SMSFundamentals | May 19 2011
By Greg Peel
Welcome to SMSFundamentals, a new feature series specifically dedicated to providing SMSFs with valuable news, investment ideas and services, in line with SMSF requirements and obligations.
In 1992, the Keating government introduced legislation that made a base-level form of superannuation compulsory for all Australians. From his days as Treasurer in the Hawke government, Paul Keating could see the writing on the wall. Eventually, Baby Boomers would retire and switch from being the country's most populous cohort of income tax payers to being the largest draw on the government purse as pensioners. Generation X prefers to produce less offspring, hence the risk is the surge in pension obligations would be met with a simultaneous decrease in income tax receipts.
Keating was one of the first politicians around the globe to recognise the problems presented by the Ageing Population.
The Superannuation Act has been modified several times in the interim, but it was changes made in 1999 under the Howard government that paved the way for the Self-Managed Superannuation Fund (SMSF). Initially seen as an option only for the wealthy, or for those with their own financial market expertise, the game changed when Australia underwent a mild recession in 2002-03 following the US Tech Wreck and 9/11.Superannuants retiring at that time found that not only were their nest eggs significantly less than they had hoped, they had also been plundered by Super Fund fees – management fees, performance fees, exit fees, anything under the sun. Suddenly SMSFs surged in popularity.
From that time to the Global Financial Crisis, a further issue emerged. Once upon a time, if one wanted to plan for retirement it was standard practice to seek help from an independent financial adviser. The experienced adviser could pick and choose between the various funds, products and asset classes on offer and tailor an investment portfolio to the specific needs of the super investor. Understandably, the adviser would charge a fee for such a service.
But the system was open to abuse. Major super funds began (legally) offering trailing commissions to financial advisers as reward for directing investors into their various fund options. Very quickly the old-fashioned financial adviser became little more than a sales agent. Independence went out the window, and still superannuants were being burdened by significant fees, sometimes effectively hidden. When the GFC hit, enough was enough, both for investors and for the government. Too many people had seen their nest eggs severely devalued, and it wasn't simply a matter of lower stock prices. Whether or not a working Australian had any of their own experience in financial markets, an SMSF seemed like a much safer option. At the very least, the investor knew just who was ultimately in control.
To start an SMSF, the investor must begin with at least $200,000 in assets. While this precludes the lower or younger earner, it is an amount accessible to Australia's vast middle class. Under Australian Securities & Investment Commission rules, an amount of $200,000 defines a “sophisticated investor”. This is an important definition because it allows the investor to become a “wholesale”, rather than a “retail” client of brokers and funds managers, meaning lower commissions and more risk/reward opportunities.
It is also a ludicrous definition, in my opinion. Clearly a line has to be drawn in the sand somewhere, but to suggest that someone who successfully backed the trifecta on the Cup and thus has two hundred grand to blow should be considered, with regard to financial markets, “sophisticated”, while the merchant banker who has made and lost millions over a long career and only has a hundred grand to his name is “unsophisticated”, is to simplify the definition dangerously. One is reminded, for example, of a certain celebrity hairdresser who invested millions into a high leverage vehicle and was blown away in the GFC. He tried to sue on the basis of poor advice, but being “sophisticated” it was deemed under law that he must have known what he was doing.
He may have been a hairdressing whizz, but why would that qualify him as an investment whizz?
For the time being we are stuck with the rules. The bottom line is that just because you are a successful lawyer, doctor, IT consultant, university professor, butcher, baker or candlestick maker – success being determined by your net wealth – it doesn't mean you understand the first thing about financial markets. Hence there is a vast number of Australians today who have chosen to manage their own super simply because they became fed up with the funds management industry, not because they consider themselves to be a financial expert of any sort.
Indeed, by the end of FY10 the proportion of Australians electing to self-manage represented 10% of all super investors. But the total of $390bn held in SMSFs represented 32% of the $1.23 trillion invested in super. That's a greater proportion than any other superannuation funds management class – greater even than those funds we once called “mutual”, such as those offered by the AMP.
