What are ETFs?
An ETF (Exchange Traded Fund) is a type of fund traded on the market which can give you exposure to a wide range of assets in a single trade. Like shares, ETFs can be sold and bought through your stockbroker.
ETFs offer a wide range of market and other asset classes, including the ASX 200 Index (referred to as QOZ or SFY), a segment of the market (e.g. small caps, large growth stocks), sectors (e.g. financial, retail), or foreign countries (e.g. Hong Kong, Singapore). ETFs can also represent holdings in commodities such as gold, oil or wheat.
More SMSFs are using ETFs
In 2012, a survey on the financial needs and concerns of SMSF Members conducted by the SMSF Professionals’ Association of Australia (SPAA) and Vanguard Australia showed that 43 percent of Trustees either owned ETFs or were considering investing in them in the future. Whilst 20 percent of participants had no knowledge of ETF products, the remaining 37 percent said that ETFs were not good investments because they were too complex, too risky or lacked transparency.
Tax Treatment
ETFs are structured as unit trusts which means the types of income earned by the trust may be split across different categories when they are distributed to SMSFs. Each ETF may earn different types of income, for example dividends, realized capital gains or interest. Also, the income may be Australian or foreign.
The income components of an EFT distribution will be shown in the Annual Tax Statement posted to the SMSF or available to download from the registry website associated with each particular ETF. When performing the accounting process for your SMSF, we rely on the Trustee to provide us with the Annual Tax Statement to record the distribution components. Please see a sample annual tax statement here:
Reasons for SMSFs increasing their exposure to ETFs
People with SMSFs are arguably the most self-directed and engaged investors in the superannuation industry, so what value are they seeing in ETF investments and how are they using ETFs to achieve their objectives?
These benefits align very well with the key benefits ETFs can bring to an investment portfolio:
- Liquidity: ETFs can be easily bought and sold on the ASX through a broker, just like shares.
- Diversification: ETFs offer a wide range of markets for you to invest in. This includes international and Australian shares, fixed income and property, or commodities.
- The opportunity to quickly, easily, and cost-effectively re-balance a portfolio to align with target asset allocations.
- Tax efficiencies can be achieved because ETFs typically will have a low turnover of underlying holdings, which minimizes the capital gains distribution impact over the long term.
- Cost-effective exposure compared to purchasing shares individually. Also, EFT fees are significantly lower than actively managed funds.
- Portfolio transparency: ETFs provide transparency by listing their holdings and the weighting of the holdings to allow investors to know exactly what they are buying and holding.
Risk involved when investing in ETFs
Like other investments, ETFs carry market risk, which means that the market or segment of the market that is invested in could take a downward turn and not provide the return you expected. Trustees should always keep in mind that a better return may expose the SMSF to higher risk.
To find out more about Exchange Traded Funds, visit the ASX website by clicking here.
An SMSF can invest in ETFs on the proviso this is allowed by the Deed and the Investment Strategy.
