Foreign investment could pose risks for SMSFs in pension phase, warns expert

There has traditionally been a “home bias” when it comes to investing in shares but the opening of global markets and technological advances to allow Australian investors to do so has seen a shift to looking overseas when deciding on an investment strategy.

“This home bias is starting to change with the globalisation of investment markets and the ability for SMSFs to access more international sharemarkets via managed funds and ETFs,” Mr Smythe said.

There are three major reasons, however, that funds, especially those in the retirement phase, should consider carefully before looking internationally for investment options.

“The first thing is the currency exchange should be taken into account. If the currency goes against you it will affect the return of investment,” Mr Smythe said.

“A lot of people just look at returns and not think about currency and if you buy individual shares it is too hard to have a fully hedged position.”

The second issue is the return dynamics of international investment and in Australia this includes franking credits and a higher proportion of dividend incomes.

“In pension phase you rely on dividends to fund living expenses and if you are overexposed to international markets your dividend will reduce and franking credits disappear,” Mr Smythe said

“If your SMSF is fully in pension, then the refund of excess franking credits can materially add to the investment return of your fund. The performance of Australian and international shares is often compared without including the impact of franking credits, so care needs to be taken here particularly for those in pension mode.”

Finally, Mr Smythe said trustees should also consider the administration complexity and additional costs incurred in holding international shares.

“The US does not recognise SMSFs, it is only used to dealing with companies and trusts so trying to explain who the holder of the investment is and why it should not be taxed can be very cumbersome,” he said.

“This does cause issues and typically fund managers will pass it on to clients to fix, so if you invest in Google, Apple or Microsoft for instance, they will write to the SMSF trustee to deal with the administration issues.”

He added the unique nature of SMSFs, and the individual reporting requirements of an annual return and audit, is also a relevant consideration.

“The administration pain of holding individual international shares is not to be sneezed at, together with the likely higher accounting and administration fees,” he said.

Mr Smythe said with the growth of younger people establishing SMSFs there is increasing interest in international markets primarily because it is dominated by tech companies, in comparison to the ASX which is still very much centred around mining and banking stocks.

“Younger SMSF members want to take a more active approach to their investment strategy and have a big interest in the tech space,” he said.

He added that although there are some considerations over international investment in pension phase, funds in accumulation phase don’t face the same challenges.

“In accumulation phase, the fund can ride out those issues in the long term. It’s only in pension phase that it can be more detrimental,” he said.