Just as an aside at this point, consider the concept of “demutualisation”. When fund managers such as the AMP became listed companies on the stock exchange, their boards then had an obligation to shareholders. Those who invested in AMP stock were looking for capital growth and dividends. Providing the capital growth and dividend potential, via their investments, were the unitholders of the various funds on offer, including super fund selections. Do the shareholders and unitholders “live in harmony”?
This might be ingenuous to suggest, but clearly an increase in management or performance fees would benefit the shareholder at the expense of the unitholder, and a decrease vice versa. The same conflict arises when considering any form of legal “kick-back” to sales agents masquerading as independent financial advisers. The same conflicts do not arise when one manages one's own finances.
Maybe there is a clue here, among others, as to why SMSF investment in Australia grew at an annual rate of 20% in the five years to 2009, while the growth of all other funds regulated by the Australian Prudential Regulatory Authority grew at 9%.
At The Risk Of Copyright Infringement…
The label “Self-Managed Super Fund” is a mouthful. In such cases it is thus easier to use an acronym, but in this particular the acronym “SMSF” is even more of a tongue-twister.
We could take a leaf out of the book of the US Federal National Mortgage Association. It's acronym is “FNMA”, which is a lot easier to say than “Federal National Mortgage Association”. And if you say it quickly, it sounds a little like “Fannie Mae”. When the FNMA listed on the stock exchange in the sixties, it changed its name officially to Fannie Mae.
I'm taking some licence here, but try this: Self-Managed sUpeRFund. From that, we get “smurf”. Given that smurf is a lot easier to say than SMSF, I will hitherto refer in FNArena's regular new SMSFundamentals column to “smurfs”, meaning SMSFs and/or the people who manage them.
The First Smurf Survey
Earlier this year, the first comprehensive survey into the SMSF industry in Australia was published. The SMSF Professionals' Association of Australia Ltd (SPAA) in conjunction with Russell Investments commissioned leading market research consultancy CoreData-brandmanagement to produce “Intimate With Self-Managed Superannuation”. The survey is intended to be undertaken annually, and the data above are drawn from this inaugural document.
Aside from producing numbers confirming the size and scope of the smurf industry, the survey attempted to get inside the head of the average smurf in order to provide those in the wider financial market with a capacity to offer services to smurfs to do so with a greater understanding. Amongst the array of crunched numbers, perhaps the most singularly fundamental finding of the survey can be summed up by the word “mentor”. Smurfs are distrusting of, and thus no longer necessarily seeking, “financial advice” in the traditional sense. But they are keenly seeking “financial mentors”, or if you like, “financial coaches”. The SPAA survey concluded that the fastest growing subset within the smurf cohort are those the survey labels as “coach seekers”.
The survey did not, however, simply collate information from existing smurfs. It's sample set included those who owned and ran an SMSF and those who didn't, as well as financial advisers and accountants. Nor was the survey seeking to ostracise financial advisers in any way. More correctly it was looking to provide financial advisers with some insight into how to best adapt to an evolved attitude among clients.
Of the financial advisers surveyed, nearly half reported a surge in new smurfs. Of the non-smurfs surveyed, 10% said they will likely set one up in the next two years. Of that cohort, 9.4% were Baby Boomers but 15.5% were Gen-Xers. In other words, the smurf population is clearly set to grow further.
The researchers concluded that all super investors can be broken into three distinct groups: the “controllers”, the “coach seekers” and the “outsourcers”. Controllers represent 20% of the population but 40% of the existing smurfs, and they like to handle things all by themselves. Coach seekers represent 30% of the population but 25% of smurfs, and they want do make their own decisions with the help of some mentoring. Outsourcers represent 50% of the population but only 14% of smurfs, and they just want to hand the responsibility over to some professional. One can see why few smurfs are outsourcers given it suggests a contradiction.
The results suggest to the researchers that the group with the greatest smurf growth potential is the coach seekers, given only 25% are currently smurfs but 30% of the general population are neither controllers nor outsourcers and would like to make their own decisions with some help from someone such as a financial adviser. They want more insight into a market that can be quite mysterious and clearly, at times, rather scary.
It is logical that the largest cohort of existing smurfs are classed as controllers. These smurfs spend an average five hours a week managing their fund, including looking for investment opportunities and monitoring the fund's performance. It is also no leap of logic to learn that 45% of all smurfs either own or part-own a business. There is a high correlation between smurfs and SMEs (small to medium enterprises).
