Smsfs shifting towards global equities, bonds

The diversification challenges facing Australia’s 600,000 SMSFs are well documented; whichever data source you prefer, it is apparent that the vast majority of self managed funds 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.

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 happened 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 the SMSF was leading to significant underperformance of SMSFs relative to other super funds, notably in the post GFC era. Interestingly 10 year data to 2016 suggest otherwise; SMSFs appear to have delivered returns approximately 5.7% pa, while APRA funds delivered 5.3%.

Recently, however, some data sources suggest that SMSF trustees are choosing to increase their allocations to previously unloved asset classes. It can be hard to elicit 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 flows, however, can be 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) and mFund.

By way of example, the top five exchange traded products on nabtrade in the week ending 23 August were:

Source: nabtrade

To put this in context, exchange traded products 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:

Source: nabtrade

The majority of these flows have gone to international equities products, in addition to fixed income and infrastructure. It should be noted that while ETF and ETP flows are significantly greater than those to mFund, SMSFs are the most significant buyers and holders of mFund products.

While investors continue to hold them, listed investment companies (LICs) are struggling with some challenges, 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 far fewer international and fixed income products than are available via the ETF and mFund markets, making them less attractive to SMSFs who are seeking diversification and access to these asset classes. It should also be noted that 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.

It can take some time for flows to influence the percentage asset allocation of the overall SMSF sector, given the nearly $700bn invested across 600,000 individual funds, however it would appear that SMSF trustees are becoming increasingly comfortable with assets beyond cash and shares. The possible reasons for this shift are many: 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, or concerns about future returns from equities as market volatility increases and indicators of future economic performance deteriorate. It is also probable that the greater availability of low cost and/easily accessible products in these asset classes make them more attractive. 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 0.77%, often via a financial planner, they can now access them via the ASX at relatively low cost. Product information and market insights are now far more widely available to the retail investor, helping inform portfolio decisions. Ultimately, however, the big shifts in asset allocation, and their benefits, remain to be seen over the long term.

^{[1] 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.}