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May 22nd, 2018
Exchange-Traded Funds (ETFs) offer real benefits to Self-Managed Super Funds (SMSFs) and investment in ETFs by SMSFs are on the rise. To put a number on it, almost 15% of the total number of SMSFs in Australia now have ETF holdings, which has doubled from 46,000 to 83,000 in one year. So, we know the appeal is there – but what are the benefits that ETFs offer SMSFs?
Perhaps the biggest benefit is that SMSFs gain exposure to asset classes, without needing to pick individual stocks. So, rather than focusing on a single company or a set of single companies, ETFs allow investors to focus their analytical energy on sectors and industries. For the purposes of superannuation savings, this is preferable. It allows for longer term and more reliable investments to be made.
When an SMSF makes use of an active manager through traditional managed funds, the manager will buy and sell shares frequently in order to outperform the benchmark. This can lead to higher levels of turnover. But, it’s not as effective as the SMSF trustee might want, as that high rate of turnover can lead to significant after-tax implications. An ETF seeks to track a market or segment which has a lower rate of turnover. Your SMSF will subsequently have far fewer tax obligations over the year, and you’ll be able to accumulate credits on share dividends over time.
Active managers come with fees, which might seem relatively small in isolation – but over the longer term, these fees can accumulate into a substantial loss in potential savings. Meanwhile, ETFs have smaller fee structures where they’re less expensive to manage.
SMSFs are strongly focused on diversification – the spreading of investments to minimise risk and to strategically target key market opportunities. A core area of opportunity for diversification is in overseas markets. But doing so via traditional shares purchasing can be problematic. There are regulatory and taxation issues in investing in overseas markets which can make the desired level of diversification difficult.
There are ETFs traded in Australia which are constructed out of stock from overseas verticals and sectors. For example, a SMSF could give itself exposure to the US technology sector through the purchase of specific ETFs in this market. As a result, a number of SMSFs are turning to ETFs as a core part of the diversification strategy.
SMSFs are subject to obligations under Australia’s Superannuation Industry Supervision Act, where the SMSF is structured in such a way to act in the best interest of its members and develop a large pool of capital to sustain the member into retirement.
Although there are risks of ETFs, they can help SMSF users to help the SMSF to meet core diversification and liquidity rules.
Unlike a managed fund, information regarding the holdings of an ETF is generally fully transparent and available in real time. This means, investors are able to make better decisions with greater accuracy, as there is more immediate and available information. So, it’s not just about keeping fees lower by doing away with the need of an active manager in a managed fund. ETFs can also be leveraged to make all kinds of investments based on what is happening in the market at any given moment, and that really does match perfectly with the philosophy of control that SMSFs themselves offer.
SMSFs account for around 30% of all superannuation assets in Australia with over $530 billion in assets. We can expect to see the percentage of those SMSFs investing in ETFs to grow more rapidly as the benefits become more widely known. Take a look at this article to see whether SMSFs are right for doctors.