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17 February 2020

17 February 2020

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NALE Nature and ramifications

High-end funds Characteristics and issues

Property holdings New regulations imposed

Investment strategy Professional implications

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What the top end looks like

While SMSFs are categorised as one segment of the superannuation system, they are really a collective of individual funds and thus have different characteristics and associated matters to deal with depending on their circumstances. Liz Westover analyses what the funds with higher balances look like and the issues they are facing.

LIZ WESTOVER is superannuation, SMSF and retirement savings partner at Deloitte.

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With 600,000 SMSFs, the features of each are always going to be diverse. From asset allocation to ATO scrutiny, the nature and complexity of issues will vary, largely based on the size of the fund. While there are consistencies in attributes and systemic issues across the entire population of SMSFs, larger funds will typically have a different profile and have their own issues to deal with. So let’s look at these unique funds using statistics from the ATO’s “Selfmanaged super fund quarterly statistical report – September 2019” to define their situation.

What does the ‘high end’ look like? For our purposes, we have determined the ‘high end’ is a fund with more than $5 million in assets. These types of funds represent 3.5 per cent of the total SMSF population, around 21,000 funds, and hold 25.2 per cent of the sector’s total assets. Table 1 shows the number of funds in each size category together with the proportion of assets

held by those funds. Clearly there is an inverse relationship between the number of funds in each band and the total assets held by those funds.

The ‘really high end’ There are currently 22 SMSFs that hold more than $100 million in assets. These funds represent 0.004 per cent of the total number of SMSFs, yet hold 0.5 per cent of the total assets. The top 100 SMSFs collectively hold more than $8.3 billion in assets. All of these funds each have more than $40 million of assets. Asset allocation High-end funds typically have a different asset allocation profile than smaller funds. In total, 20.7 per cent of all assets in SMSFs are held in cash and term deposits. High-end funds, however, will typically have significantly less of their assets in this asset class (between 12.4 per

cent and 17.9 per cent). By comparison, smaller funds with less than $500,000 hold between 29.8 per cent and 53.6 per cent in these types of investments. SMSFs in total invest 30.5 per cent of their assets in listed shares. Mid-range funds are fairly consistent with this level. Smaller funds are mildly below average (22.3 per cent to 26.5 per cent), with the really large funds typically well below average – 10.8 per cent in the case of funds with assets above $100 million. High-end funds will also typically have much higher levels, non-residential property and limited recourse borrowing arrangements (LRBA) than their smaller counterparts. While assets held in collectables and personal-use assets only constitute 0.05 per cent of total SMSF assets, the larger the fund, the less likely it is to hold these types of assets. High-end funds also invest more heavily in what has been identified as ‘other assets’. While it is unclear exactly what constitutes these other assets, high-end funds invest consistently. Funds with more than $100 million hold 7.5

times the SMSF average in these types of assets (19.3 per cent), demonstrating a willingness of these funds to invest in nonconventional assets.

LRBAs While funds in the $200,000 to $1 million category are heavy users of LRBAs, so too are high-end funds. As a percentage of assets, funds with more than $100 million are the highest users of all. The ATO has identified this as one of the areas of concern warranting a closer look within the top 100 funds. Returns and expenses

profiling the top 100 SMSFs – the “really high end”. The body of work focuses on aggressive tax planning arrangements to ensure assets are acquired and held in compliance with the law, including appropriate use of superannuation tax concessions. The ATO has determined 35 per cent of these funds warranted a closer look, particularly in relation to the following: • use of LRBAs, • reported contraventions (16 per cent), • rapid and excessive asset growth rates (10 per cent over the past four years), • non-arm’s-length arrangements, and/ or • risks identified by the ATO private wealth area (13 per cent). It should not be discounted that where issues are identified in this cohort of funds, the ATO will extend its review and audit activities to other high-end funds. If these issues are identified in the top 100, it is likely there are similar issues elsewhere.

