According to the ATO SMSF Statistical Report for the March 2015 quarter, the amount of assets invested in both listed and unlisted trusts jumped 28.2 per cent during a two-year period, rising from $61 billion at the end of March 2013 to $78.2 billion at the end of March 2015. Investment trusts now represent around 13.5 per cent of the total net Australian and overseas assets in SMSFs.

Centuria unlisted property funds chief executive Jason Huljich says Centuria has seen a surge in inflows from SMSFs, with its latest unlisted trust comprising of 75 per cent SMSF investors compared to 40 per cent five years ago.

“When interest rates drop below five per cent we see a significant increase in demand,” says Mr Huljich.

Charter Hall has likewise seen a growing stream of SMSFs investing in its unlisted trusts.

“They’re looking to alternatives to term deposits so we’re seeing roughly about 60 per cent of our total inflows to our funds coming from SMSFs,” says head of direct property Richard Stacker.

SMSF Association director of technical and professional standards Graeme Colley says while investment trusts can invest in a range of different assets including fixed income and equities, property tends to be the most common type of investment, particularly in terms of SMSF investment.

“This is because [property trusts] give you access to markets that you may not be able to access yourself, like shopping centres and really big capital items, so you get a little bit of the cake by investing in those types of investments,” says Mr Colley.

There is little difference between an equity investment trust and regular managed equity funds these days, he says, mostly due to the introduction of mFund.

“With things like mFund you can trade your units in managed funds through mFund arrangements which are only relatively new which makes it more palatable to buy and sell via that, whereas in the past it’s been relatively inflexible trying to dispose of those units in those managed funds,” he says.

“Most people can certainly trade via real estate investment trusts via the market and it’ll be a t+3 sort of arrangement and [they’ve] really got the same thing with the managed funds so they’re pretty close to each other.”

Listed or unlisted?

Investment trusts are either listed or unlisted. Whether an SMSF trustee is better off investing in a listed or unlisted trust will largely depend on the client’s liquidity needs, what level of volatility they are willing to accept and what part of the cycle they are investing in.

Listed

Mr Colley says the main benefit of listed trusts is that SMSF trustees can buy and sell on the market, similar to shares.

“Listed investment trusts have that wonderful liquidity enabling you to sell it on the market for a price – it may not be the price you want but at least you can sell it for a price,” he says.

The other advantage of listed trusts, he says, relates to tax.

“The advantage of them is that the distributions from the trust are generally not subject to tax, they can be [in some cases] but you get the advantage of franking credits and capital gains tax, so for tax purposes it’s pretty seamless,” says Mr Colley.

The liquidity that comes with listed trusts can, however, have its disadvantages, according to Mr Stacker.

“What you’ll find with the listed property trust market is that because it’s sitting on an exchange, it generally has more volatility, upside and downside compared to the underlying value than what you’ll find in an unlisted market,” says Mr Stacker.

“The main reason is that the performance of the unlisted sector is only based on independent valuations, so the property value or what the asset is worth and the income that is produced, whereas the listed market may trade depending on what investors are willing to pay.”

Mr Stacker says there is also the risk within the listed space that investors could enter the market at a point in the cycle where the value of the assets in the trust are “significantly above the underlying value”.

“You may actually have greater risk of negative performance for that reason,” he says.

Unlisted

One of the key reasons for SMSF trustees investing in unlisted trusts is often the income return.

Mr Stacker says that generally around 75 per cent of the return from unlisted property trusts comes from income while the remaining 25 per cent will come from capital growth.

Underlying income, he says, tends to be linked to a certain percentage depending on the lease.

“For example, on a five-year lease, you may have three to four per cent increases in the underlying lease a tenant makes, so your income should be going up by that on an annual basis,” he says.

Returns from unlisted trusts also tend to have greater certainty, he adds.

“There is far less correlation to what’s happening in the equity market and over time there is far less volatility compared to the listed markets,” he says.

Mr Stacker said the illiquidity associated with unlisted trusts isn’t necessarily a negative since “investors won’t rush to the door if times get tough”.

Reasons to invest

Aside from the attraction of higher yields, Mr Colley says SMSF practitioners may recommend an investment trust to a client since it provides access to markets that SMSF trustees wouldn’t ordinarily be able to get.

“You can get into a whole range of different investments; you can get into overseas shares or fixed interest, you can pick particular segments of the market, the flexibility to be able to complement your portfolio,” he says.

While the performance of investment trusts will vary considerably depending on what assets the investment trust is invested in and what sectors, Mr Stacker says the performance of listed property trusts over the past three years has been strong.

“Last year across the sector, [the return] was over 20 per cent,” he says.

Mr Huljich adds that historically most listed trusts have a lower income return.

“If you look at the index it’s about 5.2 per cent, but they’ve had some very good [capital] growth over the last two years as well, so their returns have been around 20 per cent,” he said.

From unlisted trusts, Mr Huljich says, investors can usually receive an annual income of around 7 to 8.5 per cent per annum, which is generally paid quarterly.

“Over the last 16 years we’ve completed 25 unlisted funds and that’s been an average return over that long period of about just 13 per cent per annum, so that’s made up of the income and the capital gain,” he says.

What to consider

When investing in trusts, SMSF practitioners should ensure their clients are looking at a trust with a good track record and managers with experience over a considerable number of years, Mr Stacker says.

“The second thing to look at is the underlying sector they’re investing into,” he says.

For property trusts, the tenant and the length of the lease are other important aspects to think about.

“There’s institutional property and there’s non-institutional property and institutional property tends to be in the office, retail and industrial sectors so normally in those three sectors there’s more interest or people wanting to invest in those sectors, therefore there’s greater liquidity,” he says.

Mr Huljich says SMSF practitioners should also look at the buildings or assets themselves, whether they’re modern or requiring a refurbishment or repair and how well located they are.

“You want a manager that’s managed money and property through the cycles, not just through the good times. You want to see how they fared during the GFC and other recessions,” he says.

Mr Stacker adds that it is important to consider what exit strategy exists in relation to the trust.

“In terms of liquidity what practitioners need to consider is that if [the trust] doesn’t have that daily liquid element, then what is the exit?

“They need to be very clear that the exit is written in favour of investors.”

What are the pitfalls?

Mr Colley says SMSF trustees and practitioners also need to be cautious of some of the reporting from certain types of trust arrangements.

“I might have an SMSF and go into some of these very small listed trust arrangements and sometimes getting information out of the trustees of that trust about the performance of that trust can be relatively difficult, if not impossible,” he says.

“In those cases the auditors pull their hair out because they want the information and no matter how hard some people try they don’t get the information either in the right form or adequate information about the operation of that trust so that’s another risk with some of the unlisted trust arrangements.”

Mr Colley says this is particularly the case with smaller trusts.

While the risks associated with trusts are generally lower at the moment, there’s always the chance that markets could go the same way as they did during the global financial crisis.

“In the future we may get a heated market like we did around that time and fall into the same traps – well, not exactly the same traps but traps where liquidity becomes an issue and [the managers] are unable to manage the portfolio because of the distressed parts of the investments themselves,” he says.