Matthew Collins writes in his article on ‘direct investing options’ (DIO): “The cost-effectiveness of this strategy depends upon a host of tax and investment considerations.”
This comment draws out other issues, some of which Matthew probably avoided for space reasons.
If the changes to franking credit policy do occur, the relative attractiveness of an industry fund DIO essentially represents a structural advantage. There are other examples of structural advantages that SMSFs hold, such as the ability to:
- Invest in almost any asset. The DIOs do not cover all shares, ETFs or LICs.
- Access the government guarantee on deposits, as this is available ‘per entity per ADI’. That is, the DIO only has one claim for $250,000 which is irrelevant given its scale
- Borrow using Limited Recourse Borrowing Arrangements (albeit now diminished)
- Include more than one member and therefore spread the cost.
No doubt a skilled financial adviser can add many more ways an SMSF can be used for planning and they are welcome to add more comments.
Similarly, send through any material criticisms of the DIO not mentioned in either article, other than political arguments that it’s all a union-inspired plot by Labor.
What is best for the investor?
Advisers and investors should focus on achieving the best outcome for the individual and should be agnostic to the products or vehicles used.
It is likely that few financial advisers have used the DIO option, although many in the industry are working on responses to Labor’s proposal. A sensible outcome might be that advisers and businesses serving the superannuant consider industry funds and DIOs as one of many attractive weapons in their arsenal.
But they are not mutually exclusive. It might be reasonable to run an SMSF and a DIO as well as other vehicles such as insurance bonds, retail funds, money outside super, managed accounts or whatever. Together, they may better meet the objectives of the client, as long as it does not become too complicated.
Maintaining an industry or retail fund account might be viewed as an ‘end of life’ transition strategy out of an SMSF as the members age or if their needs change such that the SMSF is no longer required. It is not one versus the other, as the two can co-exist.
The industry funds also have the motivation to improve their DIO product. For example, Matthew highlights the inability to transfer shares from an SMSF to a DIO ‘in specie’, requiring shares in an SMSF to be sold first. This capability could be built.
The relevance of the DIO limitations
The article also touches on a number of constraints or limitations that might act as a disincentive for an SMSF superannuant or their adviser. These include (but are not limited to) the product rules, especially the maximum amount that can be invested in the DIO, and the limited approved product list (APL).
Whilst these rules might be construed as unnecessarily paternalistic, they are designed by industry fund trustees in exercising their fiduciary duties. They need to consider the appropriateness of their products and services for the members for whom they are the custodians. There is judgement that an unfettered offering could result in sub optimal outcomes for inexperienced members who don’t have an appropriate appreciation as to the risks.
There are other restrictions which Matthew does not mention, such as a maximum 20% of the total super balance in a single stock.
Again, this is an opportunity for DIO development, as the rules are imposed by the trustees, probably because they know the type of members they have. They could offer a more relaxed set of rules where a member is transferring from an SMSF and can demonstrate an understanding of the risks involved. Or where a member is under the advice of an appropriately qualified adviser. This may remove a friction point for many trustees.
It’s another vehicle option
All segments of the wealth management industry should realise that the DIO may become a more serious competitor to the SMSF, especially if industry funds improve the product and engage more with financial advisers. As a result of the Royal Commission and the removal of commissions under FoFA, more advisers accept they must act in the best interests of their clients. SMSFs will then need to stress and develop the advantages they offer over DIOs.
Graham Hand is Managing Editor of Cuffelinks. This article is general information and does not consider the circumstances of any investor.