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Why are SMSFs attracted to ETFs?

For the past few years, SMSFs have embraced the use of exchanged-traded funds (ETF). And while the more traditional index trackers have been adopted more broadly, a second generation of exchange-traded products (ETP) offering more sophisticated investment alternatives, such as managed risk funds and dividend collectors, is quickly gaining momentum with the SMSF sector.

As we reported in our recent BetaShares/Investment Trends ETF report, the number of SMSFs with ETF holdings almost doubled in the previous year, up from 46,000 to 83,000, representing almost 15 per cent of the total number of SMSFs in Australia.

A key advantage offered by ETFs is the exposure to asset classes, without the need to pick stocks individually. The growing use of ETFs by SMSFs reveals they are gradually adopting a top-down approach, putting greater emphasis on the analysis of sectors or industries, instead of company by company.

ETFs also enable SMSFs to adopt a long-term, ‘buy-and-hold’ approach to investing that is almost impossible for conventional superannuation funds to replicate. Because SMSFs are aligned specifically to the needs of their trustees and members, they can be used to build a tailor-made portfolio around their specific retirement needs.

At the same time, buying direct shares and holding them 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 active managers will buy and sell shares frequently to try to outperform their benchmarks. Thus, actively managed funds will usually have high levels of turnover (often up to 80 per cent a year), which also acts as an after-tax performance drag.

By contrast, ETFs typically have significantly lower levels of turnover. This lower turnover reduces the number of tax events over a given time period and can also help by allowing franking credits on share dividends to accumulate over time.

Another reason the use of ETFs resonates with SMSFs is the reduction in the cost of investing. Most SMSFs have come to realise one of the few elements of their investment strategy they are able to control is fees, leading to a strong preference for lower fee investment options for their portfolios.

This focus on fees is particularly relevant given the reality of performance recorded by a majority of active managers. As revealed by a recent report by S&P Dow Jones Indices (the SPIVA report), the majority of Australian actively managed funds in large caps, real estate investment trusts, international equities and bonds were outperformed by their respective benchmarks over one, three and five-year periods.

Finally, there has been a recognition by SMSF investors of a need to diversify away from Australian equities and property in their investment portfolios. To that end, SMSF investors are increasingly seeking global equities products. As ETFs can be bought and sold like any share on the ASX, and as there has been a proliferation of products offering exposure to global equities, many SMSFs are now turning to ETFs to obtain their global exposure. Indeed, the launch of numerous ETFs that provide exposure to international markets with a currency hedge component is likely to continue to drive this trend.

Specifically made for SMSFs

Today, ETPs are not limited to index exposures. In fact, one of the most obvious trends from a product development perspective has been the emergence of objectives-based products that have been specifically designed for pre-retiree and SMSF investors. Examples of these include managed-risk strategies and dividend-oriented investment vehicles, among other alternatives, which have proven to be very popular with SMSF trustees and SMSF-focused advisers.

Managed-risk funds, for example, aim to provide exposure to Australian or global share markets, while seeking to reduce the volatility of the equity investment returns and defend against losses in declining markets. Products such as these, which are designed to cushion downside risk, have obvious appeal for SMSF investors.

Dividend-oriented funds, on the other hand, are also a great option for SMSFs that are structuring their portfolios around income generation. For example, we’ve had great success attracting the attention of SMSF investors with funds that aim to maximise franked dividends, with regular income distributions.

The flourishing of new products in the past couple of years has certainly made it easier for SMSFs to tailor their investments according to their specific investor needs.

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