Passive Investments An Alternative To Active Participation In The Market

If you are responsible for the investment decisions of a self-managed superannuation fund (SMSF), you may be in a situation where you have found yourself lacking somewhat in the skills required to manage your asset portfolio actively on a regular basis. Rather than stress over your predicament, there is an alternative to second-guessing the stock market.

Passive investments, as the name suggests, if selected carefully, provide a regular income stream without the constant intervention of the fund trustees. They can be concentrated in one asset class, but it is preferable that the fund portfolio is diversified to spread the risk in the event of a severe market correction.

Exchange Traded Funds (ETFs)

There are some passive investments that are especially favoured by SMSFs, but one that has continued to show remarkable growth over the past few years is the ETF or Exchange Traded Fund. All ETFs are listed on the stock exchange, allowing SMSFs to buy and sell the units when markets are open. They represent a portfolio of securities that track how a specific market index like the ASX 100 performs.

ETFs align with the goals of SMSFs in several areas, which is why they are popular with fund trustees who are looking for a long-term result, rather than getting involved in the hurly-burly of regular trading. ETFs offer a higher level of control over investment decisions, they reduce the costs incurred in regular, active investing, the investing process is simpler and more transparent and the tax outcome of the investments is also improved.

Other ETFs

Listed ETFs also offer opportunities for SMSFs to access alternative income asset classes such as equity ETFs and fixed income ETFs. These both suit investors looking for a consistent income return, which is a perfect result for an SMSF. With equity ETFs, the dividend yield is the key criteria to look at when selecting the stock rather than the traditional method of market capitalisation.

Fixed income ETFs invest in debt securities where the returns are fixed at the time the bond is issued. They suit long-term investors who do not intend to trade and when held to maturity, market changes have no impact on returns.

Real Estate

Real estate offers some opportunities for passive investments suitable for SMSFs. Listed Property Trusts (LPTs) or Real Estate Investment Trusts (REITs) invest in commercial real estate such as office buildings, shopping centres, industrial premises, warehouses and the like. The tenants in these premises are usually on long-term leases offering consistency and predictability for SMSF trustees. These funds are managed by experienced professionals, so they are a good option for SMSF trustees with little knowledge of this asset class

Bank Accounts

With interest rates at record lows, the returns on cash in bank accounts are meagre. However, the up side is the security, and the immediate liquidity it offers. When interest rates do move upward, cash in the bank is the ultimate passive investment.

As with any type of investment, getting professional advice before making a move is always essential. If assistance is needed in the administration of the SMSF, there are always companies such as SMSF Assure available to advise the trustees and they make sure their administrative responsibilities are covered.

Keeping Your SMSF Investments In Sync With Long-term Outcomes

If you are an SMSF trustee, you should already know that one of your responsibilities is to manage the fund’s investments in the best interests of the fund members, and in accordance with the law. To do this, you must have an investment strategy that sets out in writing the investment objectives and specifies the types of investments your fund can make.

Is Your Investment Strategy Document up to Date?

This investment strategy is not a static document but should be dynamic in nature, responding to the market and reviewed regularly to ensure that it still reflects the circumstances of its members. Matching your SMSF investments to the objectives outlined in the investment strategy can be challenging, especially in a market that is volatile or stagnant. The former moves rapidly and can catch out fund trustees who don’t move fast enough, while the latter allows otherwise valuable investments to languish, resulting in poor returns.

Issues That Will Have a Long-Term Impact

Trustees reviewing their fund’s investment strategy should be looking at a range of issues so that each member’s risk profile is considered. Among these issues are the length of time each member will take to reach retirement, the amount each member will require in retirement, and whether they have personal savings outside of the SMSF that they can access for living expenses. There are several others.

Could Asset Allocation be the Answer?

One of the ways in which a trustee can match SMSF investments to their objectives is by diversifying the investment portfolio across a range of asset classes to minimise its exposure to any market fall in a particular area. This is called asset allocation. It is achieved by identifying those assets that match the objectives of the SMSF members, and allocating a percentage of the portfolio to each of these asset classes.

There are four major asset classes; cash, shares, fixed interest and listed properties. Of course, there are both risks and benefits associated with each asset class, and an SMSF trustee responsible for deciding the allocation percentages and arranging the transactions can find the pressure is not conducive to making good decisions. As a result, they may become too conservative and risk not meeting the fund objectives.

