFs) is working out how to create their first investment portfolio, from the ground up.
This task has faced an estimated 100,000 fledgling membertrustees since the simpler superannuation system was unveiled in May 2006.
The creation of an investment portfolio is particularly challenging given the significant sums involved, rising sharemarket volatility and the inexperience of most membertrustees in dealing with self-managed superannuation. (Under superannuation law, all members must be trustees of their own funds or directors of a corporate trustee.)
SMSFs established over the past 18 months or so would be worth billions of dollars. And the vast majority of these super funds would have begun solely with cash contributions and cash rollovers all in need of investment.
During 200607, the then imminent introduction of the simpler superannuation system (from 1 July 2007) acted as something of a supercharger for self-managed superannuation. Fund numbers grew by almost 42,000 to 360,000 nearly 20,000 funds were set up in the June quarter alone. Total assets grew by $67bn, and membership numbers leapt by around 79,000.
Early indications at the time of writing suggest that the breathtaking boom in new SMSFs is likely to continue throughout much of the current financial year, albeit at a slower pace.
A critical point is that the creation of SMSF investment portfolios will remain a significant recurring challenge particularly given the forecast by actuaries Trowbridge Deloitte that within 15 years self-managed superannuation will become the largest superannuation sector.
So, here are eight crucial steps to creating a sound SMSF investment portfolio:
Prepare an investment strategy
Trustees are legally required to prepare and implement a written investment strategy for their funds, and it is in their best interests to also prepare an investment policy statement. These are the most crucial steps in creating a fund's first investment portfolio.
Peter Hogan, a financial planner with Avenue Capital Management, and vice-chair of the SMSF Professionals Association of Australia, says many SMSF members make large initial contributions and rollovers into their funds before preparing the investment strategy and investment policy statement (which are typically incorporated in a single document).
Investors often arrange for their accountants to establish an SMSF and then consult a financial planner about the preparation of the investment strategy, investment policy statement, asset allocation between investment classes (such as shares, property and bonds), and selection of investments.
The investment strategy must reflect the 'whole circumstances' of the fund and at least consider such points as risk, diversification, likely returns from the fund's investments, ability to pay member benefits, and members' retirement needs.
In turn, a fund's investment policy statement must set out its goals and its intended long-term or strategic asset allocation to achieve those objectives. (See step 4, on asset allocation.)
Hogan adds that a fund's investment strategy and investment policy statement should take into account the member's tolerance to risk, the extent and diversity of their non-superannuation investments, their time until retirement, their intended future contributions, and their retirement goals.
Stuart Jones is senior superannuation writer for The Australian Financial Planning Handbook (Thomson, 2006). He says 'Simply complying with regulatory requirements does not protect a fund from poor investment choices and the resulting negative returns.'
And there is nothing in superannuation law barring trustees from investing all of a fund's capital in a single asset, say, a piece of real estate after giving consideration in its investment strategy to such matters as diversity and liquidity.
Consider investment advice
Another elemental decision for new membertrustees is whether or not to consult an investment adviser. Graeme Colley, superannuation strategy manager of SMSF administrator Super Concepts, says the highest performers among the 3000 funds administered by his group receive investment advice.
Colley broadly estimates that the returns of funds in each performance quartile tend to be higher by 2 to 3 per cent if receiving investment advice.
Invest within core rules
Membertrustees should ensure that their fund complies with the core legal rules governing how a fund invests and conducts its financial transactions. Most of these particular rules apply to related-party transactions.
A fund is prohibited from acquiring most types of assets from members (with the main exceptions of listed shares and business real estate); lending to members or their relatives; and from maintaining the fund for purposes other than for the sole purpose of providing member retirement benefits.
Further, a fund must not have 'in-house assets' that exceed more than 5 per cent of its total asset value. In-house assets include investments or loans in related parties, investments in related trusts, and lease arrangements with related parties. Leases of fund-owned business property to members' businesses are not regarded as in-house assets. And funds must invest on a commercial, arm's-length, basis.
Since the 1980s, SMSFs have been barred from borrowing, apart from in limited short-term circumstances. However, recent amendments to superannuation law specifically allow funds to borrow to invest, using such means as instalment warrants, provided stringent conditions are met, including the use of non-recourse loans.
