They have been referred to as "selfies in the shadows". But a growing trend by self-managed super funds (SMSFs) to invest in riskier products just might blow them out of those shadows and onto the taxpayer-funded pension.
The latest figures from the Australian Taxation Office reveal that the self managed super fund (SMSF) sector has now hit a record number of members (1.1 million) who have invested $622 billion. Deloitte estimates that amount could grow to $2.75 trillion by 2035.
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When that growth is married with a report released by Credit Suisse, 'Selfies in the Shadows', it makes for a compelling scenario.
The report picks up on an interesting trend. It says as Australian banks have been sharply withdrawing funding of property developers, SMSFs have become attracted to the double-digit returns on offer from residential developer mezzanine debt and senior preferred equity.
![Credit Suisse downplays the systemic risks of SMSFs.](/web/20161002094254im_/http://www.smh.com.au/content/dam/images/g/r/s/h/t/8/image.related.articleLeadwide.620x349.grs19w.png/1475245145262.jpg)
They are filling a gap left by the banks, potentially building the so-called shadow banking sector. Citing the most recent data from APRA, Credit Suisse says in 2016 major bank residential developer exposure grew at an annualised rate of 5 per cent, compared with 20 per cent growth in 2015.
"It shrank in the June quarter," the report says.
Property push
This shift towards riskier investments for SMSFs is driven by a low-interest-rate environment. To put it into perspective, mezzanine debt providers are offering returns of between 15 per cent and 20 per cent, compared with a 2 per cent return on cash.
According to the report, selfies park most of their money into equities, cash and property. Equities currently make up 40 per cent, or $250 billion, cash at 26 per cent, or $159 billion, and property is $149 billion.
![Self-managed super funds are ploughing into property.](/web/20161002094254im_/http://www.smh.com.au/content/dam/images/g/r/k/y/3/e/image.related.articleLeadwide.620x349.grs19w.png/1475229001259.jpg)
"The property allocation is growing at twice the rate of cash at the moment, and at this pace, it should become the second-biggest holding for selfies in 24 months," the report says.
There is no hard data on the magnitude of lending by SMSFs to property developers, but given the plethora of funds starting up, Credit Suisse estimates the funds are collecting up to $4 billion a year for residential developers.
It estimates that two-thirds of this could be from SMSFs.
"One intermediary noted three-quarters of its clients are SMSFs. This asset for Selfies has increased at a rate of $4bn per annum since the financial crisis. While we are sure some of the residential development financing is counted here we do not know how much," the report says.
Selfies are using almost all equity to finance the residential developers Aussie banks don't want to touch.
Credit Suisse
Risks low
Credit Suisse downplays the systemic risks of SMSFs playing in the shadow banking space on the grounds that SMSFs use equity rather than borrowings.
"Selfies are using almost all equity to finance the residential developers Aussie banks don't want to touch. If any of these loans turn bad, selfies will bear the pain, but it will not start a domino of collapses like the US financial system endured in 2008-09."
That might well be the case but if SMSFs blow themselves up they have to turn to the age pension, which means the taxpayer is effectively underwriting these funds through tax concessions.
There is little doubt that the desperation of SMSFs to find higher returns in a low-interest-rate environment has spawned a growing industry of lawyers and accountants and freshly minted unlisted property trusts, all targeting the burgeoning SMSF sector.
SMSFs are an appropriate vehicle for financially literate people with a lot of money. They offer more flexibility to invest in a variety of assets that might not be available to retail or industry funds, and SMSFs can leverage.
But for unsophisticated investors with a small amount of money, it can be a weapon of destruction.
Poor returns
Figures show that almost half of SMSFs on average have not made a return in the past seven years and the smaller the fund, the worse the performance. Between 2010 and 2014, the bottom 10 per cent of SMSFs, those with balances of less than $100,000, have lost money every year since 2008, according to Tax Office figures.
A fund with a balance below $50,000 lost on average 15.9 per cent over the three years to 2014, according to statistics compiled by the ATO. Funds regulated by the Australian Prudential Regulation Authority (APRA), including industry and retail funds, rose 8.5 per cent over the same period.
While SMSF lobbyists argue that these findings are misleading and that some of these small balanced funds are in drawdown phase or have been set up and have high initial fees, not everyone agrees. Indeed, ASIC argues that SMSFs with under $200,000 in assets are "unlikely" to be in clients' best interests.
The brutal reality is the SMSF sector has inadequate regulation, limited transparency, weak consumer protections and an ability to use limited recourse borrowing, which makes them a target for dodgy property spruikers and other shoddy outfits.
Planner role
Accountants such as Pullen Pillay, who is being investigated by ASIC and who allegedly lost his clients up to $70 million in managed investment schemes that went wrong, has a website that offers a variety of services including SMSFs.
As the boon in SMSFs continues, a number of financial advisers and accountants have set up one-stop shops, offering financial advice, tax advice, SMSFs and mortgage broking. Some are encouraging their clients to roll over their super and leverage their homes into property developments that will give them massive returns.
They are being offered free flights to see where the property will be built.
One financial adviser said in Lithgow a business had set up targeting coalminers and correctional service workers to do just that. He said he was concerned that it was too good to be true.
"Also they have been telling people to go out and buy that boat or caravan because they are going to have their houses paid off in no time and that they will be able to retire sooner and to retire richer," he said.
It is why there needs to be greater transparency and regulation of the sector. With more and more SMSFs plugging the gap left by the banks in the property development space, it is only a matter of time before the blow-ups begin.