Regulator overkill – SMSFs outperform, despite ASIC criticism of size

Co-founder of the Switzer Report
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We just love regulation – however in typical Australian style, we can’t just have one regulator – we need to have multiple regulators. The SMSF space is now no different, with the Australian Securities and Investment Commission (ASIC) clamouring to get involved. It seems $500 billion in savings is too big to ignore!

Of course, the primary regulator for SMSFs is the Australian Tax Office (ATO). Every SMSF pays a levy ($321 in FY 13/14) for this pleasure. Then there is the Australian Prudential Regulation Authority (APRA), which regulates the industry and retail funds, and is also responsible for the operation of the superannuation standards, which apply to all funds. And finally, there is ASIC.

ASIC’s “mandate” is that they regulate the “gatekeepers who provide advice and services” to some trustees (eg. licensed financial advisers), and they also regulate many (but not all) of the financial products that SMSFs invest in (managed funds, securities etc). They also get briefs from Government to look at specific issues, such as happened after the collapse of Trio Capital.

Unfortunately, multiple regulators will, if history is any guide, lead to duplication, confusion and extra cost. Ultimately, regulator costs will be passed onto the members of SMSFs to pay for – one way or the other. Why do we need three regulators – and why can’t our government agencies get their (collective) act together?

With this gripe off my chest, let’s look at what ASIC had to say recently.

Advisers to warn clients

Last week, ASIC released Consultation Paper 216 – ‘Advice on SMSFs – Specific Disclosure Requirements and SMSF costs’. This paper proposes that financial advisers be required to make specific disclosures to their SMSF clients, including disclosures about relative costs and the lack of a compensation scheme.

The disclosures cover:

  • The fact that SMSF members are not covered by any compensation scheme in the event of fraud or theft (unlike members of an Industry or Retail Fund);
  • Duties and obligations associated with running a fund;
  • The risks associated with running an SMSF;
  • The need to develop and implement an investment strategy;
  • The time commitment and skills needed to run an SMSF;
  • The costs associated with setting up, running and winding up an SMSF;
  • The need to develop an exit strategy for an SMSF; and
  • The possibility that the laws and policies that affect SMSFs may change.

All good, well-intentioned stuff – and hard to argue with on paper, however, most of the points (excepting the lack of a compensation scheme) are covered by the ATO, which automatically sends to each new SMSF trustee a (well-written) explanatory booklet. Duplication!

Whenever you have “requirements”, you have reporting and compliance obligations. If advisers are required by law to disclose these matters, they will need to record making the disclosures, ask clients to sign documents to that effect, store these acknowledgements for seven years etc. etc. None of this is costless – and at the end of the day, clients of advisers and accountants will pay more for these services. Can’t the ATO and ASIC work together to get this information into the hands of trustees?

The costs of running an SMSF – minimum super balance

The “headline” grabbing part of the ASIC paper was a comparison of the costs of running an SMSF, compared with costs incurred when investing through an industry or retail fund, and what is the “minimum required super balance” that makes it worthwhile to be in an SMSF. ASIC wants advisers to inform clients setting up or switching to an SMSF of all the possible costs – set up, running costs, winding up costs, time costs, insurance costs etc.

ASIC commissioned Rice Warner to prepare a report on the ‘Costs of Operating SMSFs’, with the specific purpose of examining the minimum cost-effective balance for SMSFs, compared with industry or retail funds. Conventional wisdom is that an SMSF balance below $200,000 is not cost effective compared to the other super options, due to the fixed operating costs such as the ATO levy, audit fees and accounting/administration costs.

Conveniently ignoring investment returns (see below), Rice Warner came up with the following conclusions about a cost only comparison:

Comparing Costs – SMSFs vs Retail and Industry Funds

Bottom line – it largely comes down to the amount of money you pay for administration/accounting services, and any investment management costs (for example, through a managed fund). Rice Warner estimated the following administration costs, depending on the provider, complexity of the SMSF and services taken:

Range of Annual Administration Costs

From our experience, these costs are coming down as competition increases and new technology is introduced. We don’t see too many funds paying $7,000 to $8,000 per annum. Typically full administration costs are around $3,000 (including audit and ATO levy).

SMSFs are better investors

The most interesting part of the Rice Warner report is a comparison of investment returns. SMSFs on average do a lot better than retail or industry funds – staggeringly better!

According to the report, SMSFs outperformed industry and retail funds by 3.4% per annum over the seven years from 2005 to 2011. Moreover, demonstrating that SMSFs can perform in both good and lean years, they outperformed in six out of the seven years.

Comparison of Investment Returns – before fees

This is a high level comparison that aggregates funds and investment portfolios, and obviously doesn’t take into account individual fund performance nor individual investment objectives or asset allocations. If the difference in the average return was small, it wouldn’t mean that much. However, 3.4% per annum is massive – a stunning endorsement for the SMSF sector.

Furthermore, it really calls into question some of the conclusions ASIC has reached about the “minimum super balance”. The 3.4% additional investment performance is worth $3,400 per annum on a $100,000 fund – or $17,000 on a $500,000 fund – which goes a long way in covering costs.

Putting these together, there is nothing in the report that suggests that the “conventional wisdom” of a minimum super balance for an SMSF of $200,000 is inappropriate. As always, the more that you can get into your SMSF, the lower your effective costs are.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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