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Self Managed Super Fund (SMSF) Article
By Tony Negline.
This article may be out of date.
11th October 2006
Running your own super fund can be an exciting experience. Effectively you are given complete control on how your retirement assets are built up.
Most people who run their own super fund try as hard as they can to invest wisely so that their fund builds wealth.
The government also does what it can to help trustees invest wisely. It does this by placing a large number of restrictions around how super funds invest. For example there are restrictions on how members of a fund can use a fund’s assets, a super fund is not allowed to borrow except in limited circumstances, if a fund wants to use options and other similar financial instruments then the trustees must develop a Derivative Risk Statement and so on.
These rules are not only there to stop the fund’s trustees from doing something foolish but also to ensure that the tax concessions given to super are used wisely and appropriately. (Now it is also true that the government’s rules can stop some sensible investments taking place but this is a story for another day.)
But no matter what processes and procedures the government puts in place the size of the small super fund segment ($209 billion at the end of June 2006) attracts people with good and bad intentions.
Those with bad intentions often do this with promises of riches. It is for this reason that ASIC always warns retail investors that wild and exorbitant claims are often too good to be true. No matter how much the government authorities try, some nefarious people will always slip through the net and sadly some small super fund investors do get ripped off.
Sadly in the small super fund space there are many examples of this. Artwork and other collectibles are classic cases because the small super fund sector can be a decent source of business for artists and dealers.
Some artwork and collectibles can be very profitable. However it has to be said that most of this type of investing occurs because of love. A big mistake that many super fund trustees make is that they often decide to display their fund’s collection in their homes or business premises which is an instant breach of some super rules. Many funds also forget to insure their assets against fire or theft.
Potential problems can also be found in some financial products. For example some large financial institutions are now offering a product that provides an 11% return in a fixed interest type investment. Some even claim that the investment is capital guaranteed.
Most super funds will have a portion of their assets in fixed interest investments. Considering that a long dated term deposit currently returns less than half this rate, it is not hard to understand why some funds would be attracted to it.
Moreover for fund’s paying pensions this type of return can appear to be perfect. If the member is 65 then the minimum income payment is about 5% per annum of the account balance. This means that the fund could pay the pension and still have about 6% left over for future income needs.
At face value the product offers a great return for a lot less risk. Now how is this 11% return generated? A portion of the assets are placed in a zero coupon bond which provides about half the return and the capital guarantee.
The remainder of the return is provided by engaging in very sophisticated options trading using complex mathematical calculations. One financial planner – who did not want to be named – said that in one product the trading seems so complicated that it is “almost inexplicable. The product provider could not explain how they generated the returns because the modelling behind the product is very intricate. You would probably need a doctorate in applied mathematics to understand what is going on.”
Despite this complexity many small super funds would probably class this type of investment as fixed interest. The fact is however that the product has high risks and high rewards and should not be classifed as fixed interest. If anything the product should probably be classed as “exotic”. Most small funds would have more allocated to fixed interest type investments than they would exotics. The net effect is that by misallocating an investment a fund can accidentally make their investment strategy look skew-whiff.
It has to be said that there is nothing wrong with this type of product if it fits a fund’s needs. Moreover many large investment houses have the internal knowledge, systems and procedures in place to ensure the product delivers what they say it will (and they often can’t afford the reputational risk of letting an investment product fail).However if more and more super fund money is attracted to this style of product it will not take long before smaller market players will be tempted to develop these products. But will they have the necessary skills and knowledge? Naturally they will say that they do. And what would happen if the product failed or the manager personally got into difficulty? To focus their minds all small super fund trustees should think carefully about the Westpoint saga before allocating their money into something that seems wonderful but may ultimately cause a great deal of pain.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.