Self-Managed Superannuation Funds: Cash Kings?
Published 1 May 2020
By Dr Peter J Phillips, Associate Professor (Finance & Banking) University of Southern Queensland
More than ten years ago, we undertook the first study of self-managed superannuation fund (SMSF) portfolio allocations at the individual fund level. In that study, we concluded that there were some serious problems with the portfolio management of the funds that we examined. Most importantly, the equity (shares) part of the portfolios was usually under-diversified both in absolute terms and in terms of the companies that had been chosen. We also noted that the amount of cash held in the SMSFs was significant, especially given that it was usually held in bank accounts and term deposits earning low rates of interest.
Portfolio theory tells us that a portfolio requires around 15-20 different assets to achieve full diversification. By this we mean that the risk associated with individual companies (their products, markets, management etc.) dissipates with each additional asset that is added to the portfolios. Once an appropriate number of assets have been added, the only risk remaining for the portfolio is ‘systematic risk’ due to the ups and downs of the share market or economy as a whole. Our SMSFs held far fewer assets than this.
There was, however, a deeper, more technical problem. The companies into which the SMSF trustees had invested were often in similar industries. The reason why diversification ‘works’ is because the ups and downs of different assets’ returns dampen each other out. You get none of this benefit if your investments are all in the same industry grouping. There is little to be gained in terms of diversification from investing in each of the four banks because most of the time the returns that they generate will go up and down together. Our SMSF trustees needed more companies in their portfolios and more companies from different industries.
The large cash holdings were an equally curious matter. It is not so much the conservative nature of the portfolios that caught our attention. After all, there is nothing wrong with that. But instead of investing in, say, a fixed income managed fund or in government bonds, the SMSF trustees had opted to leave the money in bank accounts (i.e. cash accounts) and term deposits. It seems more likely that this was an indication that they had not gotten around to figuring out what to do with the money rather than any indication of a deliberately conservative strategy.
Nevertheless, there was an upside. You can’t lose money you don’t put at risk. During the GFC, the SMSFs were insulated to a substantial degree by their cash buffers. We noted this in a follow-up research paper. While the forgone returns between 2010 and 2020 might have been substantial, the issue of a cash buffer remerged during the coronavirus crisis of early 2020. SMSFs entered this crisis in a similarly insulated state. According the Australian Taxation Office’s statistics, SMSFs held a total of $715 million in assets at the end of 2019. Around $155 million of this was still held in cash and term deposits. That is more than 20 percent of the portfolios were safely secured in bank accounts. While stock markets fell by up to 30 percent during the early phase of the health crisis, SMSFs were buffered once more by their large holdings of cash. It might not be a deliberate strategy and it might not be the best strategy but it does have some advantages.
Discussion Question
Go to the Australian Taxation Office SMSF statistics site. Is there anything else about SMSFs that catches your eye?
Further Reading
For those interested in reading more about SMSFs in relation to other types of funds, go to Chapter 3 of Financial Institutions, Instruments and Markets 9e.