Why SMSFs use ETFs
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The two acronyms "SMSF" and "ETF" are responsible for some of the largest changes to the Australian investment landscape in recent years.
In this article we examine some of the reasons why exchange-traded funds have become so popular with self-managed super fund investors.
SMSFs are the largest and fastest-growing segment of the Australian retirement savings pool, while ETFs are one of the fastest-growing categories of investment products in Australia, paralleled by massive growth in the ETF market globally.
The connection in the growth of SMSFs and ETFs is not a coincidence--the forces driving the massive surge in the popularity of both are essentially the same, that is, investors' desire to:
• Take control of their investments;
• Reduce the costs of investing;
• Improve transparency and simplicity in their investments; and
• Improve the tax outcome of investments.
Of course, investor research shows there are numerous other reasons for the popularity of SMSFs and ETFs, but these are the main themes driving demand.
When we dig beneath the surface we can see some powerful opportunities for SMSF investors who adopt ETFs as part of their investment portfolios.
Control and turnover
Apart from the fact SMSF trustees control exactly what they invest in, they are also able to adopt a long-term, buy-and-hold approach to investing that is difficult for conventional super funds to mimic.
Because SMSFs are aligned specifically to the needs of their trustees and members (normally the same), they can be used to build a portfolio around their specific retirement needs.
Buying shares or property and holding the assets until they ultimately are sold down in retirement (or hopefully not at all) is difficult to achieve when using traditional managed funds.
This is because traditional actively managed funds will buy and sell shares frequently to try to outperform their benchmark.
As a result, actively managed funds will usually have high levels of turnover, which acts as an after-tax performance "drag".
Lower turnover reduces the number of tax events, lowers costs associated with trading and can also help by allowing franking credits on share dividends to accumulate over time.
All of this fits neatly with the key design features of ETFs. Because ETFs seek to track an index (or provide access to an asset class), the turnover within the ETF is essentially the same as the turnover in the index.
Traditional indices like the S&P/ASX 200 only change in composition in limited circumstances such as when indices rebalance or when corporate actions occur (for example, bonus or rights issues).
That may lead to a better after-tax outcome for investors holding an Australian shares ETF compared with an equivalent actively managed fund.
Cost control is one of the best ways to improve the overall return of your investments.
The impact of an annual investment cost of, say, 1 per cent per annum over the term of the investor's life creates a significant drag on investment performance.
ETFs typically involve far lower costs than traditional actively managed funds.
(Fees have a significant impact on investment returns--the table above indicates the value of $100,000 invested in the S&P/ASX 200 Index (total return) with a fee of 2 per cent per annum versus 0.40 per cent per annum over a 10-year period.)
SMSF trustees are looking to take control of their investments, reduce costs and improve tax efficiencies.
ETFs tick all those boxes and may be a worthy consideration for SMSF trustees as an investment for their fund.
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Alex Vynokur is the managing director of BetaShares. This article initially appeared on Morningstar.com.au in June 2014. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.
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