SMSF returns are on par with large funds

Size matters when it comes to the investment performance of self-managed super funds (SMSFs), but not as much as we’ve been led to believe.

The latest research shows investment returns of SMSFs with a balance of $200,000 or more are comparable to returns from much larger funds regulated by the Australian Prudential Regulation Authority (APRA), with several provisos.

To compete with the big end of town, SMSFs must be well diversified and not hold too much cash. However, SMSFs tend to outperform APRA funds in depressed markets and underperform in good years.

There are also differences in performance between SMSFs in accumulation and retirement phase, depending on market conditions. 

A report titled Self-managed super fund performance 2020–21 (the Report) conducted by the University of Adelaide for the SMSF Association analysed returns from over 310,000 SMSFs over two financial years to June 2020 and 2021. This represents over 45% of the entire SMSF population.

The Report builds on earlier work by the same researchers on SMSF performance over the period 2017–19. Their ongoing findings have been instrumental in debunking the once common assumption that SMSFs with less than $500,000 in assets tend to underperform APRA-regulated funds. What’s more, their research does so by comparing funds on a like for like basis.

These were the key findings.

SMSF returns consistently underestimated

Investment performance of SMSFs regulated by the Australian Taxation Office (ATO) is measured differently to the performance of large APRA funds.

While APRA relies on financial statements to generate a rate of return (ROR), the ATO uses a return on assets (ROA) measure based on SMSF annual returns. To level the playing field, the Report calculated an annual ROR for each of the SMSFs in its sample so they could be directly compared with APRA fund returns.

As the table below shows, the ATO’s traditional ROA measure of median SMSF investment returns underestimates the median SMSF ROR by more than 1% over most periods from 2017 to 2021.

SMSF median returns, financial years ending 30 June

	2017	2018	2019	2020	2021
Median ROR	6.9%	6.0%	6.2%	-0.6%	14.8%
Median ROA	5.0%	4.0%	4.3%	-1.5%	12.9%

Source: Self-managed super fund performance 2020–21, Understanding SMSF performance 2017–19

SMSFs meet and often beat APRA fund returns

When comparing SMSF and APRA fund returns on a like-for-like basis using RORs, median returns from all SMSFs were lower in three years out of five between 2017 and 2021.

But when small, cash heavy SMSFs are excluded, SMSFs outperform APRA funds in three years out of five, as the table below shows.

Median investment returns, financial years ending 30 June

	2017	2018	2019	2020	2021
All SMSFs	6.9%	6.0%	6.2%	-0.6%	14.8%
APRA funds	7.8%	7.6%	6.2%	-1.2%	16.0%
SMSFs with more than $200,000 and less than 80% cash or term deposits	8.0%	6.6%	6.5%	-1.0%	15.8%

Note: All returns are median RORs.

Source: Self-managed super fund performance 2020–21; Understanding SMSF performance 2017–19.

The Report argues that comparing SMSFs with net assets of more than $200,000 and less than 80% cash and term deposits provides a more meaningful comparison with APRA funds.

While these comparisons are only over five years, and admittedly years when interest rates and returns on cash were at historic lows, they do highlight the perils of relying too heavily on one asset class.

Interestingly, the latest report revealed valuable insights into the relative performance of SMSFs and large funds in different market conditions.

Performance in good times and bad

While SMSFs are often criticised for holding too much cash, the table above illustrates the defensive nature of cash in a market downturn. Conversely, cash is a drag on returns when markets are booming.

In the 2020 financial year, which included the Covid-induced market crash, SMSFs outperformed APRA funds (-0.6% versus -1.2% median return). However, the difference narrowed for SMSFs with more than $200,000 and less than 80% cash (-1.0% versus -1.2%).

In 2021, when markets rebounded strongly, the situation was reversed. APRA funds significantly outperformed SMSFs (16.0% versus 14.8% median return). However, when smaller, cash heavy SMSFs are excluded, the difference narrows (16.0% to 15.8%).

Retirement vs accumulation phase SMSFs

The latest study also analysed returns from SMSFs in accumulation and retirement phase with interesting results, as you can see in the table below.

Retirement vs accumulation SMSFs median returns, financial years ending 30 June

	2020 median ROR	2021 median ROR
Accumulation phase SMSFs	1.5%	14.7%
Retirement phase SMSFs	-2.7%	15.0%

While accumulation phase SMSFs significantly outperformed retirement phase funds in 2020 (1.5% versus -2.7%), the trend reversed in 2021 (14.7% versus 15.0%).

The Report then went on to see if there were any systematic differences in allocations to cash and Australian shares that might explain the difference in performance.

As you can see in the table below, accumulation and retirement phase SMSFs held almost identical cash allocations but significantly different allocations to Australian shares.

Asset allocation of median retirement and accumulation phase SMSFs

	2020 median proportion (%)	2021 Median proportion (%)
Cash and term deposits
Accumulation phase SMSFs	14.6%	13.0%
Retirement phase SMSFs	14.0%	12.9%
Australian shares
Accumulation phase SMSFs	0.0%	0.0%
Retirement phase SMSFs	20.9%	21.2%

On aggregate, retirement phase funds invest significantly larger proportions of their net assets in Australian shares than accumulation funds (around 21% to 0%). This pattern held for both 2020 and 2021, when the share market return was roughly -9% and 25% respectively.

The authors conclude the relative overweighting in listed shares seen in pension funds likely contributed to those funds underperforming accumulation funds in 2020 and vice versa in 2021.   

For investors who want to make the most of the good years while minimising losses in bad years, diversification is key.

Diversification boosts SMSF returns

Not surprisingly, SMSFs with more diversified investment allocations achieved higher returns, but there is a sweet spot.

The 2017–19 Report found each incremental increase in asset classes up to four is associated with an improved return of between 1% and 3%, but diversification beyond four assets classes only improved performance at marginal rates.

Researchers looked at seven asset classes: cash and term deposits, listed Australian shares, listed international shares, listed trusts, unlisted trusts, limited recourse borrowing arrangements (LRBA’s) and other assets.

Some of the more interesting findings were:

• Fund performance was lower for high levels of cash and term deposits and highest for SMSFs with 10% to 20% cash and term deposits
• Fund performance was highest for high levels of Australian shares but there were more limited benefits for international shares which were more volatile
• LRBAs, used primarily for real estate purchases, were associated with the highest variations in performance of any asset class, demonstrating the effects of leverage.

Professor Ralf Zurbruegg from the University of Adelaide said the performance benefits of adding a second, third or fourth asset class are strong and consistent across the 2017–19 period. “The results provide a useful reference point and education tool for SMSF professionals and investors and supports the regulatory focus on SMSFs with inadequate levels of diversification,” he says.

Size matters, up to a point

The earlier Report concluded that fund size is important, but the improvement in returns levels out once net assets reach a threshold of around $200,000, at least for the period 2017–19.

This adds further weight to earlier research by Rice Warner that found SMSFs with balances of $200,000 or more were cost effective compared with industry and retail super funds.

As the chart below shows, there are no material differences in returns for SMSFs between $200,000 and $500,000.

And while there is more divergence in returns for funds with more than $500,000 for the three years analysed in the study, larger funds had an advantage of about 1% at most.

The bottom line

The latest research shows that SMSF trustees can be confident that their fund can be competitive with APRA funds once it has assets of $200,000. But your long-term returns are likely to suffer if your SMSF is cash heavy or under diversified.

The Report also puts paid to the assumption that SMSFs in retirement phase invest more conservatively than SMSFs in accumulation phase, as retirement phase SMSFs hold significantly higher allocations to Australian shares.