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As SMSF trustees, one of our jobs is to manage the monies in accordance with our members’ instructions, whether this is you alone, or with your partner and family. With this responsibility comes an onus to say whether we are doing a decent job or not as an investment manager.
And even if you have decided to outsource the investment functions to an adviser, you are ultimately still responsible for the investment performance. So, how can you determine whether you are cutting it as an investment manager?
One way is to simply compare the fund’s performance to the fund’s investment objective(s). If for example your objective is to deliver a return of inflation plus 3% over a 10-year period, then if your fund has been growing at 6% pa over this period, give yourself a tick.
The problem with this method is that your objective might be unrealistic. Given the level of risk you are prepared to take, it may be too tough. Conversely, you might have set the bar too low.
A more direct method is to compare your fund’s performance to that being achieved by the major industry and retail super funds. After all, if you closed your SMSF, this is where the monies would go. So, how has the industry performed?
Chant West has released its review of the performance of the major retail and industry super funds in 2017. It finds, for example, that the median return for a “growth” super fund for the 12 months to 30 June is 10.7%. Going back over three years, the median return is 7.6% pa, and if you stretch it back to 15 years, the median “growth” fund has returned an average 7.4% pa. The 10-year period, which commenced just prior to the peak of the ASX in November 2007 at 6,873, shows a lower return of 4.7% p.a.
It classifies super funds according to the percentage of growth assets they target. Growth assets are assets where part of the return is expected to come from an appreciation in the price of the asset, and includes shares, property, infrastructure, commodities and collectables. Income assets are cash, term deposits and interest rate securities, such as bonds, mortgages and hybrid securities. Table 1 shows the median returns from 1 year to 15 years (net of investment fees and tax).
Source: Chant West
Because funds in pension don’t pay any tax, their returns will typically be higher than funds in accumulation mode by approximately 15%. While they might have some extra costs, a higher investment return should be expected for the same risk category. So, a pension fund investing in growth assets should expect a return for the last 12 months of approximately 12.6%, a balanced fund 9.5% and a conservative fund 6.4%.
The first step is to categorise your fund (eg. growth or conservative, super or pension). Whether you use a target asset allocation or the actual allocation at 30 June probably doesn’t matter that much, we are really just after an approximate benchmark.
Next, determine your fund’s performance for the financial year. This usually can’t be done until you have all the tax information and can lodge your annual SMSF return, and may require the help of your accountant or administrator. Most SMSF software packages can calculate investment returns, so don’t be put off if your accountant tries to give you the brush on this. And remember that to compare like with like, we are looking at returns after tax and investment/administration costs. So, if you are doing the calculation manually, don’t forget to add back the franking credit refunds and deduct the administration costs.
What time period? Let’s start with the one-year horizon, but clearly no one gets fired for marginal underperformance over such a short period. See if you can extract data for previous years, and compare the returns over three years, five years and potentially even longer.
The first task is to understand why you have underperformed. Two potential scenarios are that your mix of growth assets is different to the target or normalised allocation, or secondly, that the individual assets you have selected have underperformed compared to the overall asset class.
Table 2 shows the performance of the major asset classes over the periods to 30 June 17 (source Chant West).
Source: Chant West
If, for example, your growth assets didn’t contain any international shares, then you may have underperformed during each of the periods but more so during the last 12 months, three years and five years. If your property exposure was taken through listed property trusts, then the last 12 months may have been a little underwhelming.
Just as the performance of asset classes varies considerably, so does the performance of securities or sectors that make up each asset class. While we all understand this with individual shares, the performance of different components of the Australian share market has been quite marked over the last few years. Table 3 shows the performance of different components and industry sectors. Returns include dividends, but not the impact of any franking credits.
Source: S&P Dow Jones, accumulation returns (dividends, but not franking credits)
Many SMSFs, for example, have major holdings in the top 20 companies such as the banks, major retailers and miners. In the 12 months to 30 June, the top 20 stocks largely performed with the overall market (14.0% vs 14.1%), but over three years and five years, they have marginally underperformed. Midcap 50 stocks, which are those ranked 51st to 100th by market capitalisation, have starred over the above time periods, while small cap stocks, on average, have underperformed.
Understanding where our SMSF has underperformed is, of course, just an input into whether we should make any changes or not. Critically, we need to consider the outlook for the different assets classes/components/sectors going forward. That said, if we are materially underweight or overweight, it may be time to adjust.
If you aren’t cutting it as an investment manager, then you should probably wind up your SMSF and transfer your super to an industry or retail fund. Alternatively, engage an adviser to help you. And if you already have an adviser and they aren’t cutting it, fire the adviser.