Just under one-third of SMSF assets (31%) are currently invested in direct shares, according to the 2020 Vanguard/Investment Trends SMSF Report. Direct property accounts for 16% of SMSF assets, while 27% of assets are currently held in cash and cash products.
By comparison, just 19% of SMSF assets are held in managed investments (11% listed, 8% unlisted). The bias towards direct ownership is understandable given the stated desire of SMSF trustees to have more control over their investments.
Here are three areas where it may make sense for SMSFs to outsource to external managers.
1. Global equities
SMSFs are often criticised for being underweight global equities relative to APRA-regulated funds. One often-cited reason is that international equities don’t receive the franking credits that are applied to Australian shares, leading to an outsized ‘home bias’ to domestic equities among SMSFs. While franking credits certainly have value, there are broader diversification benefits to having exposure to share markets outside Australia.
For SMSFs that want to invest in global equities, it makes more sense to use an external manager than purchase shares directly (indeed, there is evidence trustees are already doing this). First, a well-diversified portfolio of international shares can be cumbersome and difficult to manage for an individual investor. Second, it can be tricky to get exposure across all markets. Finally, currency fluctuations need to be considered and managed.
2. Small and microcaps
Small caps have the potential to deliver higher returns to investors but, inevitably, the trade-off is higher risk. So it pays to choose a small cap manager with a proven track record of identifying under-researched and undervalued companies.
For example, the technology sector – including biotechnology or software – requires a nuanced understanding of the intellectual property behind the company. But more important is how the company will monetise the technology and what value the market will ultimately ascribe to it.
Professional managers have the time and resources to research and monitor many of the 2,000 stocks that sit outside the S&P/ASX200. So while it might make sense to go direct for the large cap end of the market, it could reduce headaches for SMSFs if they enlist fund managers to help with small and microcap stocks.
3. Responsible investment
This approach to investing money has performed strongly in recent years, particularly during the volatility of the first half of 2020. However, it is a resource-intensive approach to investment management that can be tricky for DIY investors to replicate.
Responsible investing is referred to by many different names: ethical investing, sustainable investing, Environmental, Social and Governance (ESG) investing – just to name a few.
While each strategy has its own features, most responsible investors are united by their decision to sign the international Principles of Responsible Investment. The principles begin by declaring that professional investors “have a duty to act in the best long-term interests of their beneficiaries”.
Furthermore, responsible investors agree that traditionally non-financial issues related to the environment, society and corporate governance can affect the performance of investment portfolios.
SMSFs looking to make a positive impact with their investments as well as achieving strong returns should consider a responsible investment manager. But with the flurry of activity in this sector in recent years it can be hard to identify the right fund for you.
In fact, one of the difficulties for investors when choosing a responsible investment manager is deciphering how they implement non-financial analysis into their process, and how much impact this analysis actually has on the portfolio.
Morningstar’s ESG Commitment Level
Helpfully, a new white paper from Morningstar has laid out the level of ESG commitment of 40 asset managers and 107 investment strategies. It aims to distinguish funds that “truly focus on sustainable investing” from those that incorporate ESG factors but in a limited way.
Morningstar’s new qualitative ESG Commitment Level is entirely separate from the Morningstar Analyst Rating and is designed to be read in conjunction with the existing (quantitative) Morningstar Sustainability Rating. Many investors, according to the report, “feel confused about the claims they hear and read in sales materials and are unsure about the many different approaches to sustainable investing”.
It is pleasing to see Australian Ethical named as one of only six asset managers worldwide – and the only Australian investment manager – to receive the highest ESG Commitment Level of ‘leader’. Fund managers in this category have been identified by Morningstar as having a long history of commitment to ESG investing, with these considerations “ingrained and pervasive” across the firms.
When outsourcing is your best bet
Many SMSFs relish the ability to control all their investments. For some asset classes that can make some sense, but when it comes to areas like international equities, small caps and responsible investment it’s worthwhile to consider outsourcing to professional fund managers.
David Macri is the Chief Investment Officer of Australian Ethical Investment, a sponsor of Firstlinks. This information is of a general nature and is not intended to provide you with financial advice or take into account your personal objectives, financial situation or needs.
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