Other Alternatives Available

A better alternative could be managed investments. These allow for a stronger level of diversification and they are handled by professional investment managers. They make all the difficult decisions that SMSF trustees find a struggle, but with the benefit of extensive market knowledge.

SMSF trustees are finding that running their own fund is proving to be more difficult than they first thought, and are increasingly turning to professional organisations such as SMSF Assure to help with the fund administration, and other licensed professionals for investment advice.

Getting the right financial advice to support your fund’s investment strategy is vital to the performance of the fund, and, in the long term, to the lifestyle aspirations of its members. Don’t be afraid to seek assistance if you are finding it difficult to match your fund’s investment performance to its overall objectives.

Don’t Start Your SMSF On The Wrong Foot

Are you considering setting up a self-managed superannuation fund (SMSF)? If you are, you should know that there are many rules and regulations set by the Australian Taxation Office (ATO) that you must be aware of, and comply with, if your fund is to remain compliant and attract tax benefits.

Knowing these rules and regulations in detail before you start will set you on the right path to building retirement wealth, but what is equally important is knowing that there are some things you cannot do with your SMSF. As fund trustee, you are responsible for making sure that the fund complies with all regulatory and compliance obligations. Failure to do so could see your fund hit with significant penalties and possible loss of its complying status.

As a quick example, here are five common things that some trustees have been found to be doing that have attracted the attention of the regulators.

Using the SMSF to Provide Financial Assistance to a Family Member

Trustees can purchase property as an investment for the fund, and some have leased this property to a family member. Their argument for this arrangement is that it is no different from leasing to a stranger, and they fully intend to operate it on commercial terms. However, their close family relationship prohibits this. The arrangement is considered to be providing financial assistance to a family member and also fails the sole purpose test.

Using Borrowed Funds to Improve Properties Owned by the Fund

What is important to know is that you can make improvements to property assets, provided the extent of the improvements does not change it into a different asset. To clarify that statement further, the improvements must not change the character and nature of the property.

The trustees can make these improvements using the SMSF’s own resources, that is, cash, but they cannot borrow to do so. The ATO does allow the fund to borrow for the acquisition of a single acquirable asset, as well as any costs associated with repairing or maintaining the asset, but not to make improvements.

Not Keeping Personal or Business Assets Separate from Those Held by the SMSF

This should be a “no-brainer”, especially as many trustees of SMSFs are business owners or managers. Keeping personal and business income and expenses separate has been a fundamental part of our tax structure for decades, so it should be second nature to run an SMSF the same way. However, there have been cases where the trustees have not kept records sufficiently detailed to show this separation.

Investments on behalf of the SMSF must be registered in the name of the fund with all trustees shown as signatories. They must not be used for personal or business purposes under any circumstances. To do so is a breach of superannuation law, which states that the purpose of fund investments is to provide for members in retirement.

Using SMSF Funds to Buy Residential Property for Yourself

This makes perfect sense if we go back to the sole purpose test, that is, the fund exists to provide for its members in retirement. Superannuation rules state that the trustees cannot get a benefit from their fund until they are retired. This means that you cannot buy a house to live in, regardless of the circumstances, including a holiday house through your own SMSF.

Fail to Properly Discharge Your Duties as Fund Trustee

This is one area a trustee cannot ignore. The penalties for non-compliance with the administrative and regulatory requirements are severe. Lodging all the forms and returns correctly and on time each year is part of the responsibilities of being a trustee. Doing this will keep your fund compliant. You must therefore make sure you understand and also discharge all these responsibilities.

If this all seems too much work, and changes in superannuation laws and regulations are becoming too frequent and complex, there are options available. There are now several companies in the superannuation industry, such as SMSF Assure, that provide a range of services to trustees to help them keep their funds compliant.

Would Your SMSF Portfolio Benefit From Diversification?

Are you the type of investor who is actively seeking wealth-building opportunities for your SMSF (self-managed superannuation fund), or is your approach conservative, preferring to settle for smaller returns in exchange for a higher level of security? While we can all understand the reasoning behind the latter approach, is there a better alternative?

