7 tactics to bullet-proof your DIY super

Shaken by the 15% first quarter fall in the market? Don’t be, says MICHAEL LAURENCE. Just get your DIY super’s armoury up to scratch.

By Michael Laurence

Shaken by the 15% first quarter fall in the market? Don’t be. Just get your DIY super’s armoury up to scratch.

Australia’s smartest trustees of DIY funds always adopt straightforward strategies to bullet-proof their funds as much as possible from the impact of highly volatile bear markets.

Their central aim is to ensure that their long-term returns are maximised, despite inevitable setbacks that will hit their short-term returns along the way.

Indeed, astute fund trustees will even manage to insulate at least some of their fund’s short-term returns for 2007-08 from the worst of the recent market turmoil. And trustees with enough cash on hand will use the falling prices as a buying opportunity to boost their long-term returns.

Here are seven tips, compiled with the help of leading DIY fund advisers, for fund trustees who refuse to be shaken by the fact that the S&P/ASX200 index is down 15.5% over the first three months of the calendar year.

1. Always minimise investment costs

High funds management, investment transaction and tax costs handicap investment returns much more noticeably when markets are weak. And when markets are rocketing upwards, excessive costs prevent funds from receiving all their due returns.

Fortunately, there is a solution that works in rising and falling markets.

Many DIY super funds minimise their investment costs and maximise their market diversification (see point four) by holding their core share portfolios in some of the long-established, low-cost and highly diversified listed investment companies such as Argo Investments and Australian Foundation, or in indexed share funds that track the returns of selected market indices.

Argo Investments’ $4 billion portfolio is made up of shares in 190 listed companies, headed by BHP, Macquarie Group, Rio Tinto, Milton Corporation (another listed investment company) and National Australia Bank. These are its five biggest holdings.

Apart from these funds having low management costs, investors do not face transaction and tax costs from regularly buying and selling stocks.

2. Adopt a buy-and-hold strategy

This involves a fund buying growth assets with the intention of owning them for the very long-term if appropriate for its members’ circumstances. (Listed investment companies and index funds, discussed in point one, are often used for a buy-and-hold strategy.)

Apart from minimising, regular investment and tax costs, a golden bonus is in store if an asset is not sold until the fund is paying a pension to a retired member. Assets that are supporting the payment of a superannuation pension are no longer subject to tax, including capital gains tax (CGT) – no matter how much the asset has appreciated in value over the years. The CGT savings can be colossal.

Martin Heffron, co-principal of self-managed super fund consultancy Heffron Consulting, and Sydney superannuation and tax lawyer Robert Richards both say that while the buy-and-hold strategy can make much sense, as a general rule, fund trustees should not be motivated solely by the possible tax savings. The strategy should also make investment sense.

3. Adjust pension-paying strategies for falling markets

Super funds are often forced to sell quality shares in falling markets in order to pay their pension obligations. This can be either to pay transition-to-retirement pensions (to members who are aged over 55 and still working) or pensions to retired members. The problem is the same.

This is a wider-spread concern than many people may initially think, particularly with the rapid ageing of the population and the huge popularity of transition-to-retirement pensions.

Fortunately, there is a possible solution that is well worth discussing with your investment adviser.

Graeme Colley, superannuation strategy manager for self-managed fund administration service Super Concepts, says fund trustees can consider having enough cash or similar interest-bearing investments to draw upon to pay a pension for a long period. The aim is to try to ride out market downturns without having to sell quality shares in a weak market to pay pensions.

Heffron believes “it would be prudent” for pension-paying funds to hold enough cash to pay pensions for two years.

Large, non-DIY funds with diversified portfolios generally do not provide the flexibility for members to draw down from a particular asset sector in this way. DIY funds, do, however, have this flexibility; think about making use of it.

4. Widely diversify

Some stocks have been particularly hard hit by the recent market downturn, and DIY funds with a heavy exposure to them would have had the value of their share portfolios cut to pieces. Such stocks include MFS (now renamed Octaviar), Allco Finance Group and Centro Properties Group.

It is a basic principle of sound investment practice that shareholders (inside and outside super) should widely diversify their share portfolios between companies and activities. And they should carefully consider diversifying their overall investment portfolios between at least the main asset classes of shares, property, bonds and cash.

5. Understand the benefits of franked dividends

Heffron says fund trustees should keep in mind when developing their strategies the value of franking credits to DIY funds. As super funds pay 15% tax on their earnings in the accumulation phase and zero when the assets are backing a pension, they will generally receive large tax refunds for excess franking credits (which are based on the 30% marginal tax rate).

Another point to consider is that the average dividend yield of the All Ordinaries Index has historically remained relatively stable – no matter how share prices have jumped around.

6. Get professional advice

Colley of Super Concepts says of the 3000 funds administered his group, those that gain professional investment advice average 1% to 2% higher annual returns than the other funds under its administration.

7. Watch out for dangers of gearing

The high levels of gearing involving clients of the failed broker/margin lender Opus Prime truly illustrate the risks when borrowing to invest. And DIY super funds face their own extreme risks with gearing, particularly following recent changes to superannuation law.

As outlined in my column on 26 February 26, trustees of DIY super funds should brace themselves for a flood of new gearing products aimed at their funds.

The new gearing products follow amendments to superannuation law, in force from September last year, that unequivocally allow DIY funds to borrow to invest provided strict rules are met. (These rules include that the geared assets must be held in trust until the final loan payment is made and that a lender cannot make a claim against any other fund assets of the super fund in the event of a default.)

Funds using questionable products are likely to run into deep trouble with the tax commissioner in his dual roles as tax boss and as regulator of self-managed super.

Commissioner Michael D’Ascenzo issued a taxpayer alert on Friday warning that the tax office would be looking closely to ensure that funds were entering products that complied with superannuation law.

D’Ascenzo emphasises that he is not concerned about all the borrowing by DIY funds. “We are concerned where borrowings feature non-commercial interest rates, or where there is capitalisation of interest, or where members provide personal guarantees secured beyond charges over the asset purchased.”

Another thing to watch is that some promoters of gearing products to DIY funds are charging extraordinarily high fees. Tax and super lawyer Robert Richards says that the arrangements are not complicated – you just have to get it right – and high fees are not warranted.

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