Saturday Extra

The popularity of self-managed super funds has boomed in recent years.

The sector now accounts for about a quarter of all superannuation assets, or about 300 billion dollars in funds.

And, recent changes to the rules governing how these funds can be invested will likely increase the popularity of DIY super.

But are these changes -- specifically the green light to borrow for investing -- going to allow the trustees of these funds to take too much risk?

Transcript

This transcript was typed from a recording of the program. The ABC cannot guarantee its complete accuracy because of the possibility of mishearing and occasional difficulty in identifying speakers.

Geraldine Doogue: Kevin, given the debt-driven meltdown that's afflicted global financial markets, is the introduction of borrowing to invest in self-managed funds a wise development?

Kevin Davis: I think it was a development that was pushed through without adequate discussion, and I think it creates all sorts of risks for trustees of self-managed super funds in terms of a range of often quite complex products that quite often have difficulty assessing the risk and value of, and create a number of issues associated with compliance. This enables individuals or superannuation funds to lever up their investments, which increases the risk associated with those. But the one good thing about these types of products is that they do involve a non-recourse loan, which is a loan that can only be recouped against the assets against which is given, so they can't be recouped against the rest of the assets in a superannuation fund.

Geraldine Doogue: Yes, let's get this in specifics now. So that's one aspect of it, which is very important. Are there any other restrictions around the borrowing that can take place?

Kevin Davis: I think most of other restrictions are really about the assets that can be invested in by the superannuation fund, I think one of the interesting little tricks that's going to emerge -- and this is a legal issue on which I'm not full bottle on -- is that I think you could actually have a situation where the superannuation fund could borrow from one of the members on a non-recourse basis, which means that if the asset that's being purchased goes down below the value of the outstanding loan, then there can't be a claim against the assets of the superannuation fund. But if it's a member of the superannuation fund lending to the super fund, it's not clear what the outcome of that ends up being.

Geraldine Doogue: That's could be quite significant then, couldn't it?

Kevin Davis: It could be, and I think another aspect is also that some of the adverts I've seen for various products, are that if a third party was doing the lending, they might require the individual members of the fund on their own personal account, i.e. outside of the superannuation fund, to provide guarantees over the loan. So while the assets of the superannuation fund couldn't be touched if the asset went bad, the individuals would end up wearing the loss anyway on their own private account. So it's just one pocket as opposed to another pocket.

Geraldine Doogue: So I just want to be clear before we move on. If someone, say someone is loaned money to buy a commercial property. You're saying that this non-recourse loan means that the lender does bear a little more risk, doesn't it, because if there is a property crash and the value of the property drops below the value of the loan, then the lender wears that, not the person taking out the loan, is that right?

Kevin Davis: That's correct, unless there was a guarantee by the members of the superannuation fund in their own private capacity as individuals, but not members of the superannuation fund.

Geraldine Doogue: Now legislation that paved the way for this was introduced by the Howard government despite objections from both the Australian Tax Office and APRA, which is the regulator. Why do you imagine the government was so keen on it?

Kevin Davis: I've actually got no idea whatsoever. It came in as part of the Tax Laws Amendment Act Change in September last year. There wasn't a lot of discussion beforehand. I guess part of the issue was that superannuation funds had been undertaking these sorts of transactions already through purchases of instalment warrants on the Stock Exchange. Telstra instalment receipts were the obvious example of these. They were structured in a way such that the borrowing as it is, is tied up implicitly with the purchase of the share and it's not really a separate borrowing contract, it's just a requirement to make a second instalment. People often didn't even think of it as though they were borrowing.

Geraldine Doogue: Look, Jeff Bresnahan, maybe you could come in here. What's your view about the introduction of gearing to self-managed funds?

Jeff Bresnahan: I think on a broad perspective I'm not against the introduction of gearing, and obviously it can help people accelerate their retirement savings. The reality is that the new laws, I don't think anyone thought that they would be so generous, and as Kevin rightly pointed out, they were brought in because of the issue with instalment warrants and whether in fact they were legal within a self-managed super fund, but it's gone way outside of that now, and it does open a Pandora's Box going forward which we're yet to see. So it will be interesting to see what happens when we can brand in to play that the accountants and the lawyers and the product manufacturers, basically they're going to have a field day going forward to say 'Look, how can we get more money out of the superannuation system', and this is a prime example of what could happen.

Geraldine Doogue: A survey by the ATO earlier this year showed that a high number of self-managed fund trustees weren't totally across all their obligations regarding governance and compliance, and that many were also unclear as to the sole purpose test. Now this is terribly important to understand isn't it, if you're setting up self-managed fund. Maybe you could explain it for us please.

Jeff Bresnahan: OK. Look at the moment, at June 2007, there were 359,000 self-managed super funds out there and there are certain laws that you've got to adhere to when running a self-managed super fund, and you have a fiduciary responsibility as a trustee to adhere to those laws. What we think is happening out there is a lot of people aren't aware of what they can and can't do, and tend to try and -- well they could possibly mix up their own money with super fund monies, and not seek professional advice on the way through.

Geraldine Doogue: Well the critical rule, isn't it, is that the fund's sole purpose is to provide for your retirement.

