The diversification challenges facing Australia’s 600,000 SMSFs are well documented. Whichever data source you prefer, the vast majority of SMSFs are heavily overweight cash and Australian listed securities, and underweight fixed income and international equities.
To what extent does this reflect rational investor behaviour? Recent data from the nabtrade SMSF investor base suggests that while this allocation may have been well informed and intentional, it is starting to change.
The merit of a different asset allocation
Asset allocation is not a perfect science, and the argument for greater allocations to bonds and international shares is often made most vocally by those who happen to manage products and assets in those classes. That doesn’t mean the argument is without merit. For some years, it was also believed that the average asset allocation of SMSFs was leading to significant underperformance relative to institutional super funds, notably in the post GFC era.
Interestingly, 10-year data to 2016 suggests otherwise. SMSFs appear to have delivered returns of approximately 5.7% pa, while APRA funds delivered 5.3%. SMSF performance is estimated by the ATO, while APRA fund performance is reported by APRA. As the data sets are different and the formulae are also different (eg the ATO includes contributions tax and insurance premiums as expenses, while APRA does not), there is sufficient evidence to assume that SMSFs have at least not underperformed their professionally-managed peers after costs.
Minor variations in performance can deliver material benefits to the member when compounded over many years, making asset allocation important. To this end, the historical asset allocation of the average SMSF could be considered rational.
Recently, however, some data sources suggest that SMSF trustees are choosing to increase their allocations to previously-unloved asset classes. It is difficult to identify shifts in asset allocation from the most comprehensive data source available, the ATO’s SMSF Statistical Report, as it is based on the fund returns submitted at the end of each tax year. Once collated and published, this data can be two to three years old.
Funds flow data is much more up-to-date
Funds flows, however, are far more contemporary. nabtrade data suggest that while SMSF trustees are still holding sizable cash balances and actively trading their preferred Australian equities, they are also choosing to deploy capital to diversify their portfolios into those sectors where they have traditionally been underweight. Generally, they are doing this using product structures that allow easy and cost-effective access to these assets, most notably Exchange Traded Funds (ETFs) or Exchange Traded products (ETPs) and to a lesser extent, the ASX’s mFund service.
For example, the top five ETFs on nabtrade in the week ending 23 August 2019 were:
- BetaShares Active Australian Hybrids Fund (Managed Fund)
- BetaShares Australian Investment Grade Corporate Bond ETF
- BetaShares Australian Equities Strong Bear Hedge Fund
- VanEck Vectors Australian Corporate Bond Plus ETF
- Vanguard Australian Government Bond Index ETF
To put this in context, ETFs and ETPs comprised more than 10% of nabtrade trading volumes, so while investors were seeking to benefit from volatile conditions on the local market (largely due to volatile conditions on international markets), they were also seeking to avoid market volatility through listed credit products. nabtrade investors typically show a strong contrarian bent and buy their favoured stocks on weakness during periods of volatility; SMSFs are even more likely to exhibit this behaviour.
In the same week, investors bought the following mFund products:
- 4D Global Infrastructure Fund
- Legg Mason Western Asset Australian Bond Fund
- Platinum Global Fund
- Plato Australian Shares Income Fund - A Class
- Hyperion Global Growth Companies (Class B Units)
- Invesco Wholesale Senior Secured Income Fund
- Walter Scott Global Equity Fund – Unhedged
- Fidelity China Fund
- Antipodes Global Fund (Class P)
- Aberdeen Standard Diversified Fixed Income Fund
The majority of these flows have gone to international equities products, in addition to fixed income and infrastructure. While ETF and ETP flows are significantly greater than those to mFunds, SMSFs are the most significant buyers and holders of mFund products.
LIC challenges
While investors continue to hold them, Listed Investment Companies (LICs) are struggling, including substantial discounts between net tangible assets (NTA) and the security price for most managers. LICs are also dominated by products that invest in Australian equities, with fewer international and fixed income products than are available via the ETF and mFund markets. There is not the diversity now desired by SMSFs among LICs as offered by ETFs.
Many SMSF trustees explicitly believe that they are capable of managing their own Australian equity portfolios, and are only willing to pay for portfolio management (passive or active), in asset classes that are more difficult to access or where investors are less confident in their asset selection abilities. The market capitalisation of ETFs exceeded that of LICs for the first time last year, and flows indicate the divergence between the two product structures is likely to increase rather than narrow.
Five reasons for changing allocations
It can take some time for flows to influence the percentage asset allocation of the overall SMSF sector, given the nearly $700 billion invested. However, as SMSF trustees are increasingly comfortable with assets beyond cash and shares, possible reasons for this realignment are:
- A shift away from cash as declining interest rates force investors to look for yield elsewhere.
- An understanding of the benefits of diversification in reducing overall portfolio volatility.
- Concerns about future returns from equities as market volatility increases and indicators of future economic performance deteriorate.
- Greater availability of low cost and easily accessible products in other asset classes make them more attractive.
- Product information and market insights are now far more widely available to the retail investor, helping inform portfolio decisions.
Previously SMSF trustees would generally have needed to access these assets via actively managed funds on a platform charging an asset-based administration fee of up to 0.75%, often via a financial planner. Now, they can access them via the ASX at a relatively low cost. Ultimately, the big shifts in asset allocation and their benefits remain to be seen over the long term.
Gemma Dale is Director of SMSF and Investor Behaviour at nabtrade, a sponsor of Firstlinks. This material has been prepared as general information only, without reference to your objectives, financial situation or needs. For more nabtrade insights or to open an account, visit the website. You can also access Gemma’s weekly Your Wealth podcast on nabtrade, or via Apple podcasts, Spotify or Podbean.
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