Research report nails message – SMSFs need to further diversify

First published in the Brisbane Times on 19 April 2022.

The evidence is in: self-managed super funds (SMSFs) that have diversified investment portfolios outperform those that do not.

This is the compelling finding of a comprehensive new research report entitled “understanding self-managed super fund performance” by the University of Adelaide’s International Centre for Financial Services.

The primary aim of the research – it drew on data from more than 318,000 SMSFs between July 2016 and June 2019 – was to assess the investment performance of SMSFs against larger superannuation funds. It found SMSFs were competitive after fund balances reached $200,000, but the importance of portfolio diversification also emerged as a significant part of the findings.

Such a finding is relatively self-evident – the importance of portfolio diversification is standard finance theory.

However, as the Australian Taxation Office has warned, some SMSF trustees choose to ignore this basic investment guideline, with their portfolios too heavily weighted towards one or two asset classes.

The report should make them think again.

Across three financial years (2017-19) and examining seven asset classes (cash and term deposits, listed Australian equities, listed international equities, listed trusts, unlisted trusts, Limited Recourse Borrowing Arrangements (LRBAs) and other assets) the research finds the least diversified SMSFs – those holding a single asset class – recorded the lowest performance.

The benefits of adding a second, third, or fourth asset class are strong. Each increase of an additional asset class (up to four) appears to be associated with an improvement in the median rate of return (ROR) of between 1 per cent and 3 per cent.

Diversification beyond four asset classes (up to seven) also seems correlated with improved performance, although at reduced marginal rates, with these funds generating up to 2 per cent in additional median ROR per added asset class.

The research also delves deeper by seeing how SMSF performance varies with degrees of concentration within individual asset classes, with some interesting results.

There is significant SMSF performance decay with funds allocating a greater proportion of their assets to cash and term deposits. This is unremarkable considering the recent low rates of return on fixed-income securities.

Interestingly, however, typical fund performance does not appear to maximise for those SMSFs that minimise their cash and fixed-income holdings.

Instead, the highest median fund performance – at slightly above an 8 per cent ROR – are for those that allocate between 10 per cent and 20 per cent of their net assets to cash and term deposits.

This result suggests that funds have an opportunity to optimise their asset allocations regarding cash/term deposits, but also emphasises that funds with cash holdings concentrated above 20 per cent of net assets are associated with significant underperformance.

The impact of allocations of listed Australian and international equities on portfolios is also intriguing.

Median SMSF performance improves as funds allocate larger proportions of their assets to Australian equities, with the costs associated with this equity risk premium appearing to be mild.

However, by contrast, international equity diversification appears to be less influential for improving returns and, at the same time, is associated with more volatile performance outcomes.

For listed trusts, the median fund experiences a marginal improvement in performance when the net asset allocation rises above 10 per cent. By contrast, for unlisted trusts, median fund ROR decays from about 7 per cent for funds with 10-20 per cent of net assets invested to about 5 per cent as the proportion increases.

The report says the impact on fund performance of LRBAs is more difficult to disentangle, as the data does not differentiate between loan costs and the effects of leverage and the performance of the underlying assets. However, despite these limitations, the evidence shows that SMSF performance improves for funds in higher LRBA percentiles.

Another notable finding is that LRBAs are associated with the largest variations in performance of any asset class in the study.

For SMSF trustees and their financial advisers, the research provides a foundation stone for meaningful investment education.

Although SMSFs with balances of $200,000-plus are competitive with larger super funds, greater diversification might significantly improve their performance.

Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

Opinion piece written by
John Maroney, 
SMSF Association