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Self-managed super
Putting SMSF eggs in one basket
Damien Palmer - November 21, 2007
 How do you criticise someone who bought $20,000 worth of Commonwealth Bank shares for their Self Managed Super Fund upon floating, which is now worth $250,000? Or the medico who only invested in healthcare stocks, and made over a million dollars? Or the retiree who bought a beach shack for $150,000 which at retirement was worth over $850,000? Or the client who only wants to hold cash?
All superannuation funds are required by the Superannuation Industry (Supervision) Act 1993 to "give consideration to the benefits of diversification" in formulating the investment strategy for the fund. This is the cornerstone of the financial planning community, which is as it should be. It’s a key plank in the armoury of the public offer superannuation funds and the index funds, as well as in many managed funds, even those that have a mandate such as ‘Australian shares’. Within the niche they’ve chosen, funds invest in a range of stocks.
The legislation also implies that the trustee of a SMSF must accept that they are acting in a reasonable third person capacity. This is defined as the average, presumably intelligent, person with reasonable ability to rationalise decisions, and average norms and behaviours.
Diversification has its place
But let’s consider again those lines in the Act; "give consideration to the benefits of diversification’. How should that apply to our reasonable man, our Mr X?
As the legislation implies, the trustee of a SMSF must accept that they are acting in a reasonable third person capacity. This is defined as the average, presumably intelligent, person with reasonable ability to rationalise decisions, and average norms and behaviours.
But what if Mr X was a stockbroker by trade and had a strong and ardent belief that a company was undervalued with very good prospects for growth? What if Mr X had met with the managing director and has confidence in the company board and after much analysis believes the company could be a strong long term investment for a SMSF?
It would not be a breach of compliance, if after significant research, he were to invest heavily into that company and perhaps even have a top 20 shareholder position in the company - so long as he has also considered what he is giving up, namely the benefits of diversification: reduced volatility, risk to capital, and potentially higher returns.
The same logic applies if Mr X was an ardent follower of property investing and applied similar analysis to property, looking at issues such as whether the property is located in a growth suburb, what infrastructure the suburb has, and whether it is close to transport, shops, and shopping centres.
The reality of investing
It’s also, in some senses, reality. SMSF trustees do appear to prefer having lumpy assets in their fund, whether this is shares in Commonwealth Bank or a property in Sydney CBD. Does this really matter? These trustees undertake investments with a long term strategy that is not based on the next quarter’s results (unlike many fund managers), but rather on the compliance issue of investing for the members’ retirement, which may be 10 or 20 years away. Because they are working on such long timeframes, and because they have the ability to ride through the economic highs and lows, the legislation is not going to prevent a trustee from taking this position.
Don’t discard diversification
Now, none of this is suggesting that we steer SMSFs away from diversification. But we can focus on the choice and discretion of the trustee to make intelligent, rational investment decisions. There has to be significant analysis of the available information, consideration of the timeframes to retirement, the benefits of diversification, the risk mitigation choices if an investment does not perform, and the expected returns, growth and general performance of the proposed asset. The trustee must, as the legislation requires, give due ‘consideration to the benefits of diversification’.
Your responsibilities
Diversification can provide protection. It’s also a must for someone approaching retirement when cashflow and stability in the fund performance is crucial, as is the ability to provide consistent pension payments. But it can be a slow way to grow. Pouring much of the super fund’s cash into one or two assets might provide the growth many are looking for.
For anyone considering this, a trustee’s responsibilities are to:
1. Review your asset’s performance regularly
2. Give serious and considerable analysis to lumpy asset allocations
3. Have a thorough knowledge of the lump investment
4. Fully consider the risk management that diversification enables
5. Have due regard for the age of the beneficiaries
Having an SMSF is a decision that should be carefully thought through before jumping in. The benefits of diversification are many, and are very well founded. However, for people who prefer taking a specific investment prerogative with a full understanding of the investment risks they are taking, the volatility, the risk to capital and so long as the trustee having given consideration to the benefits of diversification then the fund will be compliant.
We strongly encourage any person to seek professional guidance from an accredited financial adviser who specialises in SMSF’s or SPAA Professional member prior to making investment decisions. This article is to highlight merely one element in developing a compliant strategy for an SMSF.
Damien Palmer is the principal of Super Outsource, and prior to this was a superannuation expert at Deloitte Touche Tohmatsu, Ernst & Young and AM Corporation.
More articles from this week's edition of CompareShares:
Resident Trader: Lessons from a week rather forgotten
Stocks: Stock picks for the long haul: BHP and Coca Cola Amatil
Superannuation: Putting SMSF eggs in one basket
Commodities: Why oil refiners are getting hammered
Stocks: Stock to watch - Wesfarmers
Markets: Markets over-reacting to US slowdown
Smart Investing: There is such a thing as a cheap lunch
Expert Panel (CFDs): Pairs trading scenarios
Economics: BHP talks Rio value, steelmakers howl
Whatever your views, you can discuss this article - or any of Damien's articles - on our message board Your 2 Cents. |
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