Challenges ahead for the “SMSF basket”

The so called “SMSF basket”– the top 10 Australian shares most commonly held by the majority of SMSFs – showed resilience in the wake of the recent share market sell off, but challenges within this group are likely to re-emerge. In this article, Equities Portfolio Manager Dermot Ryan explains the drivers behind the challenges.

The so called “SMSF basket”– the top 10 Australian shares most commonly held by the majority of SMSFs – showed resilience in the wake of the share market sell off a few weeks ago but challenges within this group are likely to re-emerge.

Earnings challenges among the banks in particular will likely influence the performance of the SMSF basket in the months and years ahead, says Dermot Ryan, AMP Capital’s Equity Income Portfolio Manager.

Many of these challenges are driven by tighter regulation which could lead to banks potentially needing to raise capital as they have done in the past as well as continue to divest from non-core businesses, Ryan points out.

“Regulators want banks to be a safe core in the centre of our financial system. It was mid-way through 2015 when APRA (the Australian Prudential Regulatory Authority) started introducing macro prudential rules and banks started pulling back on riskier investment loans… We think there will be further tightening ahead, which could force banks to be more conservative,” he says.

Banks are among the top four holdings of the most tightly held stocks by self-directed investors.

The “SMSF Basket” – top 10 stocks held by SMSFs

SMSFs allocate more than 60 per cent of their total investable funds to direct shares, according to a survey of 2670 funds by SMSF administrator, SuperConcepts.

Australian shares account for 60 per cent of the direct shares allocation and the top 10 holdings are far and away the most popularly held shares.

Direct shares are a significant driver of SMSF returns, considering the fixed interest, short term deposits and cash, property, and “other” alternative allocations account for 12.1 per cent, 17.3 per cent, 19 per cent and 0.5 per cent respectively, according to the SuperConcepts data to the end of December last year.

“Dividend growth will be very difficult to achieve for the banks going forward and may become more challenging as APRA continues along the path of tightening regulation,” Dermot adds, highlighting the further potential challenges ahead for this group.

“Increasing capital requirements will mean these institutions will need to set aside more cash than they potentially have in the past, meaning they’re likely to have lower ROE (return on equity) which could play out to lower dividends and earnings,” he says.

“Overall, I think this is a positive story for the broader economy because it means we’ll have safe financial institutions, but I think out of all the big four banks’ stakeholders it’s the shareholders who might feel the pinch a bit,” he adds.

Tracking the performance of the SMSF basket in recent years shows this trade has been quite a fruitful one for SMSF investors.

Right up until September last year, holders of the SMSF basket would have more than doubled their original investment since the start of 2011, compared to the S&P/ASX200 index which returned 65 per cent during the same period, an outperformance of 35 per cent (based on an equal weighting of the basket).

Since the start of 2012, the big four banks have been amongst the share market’s strongest and most consistent performers; falling rates have worked in the banks’ favours while the domestic property market has been booming and their reliably strong dividends have remained in high demand.

The performance of the SMSF basket began to taper towards the end of last year as discussions around a Royal Commission into the banking industry began to grow louder.

While the SMSF basket bounced back stronger than the ASX200 and smaller companies index following the early February share market selloff, Ryan expects the challenges the banks are facing to begin influencing the performance of this group of shares going forward.

Ryan previously highlighted some of the challenges creeping into the SMSF basket in September 2017.