Low returns see SMSFs turn to risky strategies

July 28 2016
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Sinking interest rates and a volatile share market are leading SMSFs to risky investment behaviour including gearing strategies.

Low returns see SMSFs turn to risky strategies

Low interest rates is forcing many self-managed superannuation funds (SMSFs) into property investments due to decent yields and much less volatility than shares, but retirement investors are also adopting riskier investment strategies such as using gearing to buy property to boost their wealth as the population ages.

Reflecting the strong appeal of self-directed investment, there was a record number of 572,424 SMSFs in Australia as at March 31, 2016 (up from 565,990 as at December 31, 2015) with 1,085,286 members, according to the latest Australian Tax Office (ATO) statistics.

Clearly low interest rates and disappointing returns from the share market and bigger superannuation funds have forced many investors to set up their own SMSF to take control of their superannuation investments.

Total SMSF assets fell to $589.9 billion during the March quarter, down from $593.1 billion in the December quarter, after a 4 per cent drop for the S&P/ASX 200. Total SMSF share holdings fell 2.8 per cent to $172.1 billion, down from $177.0 billion in the December quarter and well down on an all-time high of $190.4 billion as at March 31, 2015.

In contrast to dropping share values, SMSF property assets rose over the March quarter. Investments by SMSFs into residential property totalled a record $24.4 billion as at March 31, up from $24.1 billion in the December quarter while commercial property investments jumped to a fresh high of $74.8 billion, up from $73.8 billion in the previous quarter.

Given the higher yields (around 7-8 per cent) when compared to residential property (usually 3-5 per cent), commercial property remains an attractive investment option for SMSFs, particularly for those trustees who operate their own business and can benefit from having their SMSF fund own the premises. This is likely to maintain the flow of money into this asset class given attractive yields.

Despite falling interest rates, SMSFs’ cash and term deposits holdings rose to a fresh record of $155.5 billion in the March 2016 quarter, up from $154.6 billion in the previous quarter. Cash investments now represent 26 per cent of all SMSF assets while Australian shares account for 29 per cent. In contrast, SMSFs held less than 1 per cent of their holdings in international shares, according to the ATO data.

Given that interest rates are likely to stay low for longer, SMSFs are expected to adopt more aggressive investment strategies to secure long-term goals of growth for retirement purposes. As it is, the number of SMSFs using borrowings has been steadily increasing since 2007, when borrowing by SMSFs was first introduced. In many cases, trustees have assessed the risk of using borrowings to invest in property and have applied it as a long-term strategy for growth, relying on rental returns and capital growth to secure a better financial future for retirement.

While property is not an overly liquid investment, with good planning, the rental income at the time of retirement may be sufficient to provide an ongoing income stream. Should this income stream not be sufficient over a lengthy retirement plan, the capital growth in the property coupled with a planned exit from property investments will see realised growth. This realised growth would provide enhanced financial security throughout retirement, compared to that which is currently offered by the government pensions.

Total assets in the superannuation sector now amount to over $2 trillion, equivalent to around half the size of the Australian banking system and around three quarters of assets in the managed fund sector, representing a higher share than in other advanced economies, according to the Reserve Bank of Australia.

As the Australian population ages and more members enter the drawdown phase, it is likely that even more SMSFs pump money into property given the reliable income stream that rentals deliver.

Dean Rosario is the National Manager of the SMSF division at Anne Street Partners

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Retirement