The government might be pleased to know that 74% of smurfs are confident in Australia's superannuation system as providing the means for retirement, but not pleased that only 54% of non-smurfs agree. And everyone is concerned about the prospect of legislative changes down the track. This is encouraging some smurfs to maintain other investments outside the super system, but by the same token almost half of smurfs would have tipped more money into super if not for the relevant caps.
The average target income of a smurf in retirement is $1532 per week. In terms of current balance, 26% of smurfs have more than $1 million invested and 26% have $250,000-500,000. This suggests there are a large number of smurfs currently under the original $200,000 threshold (the GFC is probably the culprit) but financial advisers believe, on average, that $241,280 is needed as a starting investment to render an SMSF worthwhile.
Only 38% of smurfs use a dedicated financial adviser. The preferred method of paying financial advisers is by hours worked plus a flat annual retainer. An important discovery of the survey was that while advisers listed managing a smurf client's specific responsibilities and obligations under the rules as a significant challenge, the majority of smurfs suggested they had a reasonable understanding of it all. There is a risk many smurfs are under-educated with regard to the rules.
In a wake-up call to advisers, around half of all smurfs make the majority of their investment decisions based on information sourced from newspapers, magazines and/or websites (more on that last one in a moment). Only two in five source information directly from a financial adviser.
The burning question for someone who is considering becoming a smurf, and for those already smurfs, is whether all the extra effort is worthwhile. The survey asked for FY10 investment return numbers from smurfs and learned that 49.5% made 5-10%, 25.8% made 11-20% and only 1.4% made a negative return. Averaging the positive returns provides an average of 10.7%, while in the same period public sector super funds returned less than 10% and each of the corporate, industry and retail funds returned less than 9% on average.
In terms of asset allocation, the average breakdown of current smurf investments is 42.6% Australian equities and 9.4% listed REITs (real estate investment trusts), and 34.3% spread across various other asset classes other than cash. The average cash component is a whopping 23.1%. Clearly the GFC is still taking its toll on investment risk mindsets, but the survey suggests a bit more than half of all smurfs are cognisant of their high cash weighting and are now just “parking” the money as they await the next investment opportunity. The remaining group nevertheless sees cash investment as a means of reducing risk. (Battle scarred, no doubt.)
These results correlate closely with the FNArena Investor Sentiment Survey last conducted in March, which concluded that respondents on average were holding 53% in equities, 18% in property (not including the family home), 8% in fixed interest and 19% in cash.
Such correlation is no great surprise to FNArena, given previous surveys had found that close to half of the FNArena database constituents are smurfs. The other half includes financial advisers, financial market professionals and non-super share market traders.
Smurfs and FNArena
FNArena was established many years ago, but became an independent entity in 2006. At the time, management had no specific agenda to be a dedicated service to smurfs but it came as no surprise that smurfs quickly began to dominate the database. This harks back to what the SPAA survey calls financial “mentoring”.
FNArena's agenda has always been one of creating a website-based service for all those interested one way or another in financial markets, and particularly the Australian stock market, which helps readers to understand the markets and formulate investment or trading ideas. FNArena receives a great many research reports each day from stock brokers, economists, research houses and others both here and from offshore, and it is our intention to sort the wheat from the chaff and distill that information down into an easy-to-understand information and guidance source, through both stories and consensus data.
In other words, FNArena has always been a financial “mentor”, and has no intention of being anything else.
The rapid growth of the smurf population suggests to us that FNArena could enhance its service to smurfs in particular with the introduction of regular features under the banner of “SMSFundamentals”. This service will, over time, provide investment and portfolio management ideas and news across an array of asset classes, including but not restricted to the stock market. Indeed the features themselves will never be “smurf only” information either, but when specific considerations of, for example, tax implications are important, this is where SMSFundamentals will prove most beneficial.
So welcome to SMSFundamentals. Feature stories will now follow on an irregular basis which are considered to be of particular interest to, and to provide beneficial information to, smurfs. We trust you will find the service a valuable addition to your regular sources of advice.