Before SMSFs took off, the vast majority of super fund members were in ‘balanced funds’ whose assets included sizeable allocations to bonds, global shares and listed property. According to the ATO December 2012 estimates, only 14% of SMSF assets are now in managed funds, with 29% in cash and deposits, 32% in Australian shares and 15% in direct property. Another 4% is in listed trusts, likely to be mostly Australian shares.
Over the past few years, these percentages have not changed much, and the evidence is that these allocations have delivered better returns than most of the balanced funds on the market. SMSF investors have turned their backs on managed funds and global shares.
However, there are danger signals ahead. Firstly, cash rates are now barely covering inflation. Unless you have a lot of money and are only interested in wealth preservation, your superannuation could be going backwards in real terms. The costs of essentials such as housing, food, gas, electricity and healthcare may well rise faster than the CPI figures.
Secondly, we are a small country whose sharemarket consists of a few high profile sectors. History is full of commodity price booms and busts so BHP and Rio are not immune even though Chinese demand is unlikely to end any time soon. The top ten stocks include four banks whose share prices have rocketed in recent times due to the attractive dividend yields on offer.
The thinking seems to be that the banks are so secure that dividend yield is pretty much the same as term deposit interest. The potential problem is that they are completely different. Interest is a government guaranteed (on deposits below $250,000) payment in exchange for a ‘loan’. Dividends are payments made to shareholders based on the profits generated by the business. Sometimes these dividends are no more than confidence-boosting payments which have no relation to profits. If profits fall, then it is probable that dividends will fall, or possibly not get paid at all.
Australian banks appear to be well run, but are the most expensive in the world. You only have to look at the share price of Apple to realise that buying a good company at a bad price can turn ugly. On 19 September 2012, Apple’s share price was $702. On 25 January 2013 sales were still rising, but the share price was $435, 38% lower.
‘Direct’ property is the third major asset class favoured by SMSFs. Despite all the media focus, residential property only represents 3.5% of SMSF assets, with the majority in ‘business real property’. Owning your business premises via superannuation is a reasonable strategy, but can be very risky if it comprises most of your fund.
Where’s all this going? Well, my points are these:
- Based on current life expectancies, one spouse will probably live past 90. In the current low interest rate environment, having 29% in cash deposits could mean that your money runs out too soon.
- Investing 30% of your super in Australian shares means that you are probably hanging your hat on the performance of a few companies in two or three sectors, if you have an index-like portfolio. The big four banks, BHP and Telstra account for almost 40% of the ASX200 and it’s a fair bet that SMSFs are heavily exposed to these companies.
- Having a high percentage of your super in property substantially reduces diversification and liquidity.
What assets are readily available that improve diversification and have the potential to deliver reasonable returns? There are three that spring to mind:
- hybrid securities issued by the major banks
Hybrid securities are so called because they are a mixture of debt and equity. One of the attractions is that they generally pay a fixed margin above the bank bill rate. For example, the latest Westpac Note pays 3.2% above the 90 day bank bill rate, which at current rates is a yield of 6.12%. If the bank bill rate rises the investor receives more interest, if it falls they get less. This is different to buying a government or corporate bond where the rate is fixed. At the end of the term, investors receive their original investment back in cash or in shares. Note that different hybrid securities have different terms and conditions. Some of the latest offerings are less favourable than previous issues due to banking regulations imposed to prevent a repeat of the GFC.
The upside is that investors are receiving a decent return which is almost certainly going to be better than inflation, and if interest rates rise you don’t miss out. The downside is that neither your capital nor the interest payments are guaranteed. Not even the major banks are immune from problems, but are less likely to default than other companies.
Global infrastructure (roads, railways, utilities, etc) improves a portfolio’s defensive characteristics. Infrastructure assets won’t save you entirely if investment markets tank, but history suggests they will not be as badly affected. The major benefits are that the world desperately needs infrastructure as populations and urban centres grow. These companies also have the ability to maintain profits (as they are ‘necessities’) and tend to deliver more income than shares.
Global shares have been on the nose for many years, and it’s entirely understandable. In most Australian-based funds, returns were abysmal before a rally in the last 12 months. Many people will also question the logic of investing in countries that have high debts and lousy economic growth. My suggestion is based on these observations:
- Investment in global corporations diversifies your fund, and accesses a much wider range of industries and corporations which are not well represented on the ASX. Look around your home or your office to see what you are missing - Microsoft, Google, Intel, Samsung, BMW, Toyota, Panasonic, Sony, Nestle, Canon, Kellogg, Glaxo, Coca Cola, for example.
- Companies with strong brands do not just sell goods and services in their own countries. They manufacture and sell them all over the world, including the fast growing Asian economies. So to avoid them because their headquarters are in countries which are struggling economically is not logical.
- Global shares are denominated in foreign currency so if the $A falls the returns from these investments can create potential currency gains. Of course this is a double-edged sword. If the $A rises, these investments will be negatively affected and you need to weigh up the risk of that happening.
These suggestions are made on the basis of increasing your super fund’s diversification, not a prediction of which sectors will do better than others. Some may suit your objectives and risk profile, some will not. As always, seek independent financial advice on your particular situation.
Rick Cosier is the principal of Healthy Finances, AFSL 240026.