by Jordan George

Post the GFC, there have been few periods in the history of the capital markets where investment markets have been so volatile. In this environment, and especially when coupled with a low interest rate regime, it has placed a premium on yield and capital preservation. SMSF trustees have not abandoned capital gain as an investment goal, but it’s not to the extent it was in those heady years before 2008.

What this new investment paradigm has meant for many trustees is a search for new sources of yield at a time of historically low interest rates. Since the GFC, blue-chip, fully franked shares on the ASX (think the big four banks and Telstra) have largely met this objective, but as the sharp drop in bank share prices earlier this year reminded trustees, these yields can go hand in glove with a capital loss. And in the case of the big miners lower dividends. For trustees, especially for those in the retirement phase, this can cause sleepless nights if the asset allocation is heavily weighted in this direction.

So trustees, often in partnership with their specialist SMSF advisors, are responding. Like an ocean liner, the shift in investment direction is slow; but it is happening.

What is occurring is a thirst for alternative investments that are defensive in nature while offering a yield that’s better than the cash rate. In the past, the obvious choice would have been fixed interest. Leaving aside the fact trustees have traditionally shied away from this asset class (a pity considering the bull market it enjoyed post GFC as interest rates fell and bond prices rose), the reality is that interest rates are unlikely to fall further, with any movement more likely to be on the upside.

Alternative assets

So what alternative assets have appeal? Property has an obvious attraction, particularly if it’s unlisted and non-residential. Despite all the hype around SMSFs and residential property, trustees have a far larger percentage of their property assets in commercial/industrial/retail holdings. At 31 December 2015, non-residential property investment stood at $75 billion compared with $24 billion for residential. Although unlisted property has the disadvantage of lacking liquidity (many fund managers want the capital for a set period), it does offer yields in the high single digits and relative capital security compared with equities. Trustees also have bad memories of REITs post the GFC.

Over the past 15 years, the average compound annual return and volatility (standard deviation) for commercial property has been 10.4% with a volatility level (standard deviation) of 5.5%. By contrast, the numbers for Australian equities over the same period show an 8% annual return with an 18.1% volatility.

Trustees have noted the lower volatility and higher returns and acted accordingly. ATO figures show investment in non-residential property rose from $48 billion at 31 December 2011 to $75 billion at 31 December 2015 – a 54% increase. Admittedly, the total SMSF asset pool rose 49% over the same four-year period, but what that number conceals is the increase in non-residential investment in the past year to 31 December, up $9 billion or 14%.

Looking overseas

Trustees are also looking increasingly to investments that diversify their risk geographically as they understand that overseas assets create a more balanced portfolio.

The early entry point to these investments was via ETFs and managed funds, but investors are now seeking advice to do this individually. It’s only for a minority, and typically requires specialist advice, but it’s a growing minority.

Infrastructure

The asset class that would offer yield and relative capital security, but is largely out of reach of the SMSF trustee, is infrastructure. SMSFs are effectively excluded from this asset class due to regulatory and economy-of-scale impediments, despite the fact there is an obvious relationship between SMSF trustees with long-term investment horizons and lower risk infrastructure assets.

But the investment reality is that SMSFs find it extremely difficult to invest directly in infrastructure, due to the high dollar threshold – typically $A100 ($US80 million) to $A500 million ($US400 million), illiquidity and the high entry and ongoing management fees these investments often attract. A solution needs to be found to give trustees access to these assets.

Finally, for trustees still in the accumulation phase, there is often the option of paying down the mortgage instead of topping up their SMSF either pre or after tax. There are several factors to consider, such as a trustee's age, likely rate of return of any investment versus the interest rate, mortgage balance and financial commitments. It’s not a simple decision, so trustees should get advice.

No one doubts the challenges low interest rates and heightened volatility pose for SMSF trustees – or the APRA-regulated funds for that matter. What’s encouraging is that on the available evidence they are rising to the challenge. Just as SMSFs emerged from the GFC in far better shape than many believed possible, now they are adapting to a difficult investment environment with a sure touch that’s still surprising many.

Jordan George is the head of policy at the SMSF Association