The tax office is writing to 17,700 self-managed superannuation funds (SMSFs) concerned that they are overexposed to property and are breaching legal obligations on investment.
It is writing to the SMSF trustees warning them about the risks they run.
In the Australian Taxation Office’s (ATO) sights are 17,700 SMSFs that “have more than 90 per cent of their assets in a single asset class”, assistant commissioner Dana Fleming told The New Daily.
Ms Fleming said the letter would “alert them to their potential exposure to concentration risk and regulatory breaches”.
Small funds in the gun
Worryingly, the ATO is directing its attentions to funds with limited-recourse borrowing arrangements (LRBAs), which are overwhelmingly smaller funds.
Some 64 per cent of funds with LBRAs are worth $500,000 or less, and 85 per cent are valued below $1 million.
Ms Fleming said that an alarming 41 per cent of SMSFs with LBRAs, or 17,700 funds, hold 90 per cent of assets in one class and 62 per cent of funds with LBRAs hold 80 per cent of assets in one class.
What worries the ATO is that “one class” often means holding a single property with debt attached that could sink the fund if things go awry.
The fact that the funds the ATO is concerned about are small, lends extra weight to the Productivity Commission’s observations that small SMSFs erode their owners’ potential retirements.
“Large SMSFs earn broadly similar net returns to APRA-regulated funds, but smaller ones [with less than $500,000 in assets] perform significantly worse on average,” it said in a report issued in January.
Not only are smaller funds more likely to hold leveraged property as virtually their only asset, 85 per cent of all SMSFs have assets less than $1 million.
These “are also likely to have much higher weightings to cash and lower weightings to equities than larger, higher-performing SMSFs which hold the majority of SMSF assets”, according to a report from researchers SG360.
Trustees of SMSFs breaching diversification and investment strategy rules could face prosecution from the ATO.
SMSFs return less
The news comes as research from SG360 shows SMSFs have returned less than the average growth fund where most Australians invest. This comes despite claims from the SMSF movement that they have outperformed pooled funds.
SG360 has reported that for the 12 months to August 31, SMSFs returned 11 per cent, the same figure that Chant West reported for the average growth fund invested 61 to 80 per cent in growth assets.
However over the longer term, SMSFs have underperformed with $100,000 invested in 2009 now being worth $177,539 – compared to $184,702 invested in the average pooled default fund.
As the chart beneath shows, the pooled funds have outperformed the SMSF index that is built on the average investment profile of SMSFs, according to ATO figures.
Many of the small funds the ATO is worried about do not follow the average because they either have virtually all their money in one property or they are heavily exposed to low-yielding cash investments and are therefore underperforming pooled funds.
“This means that the majority of SMSF members are in funds likely to achieve lower-than-ideal investment outcomes,” SGO said in its report.
The SMSF association recently claimed that in the year to June 2017, SMSFs had returned 10.2 per cent, compared with 9.1 per cent for the overall average for pooled funds.
However, Chant West researcher Mano Mohankumar said the comparison was not relevant as “no one invests in the whole-of-funds average, they choose an investment category that suits their needs”.
For the year to June 2017, the growth category most people invest in returned 10.8 per cent, he said.
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