Set asset allocation
A fund that is invested for the long term should aim to hold sufficient growth investment to at least counter inflation, says Sydney financial planner and actuary Graham Horrocks.
Actuarial tables indicate that retirees should expect their retirement savings to have to last for up to 30 years. The setting of a fund's long-term asset allocation between investment classes is widely recognised as a key to obtaining satisfactory returns.
A classically diversified portfolio holds about 70 per cent growth assets (such as shares and property) with the remaining 30 per cent in bonds and cash. The percentage of growth assets is then increased or decreased in accordance with the members' personal tolerance to risk, their other personal circumstances including financial goals, and expectations for returns from various asset classes. Short-term adjustments to the long-term or strategic asset allocation are known as 'tactical asset allocations'.
Avenue Capital Management's Hogan gives a broad guide to long-term asset-allocation thresholds for three types of investors, emphasising that other financial planners may use different thresholds or benchmarks.
He says aggressive investors might have up to 100 per cent of their assets in growth assets; moderately aggressive investors, up to 75 per cent; balanced investors who are between moderately aggressive and conservative, up to 60 per cent; and cautious investors, up to 40 per cent.
And for each type of investor, Hogan sets parameters for moving away from the benchmarks according to changing influences.
The SMSF Investor Report, which is published by specialist researcher Investment Trends, conducted a detailed survey during 2007 of 2100 SMSFs, providing a valuable insight into how their investments are diversified.
The survey shows that their average portfolio at the time comprised direct Australian shares, 35 per cent; managed investment funds (including Australian and overseas equity trusts, listed property trusts and listed investment companies), 23 per cent; direct residential and commercial property, 18 per cent; cash (bank deposits, term deposits, online accounts and cash management trusts), 14 per cent; structured products, 2 per cent; other (including bonds), 8 per cent SMSFs have only a very small exposure to bonds, according to Mark Johnston, principal of Investment Trends.
Select investments
The next challenge for a new fund is to move from cash into actual investments within the chosen asset allocation.
As shown in the SMSF Investor Report, SMSFs invest a large percentage of their assets through managed investment funds. Their frequently high initial asset values new funds have an average starting value of $300,000, according to Investment Trends can open access to wholesale investment funds that have lower fees.
Hogan says investment administration or wrap accounts can provide SMSFs with consolidated reporting and access to a large range of wholesale managed funds.
A point to watch here is that ASIC warns investors that wrap account fees can vary significantly, and some are costly. Hogan emphasises that funds seeking true investment diversity should ensure their shareholdings, for instance, include a range of sharemarket sectors and companies.
And when investing through managed share trusts, members should consider investing with managers who have different styles such as value and growth, and various styles in between.
Avoid excessive cash
Financial planners stress that SMSFs should take care not to hold excessive cash in their portfolios, if investing for the long term.
However, it is somewhat of a myth that SMSFs have portfolios dominated by cash, as confirmed in research by Investment Trends and Australian Taxation Office statistics.
Nevertheless, average SMSF portfolios have high percentages of cash in their portfolios compared to the default portfolios of the large funds. At the time of the Investment Trends survey in mid-2007, some funds were increasing their cash levels, aiming to take advantage of possible sharemarket opportunities.
Consider liquidity of property
One of the challenges for SMSFs with direct property investments, which often include the member's business premises, is whether the assets are going to be sufficiently liquid to pay member retirement and death benefits when necessary. Direct property cannot always be readily sold.
Hogan says the liquidity of an asset is less of a problem when a fund has, say, a 20-year investment horizon. And he says the suitability of a large, costly piece of real estate for a fund will also depend on the size of the property's investment income. 'Trustees [also] need to address the issue of a lack of diversity if single assets [such as costly investment properties] dominate their portfolios,' he says. When considering this issue, trustees might consider the diversity of the members' superannuation and non-superannuation investments.
Buy shares progressively
Membertrustees who have made exceptionally large contributions should consider whether their fund should buy progressively into the sharemarket, rather than all at once, as Hogan suggests. Progressive investment is intended to cushion the portfolio from a sudden fall in share prices.