While it is difficult to compare returns Embedded pop-out and expenses for the SMSF sector,video as

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the variance per fund is likely to be significant, overall larger funds consistently outperformed smaller funds in the five years to 30 June 2017. As would be expected, larger funds consistently had lower expense ratios than the smaller funds.

ATO scrutiny The ATO undertakes a program of risk

Related-party transactions Investments in unlisted assets, particularly trusts, are often associated with relatedparty transactions. All of these factors lead to an increased propensity for high-end funds to engage in related-party transactions Unit trusts are often used as a vehicle for purchasing business real property, which is then leased back to related parties. Pre-1999 unit trusts feature frequently in these high-end funds as they tend to have been in existence for a longer period of time. Further, it is not unusual for members of these high-balance funds to hold significant wealth and have complex financial arrangements outside of super and often operate their own or a family businesses. All of these factors lead to an increased propensity for high-end funds to engage in related-party transactions. While related-party transactions are Continued on next page




Continued from previous page

permissible in an SMSF, they must always be conducted on an arm’s-length basis. The ATO has identified non-arm’s-length arrangements as an issue in the top 100 SMSFs, so clearly a number of these funds may not be getting it right.

Valuations The higher rates of investment in unlisted assets, including trusts, shares and non-residential property, by larger funds means attaining year-end valuations becomes a bigger issue for them. All SMSFs have been required for some time to report market valuations on assets at year end. For some assets, such as cash and listed securities, it is relatively easy to obtain year-end valuations. Unfortunately, it can become far more difficult for unlisted assets. The ATO requires substantiation valuations used. While not necessarily prescribing the methodology for all assets, must be accompanied by objective and supportable data. Accordingly, trustees of these high-end funds need to undergo greater scrutiny and provide more solid support for valuations. A director’s is likely to be insufficient in the absence of other support. Contributions One of the challenges for larger funds is the inability of their members to make larger contributions to increase their balances. Any members with a total super balance of more than $1.6 million will be unable to make further non-concessional contributions, relying on (where eligible) concessional contributions to inject capital into the fund. After that, increased balances will be reliant on investment growth. Administration High-balance funds typically hold a welldiversified portfolio, frequently using a range of portfolio managers, brokers and advisers. They are more likely to have overseas assets, unlisted assets and

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assets or transactions with related parties and assets classed as ‘other’. Overall, this means high-end funds tend to have more complex administration needs than their lower-balance counterparts. Gathering reports, valuations, support and compiling transaction lists, as well as undertaking and maintaining compliant

The AT O has identified non-arm’s-length arrangements as an issue in the top 100 SMSFs, so clearly a number of these funds may not be getting it right.

transactions, can be time consuming and difficult. In most cases, high-end funds will need the support of and typically are supported by a range of SMSF advisers.

Dealing with death While most SMSFs are likely to have to deal with the death of a member at some stage, estate planning is one of the most significant issues for high-end SMSFs, with many of their trustees and members still not fully appreciating how superannuation benefits are dealt with upon their death. Particularly with sizeable balances, it is imperative individuals make provision for how. The introduction of the transfer balance

cap provisions significantly compounded the issue. Previously, a reversionary nomination for an income stream was taken to deal with such matters as the whole member balance in retirement was typically in pension phase. With the certainty now of an accumulation balance in these larger funds, a reversionary nomination will have limited application. Provisions for payment of these accumulation balances must be considered.

The rise and fall of high-end funds There was much discussion (and awe) when commissioner of taxation Chris Jordan revealed a number of years ago that there were four SMSFs with over $100 million in assets each. At the time there was a general feeling SMSFs of this was a legacy issue, with observations that contribution would make it difficult to inject monies into an SMSF and the age demographic of those members with big balances meant their impending demise would necessitate large death benefits being paid out of the system. Over the four years to 30 June 2018, the percentage of high-end funds grew consistently as did the percentage of total assets held by them. In fact, the number of high-end funds grew from 2.7 per cent to 3.5 per cent in the period with the assets held growing from 21.3 per cent to 25.2 per cent. It’s hard to imagine many new SMSFs, subject to current contribution caps, would easily grow to these balances without aggressive and fortuitous investments and the reality is large death benefit balances subject to transfer balance caps can no longer be retained in super. Increasing the number of members within a fund to six might facilitate an increased SMSF size (currently, 93 per cent of SMSFs have one or two members). Therefore, while not impossible, the truly high-end funds are likely, in the long run, to be an endangered species and the largest funds will have a significantly lower balance.







