It's been another turbulent year for Australia's 600,000-strong SMSF community. Just as trustees put the franking credit debate behind them, the coronavirus hit, causing the market to plunge almost 40 per cent and slashing dividend payouts. Meanwhile, saving and term deposit rates are at record lows, and income from investment properties has dropped amid pleas for leniency from distressed tenants.

Despite US indices erasing the losses, trustees have reported high level of concern and negative return expectations over the next 12 months.

The downturn also pushed some trustees to make drastic changes to their portfolio. Eight per cent of SMSFs made substantial changes (50 per cent or more of the fund) to their asset allocation in 2020 – doubling the number who did the same last year (4 per cent), the highest level on record.

The 2020 Vanguard/Investment Trends SMSF Investor Report surveyed trustee's response to the pandemic market sell-off and asked how they're positioning for the future.

Here are this year’s biggest trends:

SMSF sector growth is slowing

The number of SMSF trustees continues to rise – reaching almost 600,000 in 2019 – but the annual establishment rate has declined to a decade low. Last year, only 20,028 new SMSFs were set up, halving from a peak establishment rate of 42,033 in 2012.

Investment Trends chief executive Michael Blomfield attributed some of last years' slowing to the raging franking credits debate which permeated through the sector in the lead-up to the 2018 federal election. For several years, SMSFs have also expressed frustration at the increased complexity and expense of running a fund.

Blomfield expects establishment numbers to grow in the coming years and is keenly awaiting the response of trustees to the sell-off.

"What we saw following the GFC was a surge in establishment of SMSFs as people lost confidence in the value equation of paying for alpha – or investment management," he says. 

"It remains to be seen this time whether that view is arrived that. I don't see some big contraction in the number of SMSFs in existence in the next 12 to 24 months."

Desire for control drives establishment

There are two main factors driving establishment of an SMSF: first, the desire of trustees to gain control of their investments; and two, to achieve better returns. It seems that trustees across all establishment dates believe they can do a better job than the nations leading fund managers.

Notably, the response "invest in property" has come to the forefront with trustees who established a fund over the past five years – and this despite increased controls around SMSF borrowing.

There has also been a drop-off in the number of people establishing a fund on the advice on their accountant. In the early 2000s, almost 40 per cent of respondents listed "advice from my accountant" as the main reason for setting up an SMSF. Today, that number is less than 15 per cent.

Over the decade, the number of trustees who use an adviser – including accountants for tax advice, full-service stockbrokers, private bankers and mortgage brokers – has soared. At the same time, the number of SMSFs using a financial planner has dipped.

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Source: 2020 Vanguard/Investment Trends SMSF Report

SMSFs have a back-up plan

It seems SMSFs want to have their cake and eat it too. In recent years, new trustees expressed an intention to hold on to their employer super fund – be it an industry, retail or corporate fund – when they establish an SMSF. And this trend is firming. Almost half of those who establish an SMSF said they intend to retain their APRA regulated fund, up from 29 per cent just four years ago.

There are several reasons for this, Blomfield says. Firstly, trustees view their super fund as a "personal insurance policy" in case of problems running their own fund. Secondly, as employer contributions are paid into the current super fund, trustees want to maintain this flow. Lastly, trustees want to continue accessing group insurance offered by regulated funds as these policies are often cheaper than those offered by external providers.

Blomfield views this trend as a positive for the industry and as a sign of a maturing market.

"What we're seeing is a more and more mature SMSF trustee market – using their self-managed fund for the reasons they value it but retaining professional advice and money management to lower their risk overall," he says.

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Source: 2020 Vanguard/Investment Trends SMSF Report

SMSFs freaked out during the height of covid crash…

Concern levels reached new heights during the pandemic, following the ASX 200’s 37 per cent plunge from a peak of 7,255 in mid-February to lows of 4,564 by 23 March. 

Investment Trends measures concern levels on a scale of 0 to 10. "Zero defined as lying on the beach drinking a margarita and 10 defined as standing at the edge of a very tall building taking one last breath," Blomfield says. During March and April, SMSF concern levels about the situation in financial markets peaked at 7.9, up from 5.6 in January 2020. Concern levels are also volatile.

