SMSFs have been particularly hard hit as there is a reliance on dividend payments to fund pension payments to members. Traditionally, this has left little motivation for SMSF trustees to look outside of Australian equities to find a consistent return on their investment.

It is well known that SMSFs hold a large proportion of their assets in Australian equities and cash, which includes term deposits. The most recent data released by the Australian Taxation Office (ATO) shows, on average, SMSFs hold over 50 per cent of their assets between these two asset classes. 

The investor’s big four headache

Australia’s big four banks all rank in the top six listed shares held by SMSFs, based on data shared by Class Super last year.

With falling interest rates being the focus for SMSFs in 2018 and 2019, many were already feeling the pinch to their cash flows, and with record-low interest rates set to continue and a new set of challenges resulting from COVID-19, the pain for SMSFs is far from abating.

In early April, APRA began putting pressure on banks to reduce their dividends in order to firm up their capital positions until the full impact of COVID-19 could be quantified. This is prudent for the company’s balance sheet but will negatively impact SMSFs reliant on dividends for income.

Late last month, NAB released its half-year results and announced a $3.5 billion capital raising ahead of an expected spike in credit losses. It cut its dividend by 64 per cent.

ANZ and Westpac followed suit this week, citing COVID-19 as a primary reason for deferring a decision on first-half dividend. Other companies, particularly in hard-hit industries like airlines, hospitality and tourism, will likely follow the banks’ response.

While we have faith the big four banks can ride out the short- to medium-term impact to profits, the resulting reduction in dividends is a burden investors are going to have to carry.

Investors seek diversification to counter dividend loss

Those SMSFs in retirement phase who are on a zero tax rate will lose the most, given the benefits of franking credits, and those who are required to withdraw to meet annual pension payments may now need to sell bank shares at a low price to ensure they have enough cash to meet the requirements.

The government’s temporary halving of pension minimums will likely go some way to reduce the pressure on SMSF cash flows, but will it be enough? For members who rely on this income to fund their day-to-day living expenses, it may provide minimal help.

It is no surprise then that SMSFs are looking to alternatives to support their weakening cash-flow positions.

What we are seeing

At Citi, we have noticed an increase in SMSFs wanting to lock in returns and reduce risk. Current market volatility and uncertainty is driving a renewed focus on income options like corporate bonds and tailored investments that can give investors access to equities in a structure that can reduce risk, and which provides an agreed rate of income upfront.

The benefits of investing in fixed income for our SMSF clients is two-fold.

Fixed income tends to be more resilient during times of market volatility. Adding fixed income to an equity portfolio using bonds can have a dramatic effect in reducing volatility in portfolio returns, without overly hindering performance.

It is also a source of reliable income with coupon payments guaranteed by the issuer upfront and paid regularly, assuming the company does not default. For the 47 per cent of SMSFs paying a retirement income stream to members, this certainty provides some confidence that cash-flow requirements will be met in times of stress.

Leonie Di Lorenzo, SMSF technical specialist, Citi