It was a well-balanced event with up-todate information, regulatory presence and opportunities for investment. I was very pleased I attended and hope future events incorporate this mix as well.

As every year, the event content and the quality of presenters has been first rate. Highly informative regarding trends and compliance, and provides a wealth of information on new products available for SMSF Trustees to consider.

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Charting the course

The The SMSF SMSF investment investment strategy strategy has has been been under under increased increased scrutiny scrutiny in in recent recent times. times. Rob Rob Lavery Lavery takes takes aa look look at at the the items items to to be be considered considered when when formulating formulating an an SMSF’s SMSF’s investment investment plan. plan.

ROB ROBLAVERY LAVERY isissenior seniortechnical technical manager managerwith withthe theknowIT knowIT Group. Group.

In Inaa2018 2018report, report,the theAustralian AustralianSecurities Securitiesand and Investments InvestmentsCommission Commission(ASIC) (ASIC)found, found,having having surveyed surveyedmore morethan than450 450SMSF SMSFmembers, members,almost almost one-third one-thirddid didnot notrealise realisetheir theirfund fundwas wasrequired required to tohave havean aninvestment investmentstrategy. strategy.What’s What’smore, more,28 28 per percent centof ofthose thosesurveyed surveyedadmitted admittedto togiving giving no noconsideration considerationto tomembers’ members’insurance insuranceneeds needs through throughthe thefund. fund. The Thenew newyear yearisisaagood goodtime timeto torevisit revisitthe the investment investmentstrategy strategyrequirements requirementsof ofSMSFs SMSFsand and to totake takethe thetime timeto toreview reviewthose thosethat thatare arein inplace placeto to make makesure surethey theycomply complywith withthe thelaw. law.

The Thelegislation legislation The Theobligation obligationfor forall allSMSFs SMSFsto tohave havean aninvestment investment strategy strategyisiscaptured capturedin insection section52B 52Bof ofthe the Superannuation SuperannuationIndustry Industry(Supervision) (Supervision)Act Act1993. 1993.ItIt states stateseach eachtrustee trusteeof ofthe thefund fundmust mustformulate, formulate,

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review reviewand andgive giveeffect effectto toan aninvestment investmentstrategy strategythat that considers considersthe thewhole wholeof ofthe thefund’s fund’scircumstances. circumstances. Furthermore, Furthermore,this thissection sectionoutlines outlinesthe thesorts sortsof ofissues issues an aninvestment investmentstrategy strategyshould shouldinclude, include,being: being: •• the therisk riskof ofthe theinvestments investmentsand andthe thelikely likelyreturn return from fromthose thoseinvestments investmentsgiven giventhe thefund’s fund’scashcashflow flowrequirements, requirements, •• the thediversification diversificationof ofthe thefund’s fund’sinvestments, investments, •• the theliquidity liquidityof ofthe thefund’s fund’sinvestments, investments,given given cash-flow cash-flowrequirements, requirements,and and •• the theability abilityof ofthe thefund fundto topay payits itsliabilities. liabilities. The Theaccompanying accompanyingregulations regulationsadd addthe the investment investmentstrategy strategyshould shouldalso alsoconsider considerwhether whether the thefund fundshould shouldhold holdinsurance insurancepolicies policiesover overthe the lives livesof ofone oneor ormore moremembers. members. ItItisisworth worthexamining examiningthe therole roleinvestment investment strategies strategiesplay playthrough throughthe thelens lensof ofthese thesethree three obligations: obligations:

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