DIY fund alert

Number-crunching data recently released from the ATO and APRA give a mixed impression of how self-managed super funds have coped with the global financial crisis and of their ability to take advantage of the rebound in share prices.

In short, DIY funds on average are extremely cashed-up – which would have cushioned them from the worst of the GFC – but now face the challenge of astutely boosting their equity exposure, if appropriate for their members’ circumstances, before missing out on much of the rebound.

And fund trustees should not kid themselves that they have managed to largely sidestep the impact of the crisis because of their leaning towards cash and bonds.

The average asset value of a DIY fund has slipped from just under $918,000 two years ago to $810,000 by June 30 this year – down almost 11.8%.

It is hard to measure the impact of the GFC on self-managed funds given that this is a sector with strong inflow of employer and employee contributions as well as large transfers from other funds. But this inflow should be balanced against the fact that about 30% DIY fund assets are held for members who have retired, according to estimations by Rice Warner Actuaries, and would presumably be drawing down on their super savings.

In 2007-08, the latest figures available from the ATO – in its role as regulator of self-managed super – DIY funds received an estimated $50 billion in contributions and transfers from other funds. (This compares palely with $80 billon of fund inflows in 2006-07 thanks largely to the huge dollars attracted by the revamping of the super system and the one-off provision for after-tax contributions of up to $1 million.)

One of the pieces of good news for DIY funds is that in the latest June quarter, their total assets grew by 8% to $322.3 billion – outstripping the growth rate of retail, industry, corporate and public-sector funds. Further, self-managed super has consolidated its position as by far the largest superannuation sector in terms of total assets.

Here are eight strategies to help you take a smarter approach with your DIY fund:

1. Confront any underperformance of your fund: Don’t give yourself excuses such as “I am in this fund for reasons other than for performance”. At the very least, compare the after-tax and after-cost performance of your fund with that of the large funds. After doing this comparison, you can then consider whether your other reasons for having a DIY fund, apart from obtaining investment returns, justify its existence. (See strategy six.)

The straightforward logic of making this comparison of investment returns is if you didn’t have a self-managed fund, you would hold your super savings in a large fund.

The performance figures of the large funds are available at no charge from the superannuating rating agencies: SuperRatings, Chant West and SelectingSuper.

2. Don’t be reluctant to dump a fund if you are losing interest or if the most active member is sick or has died: One of the factors that is always surprising in the ATO statistics is the big number of DIY funds always opening while relatively few ever close each year. This suggests that there must be many thousands of funds in existence that don’t earn their keep and should have been closed years ago.

Consider that in the 12 months to June, 29,000 funds were established yet just 2,310 funds were wound up.

The ATO has some valuable guides to winding up a DIY fund, see here.

3. Understand the lost opportunities if your fund holds excessive cash: At the end of June, DIY funds held an average of more than 30% of their assets in cash and term deposits.

Despite the markets negative finish to last week and the apparent return of more volatility, share prices have still, of course, enjoyed a powerful surge. In the September quarter, prices rose by 20% – their biggest gain since the September quarter of 1987.

4. Carefully stage your return to the market: Particularly given the prevailing volatility, one smart approach – if your intention is to increase your fund’s exposure to equities – is to drip-feed capital into the market. This means investing at regular intervals over the next six months or so, rather than in one chunk. And in order to keep your costs to a minimum and to gain wide diversification, a traditional index fund or an exchange traded fund (investing in index portfolios through these listed securities) may well be appropriate depending upon personal circumstances and any quality professional advice received.

5. Shave your investment costs to a minimum: This is linked to the preceding point. The negative returns of the past couple of years have highlighted the high fees being paid to active investment fund managers against the low fees of passive fund managers with their index funds.

Investors, including DIY funds, are increasing using traditional index funds and exchange traded funds as a means to provide the core of their share portfolios, and then using favoured active fund managers and some direct shares as “satellite” investments.

6. Ensure your superannuation savings are large enough to justify a DIY fund: While the average asset value of a DIY fund is $810,000 as discussed – that means the combined account balances of fund members – there are plenty of funds with asset values much below that level. In 2007-08, according to ATO statistics, more than 15% of funds have under $100,000 in total assets. And 9.5% of funds hold $50,000 or less. On the face of it, these balances are far too low to justify a DIY fund.

ASIC has calculated that a DIY fund needs at least $200,000 in total assets in order to have an expense ratio that is comparable to large, professionally managed super funds. However some trustees who intend to quickly increase their fund assets with extra-large contributions may, understandable, justify having smaller starting balances.

And, of course, some individuals begin a DIY fund for reasons other than to minimise costs. For instance, some want to hold unlisted shares or to eventually buy directly-owned business real estate that cannot be held in a large fund.

7. Undertake proper estate planning for your fund: The rapid ageing of Australia’s population and the reality, referred to earlier, that almost a third of DIY fund assets are held for retirees underlines why fund trustees should face the need for adequate estate planning.

Typically, one member of a husband-and-wife team is active in the running of a fund. This means that if the active member were to die, the surviving spouse could be completely bewildered about meeting the compliance regulations and about looking after the fund’s investments – on top of grieving for the deceased member.

The ATO has had experience with what could be called “orphan funds” where the regulatory and tax returns are not filed for years and the investments aren’t looked after for years after an active member’s death. (Under superannuation law, all members must be trustees of their DIY funds or directors of the funds’ corporate trustee. In other words, they are all responsible.)

Interestingly, many people establish a DIY fund when already in their mid-50s and older. Almost 35% of the members of funds established in the June quarter 2009 were 55 upwards in age. And 7.50% were older than 64.

8. Understand where the ATO will strike next: The ATO, as regulator of self-managed super, is increasing the heat on non-compliant DIY funds while looking upon breaches of superannuation law triggered by the global financial crisis in a somewhat understanding manner – provided trustees are working to fix those breaches.

The DIY super hit-list for the ATO in 2009-10 includes:

• Making loans to members and their relatives. These loans are prohibited.
• Exceeding the in-house asset limit applying to DIY funds. Under superannuation law, funds are not allowed to invest more than 5% of their funds’ assets (by value) in what are termed as in-house assets. These assets include investments and trusts involving related parties such as fund members and their relatives. An in-house asset also includes fund assets leased to a related party.)
• Borrowing by a DIY fund – outside the very few exceptions to the rule which include using instalment warrants or similar instruments under strict conditions. (For more details on the borrowing rules see here.)
• Failing to conduct transactions with related parties on an arm’s length or commercial basis.

An understanding of the ATO’s latest compliance activities provides fund trustees with both a guide to where the regulator might strike next and a valuable reminder of some of the fundamental rules of running a DIY fund.