SMSF Asset Allocation Critical To Performance

By James Dunn | More Articles by James Dunn

The success of self-managed super has been stunning. In 2003, according to super research group Rainmaker, there were just over 260,000 SMSFs, holding about $108 billion in assets, or one-fifth of the superannuation pool.

Ten years later, there are 503,320 funds – representing almost one million individual trustee-members – holding $496 billion, nearly one-third of all superannuation money. SMSFs now represent the largest single chunk of the Australian super pool, and thousands of new SMSFs are being established every quarter.

Australia’s army of SMSF trustees love the fact that you can own virtually anything in your SMSF: land, a holiday house, art or even expensive jewellery, as long as it accords with their investment strategy and it complies with the Australian Taxation Office’s arms-length rules – which means you or your family can’t live in any property your fund owns, hang the art on your walls or wear the jewellery.

This for many people negates the appeal of owning such assets, but for others, who understand the investment case for those assets, they can be perfectly valid assets for a super fund.

But most SMSFs stick with cash, Australian shares and direct property.

The excellent SuperGuide website ( tracks where SMSFs put their money. At December 2012, says SuperGuide, SMSFs held 31.6% of their assets in direct Australian shares, 28.6% in cash and term deposits and 15% in direct property.

Of the remaining 24.8% in total SMSF assets, 13.3% was held in trusts (9.1% in unlisted trusts and 4.2% in listed trusts), 4.7% in ‘other managed investments and the remaining 6.8% spread across 12 other categories, including collectible assets (such as art and jewellery).

Similar research by Russell Investments/CoreData found that cash and term deposits accounted for 33.9% of SMSF investments in 2012, an increase from 2011 when they had 25.6%. SMSFs had reduced holdings in Australian equities to 37.1%, down from 43.5% in 2011.

Having their second-largest asset allocation in Australian shares helped SMSFs in 2012 when that asset class returned 19.7%. But the counterweight to this statistic is that international shares returned 19.1% in 2012, yet the Russell Investments/Core Data research indicated that SMSF trustees on average only have 6% allocated to that asset class.

This implies a failure to get adequate asset allocation advice. There is a wide investment universe available through exchange-traded-funds (ETFs) or managed funds, which can offer SMSFs broader diversification, across multiple asset classes.

People who have chosen to run their own super fund want to have greater (even total) control over how their retirement funds are invested. An SMSF gives you a greater ability to tailor your portfolio to suit your needs, and invest directly. An SMSF also gives you more control over how you design your benefits; you can optimise the tax and estate planning benefits that you get from superannuation.

But with the benefits of an SMSF comes plenty of responsibility.

The regulations governing SMSFs are strictly enforced. Every member of the fund must be a trustee (there are special rules for single-member funds) and with that comes trustee responsibilities. Since July 2007 all new trustees of SMSFs have been required by ATO to sign a trustee declaration, formally acknowledging that they understand their duties, obligations and responsibilities.

A SMSF must choose to be regulated under the Superannuation Industry (Supervision) Act 1993 to be eligible for the concessional tax treatment of super funds. Under the sole purpose test set out in the SIS Act, the trustees must ensure that the fund is maintained for the sole purpose of providing retirement benefits to members.

The trustees must ‘formulate and implement’ an investment strategy for the fund, ‘having regard to liabilities, risk and return, diversification and liquidity’. If the fund maintains reserves, the fund must have a defined strategy for managing those reserves, in line with its investment strategy and its ability to meet liabilities.

A portfolio in a SMSF must meet four conditions: liquidity; the matching of cash flows to liabilities in the pension phase; risk; and diversification. In considering risk, the fund has to look at the age of the members, when they plan to retire, and match its portfolio to those factors. If a fund is not administered properly and loses its status as a ‘complying’ fund, the penalties are severe, including penalty rates on the fund’s earnings. If a fund becomes non-compliant, the top marginal tax rate of 46.5% is levied on the assets of the fund.

A SMSF is required each year to have a set of accounts prepared, it is required to be audited and a tax return for the fund must be lodged. Typically that will mean that your accountant will prepare the accounts, and the accountant will have arranged an auditor – the accountant that prepares returns cannot also do the audit.

Not only do trustees have to ensure that their fund is operating in a complying fashion for the purpose of providing benefits to its members upon their retirement (or their beneficiaries if a member dies), they must sign off that they understand (end ensure) that member benefits are only withdrawn when permitted by the super laws; that they understand that the assets of the super fund must be kept separate from their personal assets; and that there is adequate insurance.

But there are genuine grounds for concern in asset allocation, that SMSFs can have roughly two-thirds growth assets and one-third defensive assets for too long. As the funds begin the move from accumulation mode to pension-mode – where they start paying pensions to their members – the asset allocation that served the accumulation mode well might not be adequate for this transition.

Asset allocation in the accumulation phase may differ from that in pension phase due to cash flow requirements. The Russell Investments/CoreData research showed that only 43% of SMSF trustees were changing their asset allocation in retirement or planning to do so.

That is an alarming finding. “Sequencing risk” – the risk of experiencing poor investment performance leading up to or shortly after retirement – can be a big problem for SMSFs. If a fund is not getting good asset allocation advice leading up to this point, it should be.

James Dunn

About James Dunn

James Dunn was founding editor of Shares magazine and has also written for Business Review Weekly, Personal Investor, The Age and Management Today. He was subsequently personal investment editor at The Australian and editor of financial website,

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