SMSFs and the property boom: rebalancing for a more secure future

Self-Managed Superannuation Funds (SMSFs) are heavily weighted in property assets and shares and could benefit by diversifying their portfolios into fixed income assets to spread their risks.

By incorporating fixed income investments into a portfolio, SMSF trustees can potentially reduce the risk of equity portfolio losses during periods of downturn in either property or stock markets.

Compared to equity investments, real estate private credit, which is a form of fixed income secured by property, provides investors with attractive yields at much lower volatility. Furthermore, with inflation remaining sticky, this will favour yields on private credit given interest rates on loans are typically floating, allowing investors to take advantage of interest rates in a higher for longer scenario.

SMSFs: a love affair with shares and property

SMSFs commonly allocate significant portions of their portfolios to direct property, equities, and cash. According to ATO statistics, property investments and Australian shares make up a large proportion of the total asset allocation in SMSFs. 

Currently, SMSFs have direct Australian property investments valued at nearly $150 billion; as of March 2024, residential and non-residential property investments totalled a record $141.8 billion, constituting 15% of their total net assets.

Another $287.1 billion was invested in Australian and overseas shares, or around 31% of total SMSF assets. These asset classes often promise capital growth and income, but they are also subject to market volatility. For instance, equity markets can be react significantly to economic changes, which could expose SMSFs to greater risks, especially during times of financial instability.

While this strategy has been profitable in the past, the concentration of investments in direct property raises concerns about risk exposure. The property market, although currently buoyant, is not immune to fluctuations and remains vulnerable to slowing economic growth and rising unemployment.

The case for diversification

As of March 2024, SMSFs had invested just $9.5 billion directly in debt securities and $6.5 billion in loans. This is significantly lower than funds deployed into property and equity-aligned investments and underscores the importance of diversification for SMSFs. Over-reliance on any single asset class, even one as seemingly reliable as property, can expose investors to undue risk.

Diversification into other asset classes, particularly those offering stable income streams, can help mitigate risks and ensure a steady flow of income for retirement. This is particularly important given the rising cost of living and the requirement for a recurring income stream, particularly amongst retirees.

Fixed income investments like private credit is a fast-growing alternative asset class that appeals to income-seeking investors. As regulators globally reduce systemic risks in financial markets by increasing regulations on banks, more businesses are turning to non-bank lenders for funding.

Private credit offers several advantages that make it an appealing option for SMSFs. The benefits to investors include:

• High yields: Many private credit funds offer yields between 9% and 12% per annum. This is higher than those offered by corporate bonds, as measured by the S&P Australia Investment Grade Corporate Bond Index, which returned 8.65% over the year to 24 September 2024. This represents an attractive opportunity for investors to benefit from regular income while their capital is protected by loans’ senior secured position at the top of the capital stack.
  
  
• Capital protection: Real estate private credit loans are secured by a registered mortgage (usually first ranking) over property assets. Security is further enhanced with company charges over the borrowing entity and personal guarantors from directors. Some loan managers will also offer a first loss position across an entire portfolio of loans.
  
  
• Lower volatility: Compared to equity markets, private credit offers lower volatility, making it a more stable investment option. Since the performance of fixed income assets is often less correlated with equity and property markets, they serve as a stabilising force, offering predictable returns regardless of economic fluctuations.
  
  
• Inflation hedge: With inflation remaining elevated, the typically floating interest rates on corporate loans allow investors to benefit from a 'higher for longer' interest rate scenario.
  
  

With more fund managers offering private credit investment products, the asset class is becoming more accessible to SMSF investors. Ultimately, diversification into fixed income can enhance the long-term sustainability for SMSFs, ensuring the preservation of wealth and consistent income. 

 But a word of caution. It is important to invest with an experienced private credit fund manager to maximise the benefits offered by the asset class. A manager with a strong focus on robust loan selection and track record will be key to a successful private credit investment.