Vanguard's thoughts on SMSFs borrowing

The most complete summary of the new rules is in our Dollar Notes section of www.mcmasters.com.au.

But Vanguard's thoughts on the matter are worth noting too"


Super changes open the gearing door by Robin Bowerman*



Gearing is one of investing's visceral pleasures. When it is good it is very good. When it turns bad it can be catastrophic.

For super funds gearing has been an investment approach that has been strictly off limits but a recent change to the law means that may be about to change and the ramifications of it for individuals running their own self-managed super funds could be dramatic.

Given the impact of the June 30 changes you might have thought a period of regulatory calm to allow investors, fund administrators and advisers to catch their breath was to be expected.

But the change to the law to ratify the use of instalment warrants in super funds has - if the legal experts in the industry are correct - opened a much wider door than simply applying to instalment warrants.

The background to this is that instalment warrants initially were thought to be allowable investments for a super fund then the tax office came to the view that a warrant did represent a borrowing and therefore was not allowable. But by then warrants had become such common instruments both within SMSFs and larger super funds that the tax office sought to have the law changed to reflect market reality.

That has now been done and the new laws took effect from September 24.

The changes do not mean a super fund has open season to go out and start borrowing against fund assets. But according to the managing director of Smart Super, Andrew Bloore, it is now possible for a super fund to invest through a specific type of trust known as a debt instrument trust - a vehicle that facilitates the instalment warrant.

For people not familiar with instalment warrants the best real-world example was the Telstra share float where investors paid an initial amount and with the second instalment paid later to complete the share purchase.

So by investing through an instalment warrant structure it means super funds may be able to gear any of the usual investments a super fund can buy. Andrew Bloore gives the example where a SMSF has $500,000 in cash, a matching $500,000 is borrowed from a lender and the debt instrument trust then buys the investment - perhaps a residential property for example. The super fund receives all the rental income and gains.

This may sound relatively straightforward but Bloore warns that it will be critical for the proper procedures and process to be followed otherwise the loan could be deemed a "non-excepted borrowing" which makes the entire fund non-complying.
Also the usual restrictions around related parties still apply.

Any change like this should come with big health warnings. First it may take some time for the market to understand where the boundaries are in terms of product's designed for super funds. Inevitably there will be product promoters who will abuse the intent of the change and potentially force a rethink within the tax office and government if they see revenue impacts they were not intending.

So being patient, take the time to educate yourself on the changes and letting the market test and draw the boundaries seems a sensible approach. Getting strong technical and legal advice will clearly be critical and after all that you will get back to the original question - is gearing a good idea?

These changes seem to clear the way for super funds to use gearing. But just because you can do something doesn't make it a good idea.

* Robin Bowerman is Head of Retail at index fund manager Vanguard Investments Australia. To receive this column by email each week go to www.vanguard.com.au and register with smart investing.