Jeff Bresnahan: That's correct, yes, the sole purpose test is the key one there.

Geraldine Doogue: So you're not setting it up so you can loan money to your children, or pay off a debt, or whatever, and therefore...I mean surely this is going to have to be tested, there's going to be some people make real messes of themselves aren't there, in terms of this?

Jeff Bresnahan: Well they will, and that's where the problem will come, in that because you've got geared products now effectively the returns will look a lot more attractive during the good times, so you may see 50%, 60%, 70% returns when share markets are returning 20% or 30% depending on the level of gearing. Now Mum and Dad investors, particularly when they're financially illiterate, are more likely to jump on board at the wrong time, and the gearing will provide enhanced risks, meaning that the downside will be all the worse.

Geraldine Doogue: I mean Kevin Davis, an investment property, if you think about it, it's long been a favourite of Australians as a provider of retirement income. Now other than removing capital gains tax from the equation, is there any difference with a property that's bought within a self-managed fund, versus one outside a self-managed fund under these new rules?

Kevin Davis: Well I think as you mentioned, there is the capital gains tax that basically the tax rate within the super fund is less, and in that sense both the taxation on receipts of rental for example, as well as the capital gains component, would be less. I think there is probably quite an incentive for people to try and put investment properties into their superannuation fund, as opposed to holding them outside the superannuation fund, given that they can lever them both by borrowing under some instalment contract arrangement.

Geraldine Doogue: So in a way, what this further describes is already -- it augments the already generous tax treatment, doesn't it, given to superannuation. Is that something we ought to be discussing as well?

Kevin Davis: I think that's certainly an important issue that there is generous tax treatment for superannuation. There are limits on how much people can put in to superannuation, the age limits in terms of $50,000 contribution under a certain age. What this does is enable people to actually get more assets into their superannuation fund even though their contribution is limited to a maximum, of, say, $50,000, they can have $200,000 of assets if it's $50,000 contribution they put in one year, and borrowed $150,000 as well. So it's exploiting the tax benefits more than I think is probably intended.

Geraldine Doogue: Well you see knowing what Australians are like, that little loophole that you've just described, there'll be loads of people now trying to drive a truck through all that. I mean that seems to be the way we go. The government changes the rules about tax, and suddenly it skews business investment, wouldn't you agree, Jeff Bresnahan? Is that really good for Australia?

Jeff Bresnahan: Well some people argue it will be very good for Australia and certainly those that love property will say that, and they will go out and maybe push the property market further up, and start something there. And I agree with Kevin, that a lot of self-managed super funds will try and get that investment property into their self-managed super fund. So it remains to be seen what goes on going forward, but as I said before, there's going to be a lot of product out there that is going to be geared and will carry with it a much higher degree of risk. I think one of the things they've got to look at is maybe capping the level of gearing that can be associated with these sorts of products or trusts, and at the moment it looks as though there is no cap on that, and that's where the big risk lies.

Geraldine Doogue: Sure does. Look, for both of you, for those who can afford it, will these developments, or might these developments lead to an exodus out of the retail and the industry funds, and into the self-managed sector, which is already growing like Topsy, but might that accelerate that?

Kevin Davis: I think there are probably some incentives. I think the real issue here is that to set up a self-managed super fund, one really needs to have $200,000, $300,000 in the fund to make it worthwhile for the administrative costs and so on. I think the issue that really worries me about all this is that there will be, as Jeff mentioned, lots of product being put forward by financial advisers and investment banks and everybody out there, whose objective of course is money, to make money themselves. So there'll be very high fees being paid, often in ways that individuals may not really recognise: in an instalment warrant type product, you pay one instalment up front and you pay another instalment later on. I'm not sure that most people really sit down and think about what's the interest rating puts it in the borrowing.

Geraldine Doogue: A final word to you, Jeff Bresnahan.

Jeff Bresnahan: I think there is this risk that we will far overpopulate self-managed super funds. Last year alone, there were 45,000 new ones set up, and we don't know who's driving the new funds, and it could well be the accounting fraternity, it could be the planning fraternity, we don't know. But for sure and certain, somewhere down the track a lot of people are going to get taken advantage of, products are going to become more complex to the point where the people, Mums and Dads on the street, won't understand the product but will get sucked in by the advertising side of it, and that's where the problem lies.

Geraldine Doogue: My goodness. Thank you both very much indeed for your time today and those insights. Jeff Bresnahan, thank you to you.

Jeff Bresnahan: Pleasure, Geraldine.

Geraldine Doogue: And Kevin Davis, thank you to you.

Kevin Davis: Likewise a pleasure, thank you.

Geraldine Doogue: And Kevin is director of the Melbourne Centre for Financial Studies. Jeff Bresnahan the MD of Super Ratings.

And given that we were talking about property, I did notice in yesterday's Financial Review that the International Monetary Fund believes that Australian property is among the most over-valued in the developed world, and the risk of a correction in house prices is high by international standards. So just even further need for buyer beware in terms of these various changes. So do let us know -- look this is really the sort of feedback that I'd welcome from you via our guestbook.

Guests

Jeff Bresnahan
Managing Director, Super Ratings

Kevin Davis
Director, Melbourne Centre for Financial Studies.

Story Researcher and Producer

Scott Wales