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Size matters when it comes to the investment performance of self-managed super funds (SMSFs), but not as much as we’ve been led to believe.
The latest research shows investment returns of SMSFs with a balance of $200,000 or more are comparable to returns from much larger funds, with two provisos. To compete with the big end of town, SMSFs must be well-diversified and not hold too much cash.
A report titled Understanding self-managed super fund performance, February 2022 (the Report) conducted by Adelaide University for the SMSF Association analysed returns from over 318,000 SMSFs over three financial years from 2017 to 2019. This represents almost 56% of the entire SMSF population.
Not only does the Report debunk guidance by the Productivity Commission and the Australian Securities and Investments Commission (ASIC) that SMSFs with less than $500,000 in assets tend to underperform APRA-regulated funds, but it does so by comparing funds on a like for like basis.
These were the 5 key findings.
SMSF returns consistently underestimated
The investment performance of SMSFs regulated by the Australian Taxation Office (ATO), is measured differently to the performance of large funds regulated by the Australian Prudential Regulation Authority (APRA).
While APRA relies on financial statements to generate a rate of return (ROR), the ATO uses a return on assets (ROA) measure based on SMSF annual returns. To level the playing field, the Report calculated an annual ROR for each of the SMSFs in its sample so they could be directly compared with APRA fund returns.
As the table below shows, the ATO’s traditional ROA measure of median SMSF investment returns underestimates the median SMSF ROR by more than 1.9% over the three years from 2017 to 2019.
SMSF median returns, financial years ending 30 June
| 2017 | 2018 | 2019 | |
|---|---|---|---|
| Median ROR | 6.9% | 6.0% | 6.2% |
| Median ROA | 5.0% | 4.0% | 4.3% |
SMSFs meet and often beat APRA fund returns
When comparing SMSF and APRA fund returns on a like-for-like basis using RORs, median returns from all SMSFs were lower in two years out of three between 2017 and 2019.
But when small, cash heavy SMSFs are excluded, SMSFs outperform APRA funds in two years out of three, as the table below shows.
Median investment returns, financial years ending 30 June
| 2017 | 2018 | 2019 | |
|---|---|---|---|
| All SMSFs | 6.9% | 6.0% | 6.2% |
| APRA funds | 7.8% | 7.6% | 6.2% |
| SMSFs with more than $200,000 and less than 80% cash or term deposits | 8.0% | 6.6% | 6.5% |
Source: Understanding SMSF performance report.
The Report argues that comparing SMSFs with net assets of more than $200,000 and less than 80% cash and term deposits provides a more meaningful comparison with APRA funds.
While these comparisons are only over three years, and admittedly years when interest rates were at historic lows, they do highlight the perils of relying too heavily on one asset class.
Diversification boosts SMSF returns
Not surprisingly, SMSFs with more diversified investment allocations achieved higher returns, but there is a sweet spot.
While the Report found each incremental increase in asset classes up to four is associated with an improved return of between 1% and 3%, diversification beyond four assets classes only improved performance at marginal rates.
Researchers looked at seven asset classes: cash and term deposits, listed Australian shares, listed international shares, listed trusts, unlisted trusts, limited recourse borrowing arrangements (LRBA’s), and other assets.
Some of the more interesting findings were:
- Fund performance was lower for high levels of cash and term deposits and highest for SMSFs with 10% to 20% cash and term deposits
- Fund performance was highest for high levels of Australian shares but there were more limited benefits for international shares which were more volatile
- LRBAs, used primarily for real estate purchases, were associated with the highest variations in performance of any asset class, demonstrating the effects of leverage.
Professor Ralf Zurbruegg from the University of Adelaide said the performance benefits of adding a second, third or fourth asset class are strong and consistent across the 2017–19 period. “The results provide a useful reference point and education tool for SMSF professionals and investors and supports the regulatory focus on SMSFs with inadequate levels of diversification,” he says.
Size matters, up to a point
The Report concluded that fund size is important, but the improvement in returns levels out once net assets reach a threshold of around $200,000, at least for the period 2017–19.
This adds further weight to earlier research by Rice Warner that found SMSFs with balances of $200,000 or more were cost effective compared with industry and retails super funds.
As the chart below shows, there are no material differences in returns for SMSFs between $200,000 and $500,000. According to SMSF Association CEO, John Maroney, “The notion that smaller SMSFs in this range deliver materially lower investment returns, on average, than larger SMSFs in this range is not supported by the research results.”
And while there is more divergence in returns for funds with more than $500,000 for the three years analysed in the study, larger funds had an advantage of about 1% at most.
The benefits of advice
The Report also found that the investment performance of SMSFs varies far more than the performance of APRA super funds. SMSFs are more likely to both outperform and underperform bigger funds.
“The greater variation in fund-level performance, and a higher tendency to outperform relative to APRA-regulated funds, presents opportunities for advisers to add value and deliver higher rates of return for suitable superannuation investors.
“It also presents opportunities for advisers to assist those SMSF investors who have a higher tendency to underperform,” says Maroney.
The bottom line
The latest research shows that SMSF trustees can be confident that their fund can be competitive with APRA funds once it has assets of $200,000. But your returns are likely to suffer if your SMSF is cash heavy or under diversified.
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