According to the ATO (Australian Taxation Office), current SMSF fund trustees have placed their investments predominately in property, cash and Australian shares. While there is nothing wrong with that, they may be missing opportunities to build more diverse and robust portfolios. They may also be exposing their funds to diminished returns should the Australian market drop sharply against the rest of the world.

It all depends on the asset class that features most strongly in their fund portfolios. Not all asset classes perform at the same level in the same time frame. For example, since 2008, interest rates have fallen to unprecedented levels. A fund that holds the bulk of their assets in cash will not have built as much wealth for its members as one that invested heavily in property during the same time period.

Many SMSF trustees are comfortable with outsourcing the administration of their fund to companies such as SMSF Assure, but some of them still prefer to make the investment decisions themselves. When they first established their fund, they were required to develop an investment strategy with a licensed financial adviser but, too often, they stick with this strategy year after year. This may not deliver them the best long-term outcome for their members, especially if their knowledge is limited to domestic shares and property.

A better solution could be to diversify their portfolios across a range of investments to not only spread the risk, but also to even out the peaks and troughs that occur in any type of market. Managed funds are one option that could appeal to fund trustees who are ready to be a little more aggressive in their investment choices, but still want a reasonable level of safety.

Managed funds offer both diversification and professional expertise. Instead of the fund trustee being responsible for investment decisions, these decisions are made by professional investment managers. Provided the trustees understand there is still a risk that the products chosen by these investment managers may not perform as expected, managed investments offer the opportunity to hold diverse assets that most direct investors cannot access.

The purpose of setting up an SMSF is to provide an income in retirement, so every trustee must be aware that investment requirements will change over time. New members may join the fund as old ones depart or retire, and these changes will alter its priorities and goals. An annual review of asset allocations should be part of the role of every trustee, offering the opportunity to change the mix of investments to suit these new goals and priorities.

Transforming your current SMSF portfolio is not something that should be rushed into, but given serious thought in conjunction with professional advice. As with any investment decision, ensure that the benefits and risks of diversification match the goals and risk tolerance of you and your members. What is right for your SMSF may be inappropriate for others.

Does your LRBA comply with the new ATO requirements?

Since the rules around using an SMSF to purchase property were relaxed, first in 2007 and with further amendments in 2010, thousands of SMSF trustees used this as an opportunity to invest in both residential and commercial property. However, loans were restricted to a limited recourse borrowing arrangement or LRBA and this practice continued for a decade.

Two issues arose in that time, and the first was concern by the Reserve Bank of Australia about the number of SMSFs going into significant debt to acquire property. The second came from the ATO (Australian Taxation Office) and the possibility that some taxpayers were dodging superannuation caps. By using LRBAs, they could place extra money into their super funds where they would be taxed at concessional rates.

As a result, the ATO issued new guidelines to SMSFs choosing to use related-party loans rather than bank finance to purchase property. Trustees had until 31 January 2017 to review their fund arrangements and it is possible that some trustees have not yet made the necessary arrangements to ensure compliance with the new rules.

Trustees must understand that any loan terms they have accepted to buy property must be “an arms-length commercial arrangement”. In some cases, LRBAs have been established with related-party lenders on terms that would not typically be accepted as a commercial arrangement. Usually these terms are more generous than bank finance with lower interest rates, excessively long loan terms and no requirement to make regular payments.

While this may seem a good deal at the time, it puts at risk the overriding purpose of establishing an SMSF, which is to provide retirement income for the fund members. There are key issues with some LRBAs that put this purpose at risk such as:

  • The possibility that there will be insufficient income and contributions into the SMSF to service the loan;
  • How the members would pay out the loan when they have retired and are no longer making contributions to the fund; and
  • Whether the property or properties will be sufficiently liquid or earning enough income to pay pensions to members in retirement.

SMSF trustees who did not use bank finance for their property purchases and who have not sought information about the new rules themselves or by consulting SMSF service providers such as SMSF Assure should act immediately. It could be that they need to wind up the LRBA or refinance their loans on commercial terms, and notify the ATO that this has been done.

These are major changes to previously accepted loan arrangements that will have financial consequences for members if they are not addressed. The income from these properties can be taxed at the highest rate of 47% instead of the 15% concessional rate. If you are a fund trustee and have not addressed this issue yet, get professional advice on what steps to take, and act now.