"You can see that move from 7.9 in mid-March down to 6.4 around April, then back up again. You really see the sort of volatility of concern level coming through," Blomfield says.

Return expectations (ex-dividends) have also been volatile since the pandemic, rocketing from lows of -2 per cent in early April to highs on 7.4 per cent in May. Today they are about -1.1 per cent.

Trustees similarly reduced their dividend yield expectations, from highs of 4.8 per cent in mid-February to around 3.1 per cent today – or down 35 per cent.

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Source: 2020 Vanguard/Investment Trends SMSF Report

…but didn't move entirely into cash

Despite high levels of concern, the response among trustee was not uniform. While almost half of SMSFs (44 per cent) said they made a substantial change to their portfolio in the last 12 months* – the highest level since survey inception 14 years ago – some trustees became more defensive (55 per cent), selling assets into cash, while others saw the downturn as a buying opportunity (29 per cent).

"Those people who took a more aggressive position had a more positive view on Australian shares and overseas shares – and were more focused on growth," Blomfield says.

Blomfield was quick to note only a minority of trustees sold into cash following the downturn.

"The proportion of people who made substantial changes of their asset allocation was low. Only 27 per cent of trustees made substantial changes to as much as 20 per cent of their fund. Only 17 per cent made changes between 30 per cent 50 per cent or more."

He also cast doubt on claims that trustees have been "doing all the wrong things" in response to the pandemic saying: "the view that everyone sold out at the bottom and started to buy back in at the top is not supported by our research".

*This is not enormously higher than the historical average which is around 36 per cent. A substantial change is defined as an asset allocation change of greater than 10 per cent of the fund.

SMSFs are shunning direct shares in favour of property

For several years, SMSFs’ allocation to direct shares has been in decline. This trend has only accelerated following the pandemic.

In 2013 trustees allocated 45 per cent of the portfolio to shares. Today, allocation is down to 31 per cent. As such, property and cash assets now comprise a larger portfolio of balances. Blomfield says direct property has been the main beneficiary of the reallocation of assets.

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Source: 2020 Vanguard/Investment Trends SMSF Report

In the year ahead, more trustees than ever say their focus in on maximising capital growth. There is also significant appetite to rotate into equities – local and global – and increase super contributions.

Older trustees expressed a preference for managing risk and building a sustainable income stream.

No love for fixed income

Despite expressing a desire for sustainable income streams, SMSFs have a lukewarm response to fixed income. Just 5 per cent of trustees said they intend to increase their exposure to fixed income/bonds in the next three months, compared to 37 per cent of trustees who are eyeing Australian shares. Instead, they are turning to the equities market, and the hybrid market, to access fixed income-like returns.

"Bonds are almost nowhere," Blomfield says. "In the absence of good fixed income exposure, people are still intending, even going forward, not withstanding the volatility of the markets, to look for equity-based yield."

Those who do invest in the asset class, primarily to balance growth and manage risk, do so via bond ETFs (9 per cent) or direct bonds (9 per cent). From barely a dozen fixed-interest ETFs five years ago, there are now nearly 30 Australian and global funds, with more in the pipeline.

Among the top five ETF inflows for October 2019, fixed income headed the list with around $372 million invested, outpacing international and Australian equities, according to BetaShares. This trend reversed in 2020.

The biggest issues bonds face with trustees is the perception of low returns. Blomfield says this is a function of trustees comparing equity markets and fixed income markets. He says trustees appear to be loading up on riskier asset classes and are failing to get the message that bonds exist as a truly defensive asset class in a diversified portfolio.

"This is not a meaningful comparison when you think about the risk characteristics of each of the products," he says.

"What trustees are telling us here is that they're chasing yield – yield as a function of asset allocation is not the game they're playing. Chasing yield by the way of equity exposure is what they’re doing."

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Source: 2020 Vanguard/Investment Trends SMSF Report

The 2020 Vanguard/Investment Trends SMSF Investor report surveyed over 3,000 SMSF trustees between February to May 2020.