The fallout for shareholders from the Banking Royal Commission

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The initial findings of the Hayne Royal Commission have comprehensively demonstrated that many assumptions about Australia’s banking and financial services industry have, for a couple of decades, been fatally flawed. Now, SMSF investors need to assess how this might affect them.

The wash-up

We have seen clear evidence that self-regulation does not work; that competitive pressures are ineffectual when there is an effective oligopoly; that consumers are ill-served by “advisers” who have been turned into salesmen by chasing commissions; and that the whole system has been badly wounded by regulators not up to the task of protecting consumers.

Australia’s financial industries will now see a major makeover, a decade after the Global Financial Crisis. There are plenty of areas where reforms are likely; their impact on the economy and investors may depend partly on the attitude of which government is in power from 2019. Realistically, investors should be listening as much to Bill Shorten and Chris Bowen as to Scott Morrison and Josh Frydenberg.

However, for subscribers to the Switzer Report, the inquiry has justified the decision by thousands of investors to run their own self-managed super fund and has turned a spotlight on retail super funds, which are now losing investment flows to the not-for-profit funds (which the Coalition has long hated).

SMSFs triumph

Effects from the Hayne report also coincide with a major structural change in the super landscape. The not-for-profit industry funds’ assets have surpassed the bank-owned and retail funds. Even more significantly, do-it-yourself SMSFs are now the largest single sector. (At June 30 this year, ATO-regulated self-managed funds had reached $750 billion, against $631 billion in industry funds and $602 billion in retail funds.) It looks like individuality and the non-profit motive have triumphed over the past financial sector model.

The banking, financial and superannuation industry will have to wait for the formal, final report, but the initial report already has exposed widespread wrong-doing and likely breaches of the law, which may trigger major reforms. While the super industry is probably large enough to weather the worst revelations, some major, for-profit players are unlikely to recover their former reputations and status (and the banks are looking to exit their wealth and super operations).

Now SMSF investors’ future will depend even more on their investment decisions, especially for those seeking to maximise their income. SMSF investors will need to focus on what it means for their investment policies which, in many cases, have been heavily weighted towards banking and financial services shares. Given the declines in these shares, it’s probably too late for any drastic selling, while buying, at the moment, may be only for the bravest investors.

Major holdings

Banks not only represent a major part of the economy but many SMSF investors also rely on their higher than average share yields. The key question is whether current bank yields are sustainable.

SMSF investors face a similar dilemma to high-yielding property trusts during the GFC, in that they may need to balance a current desire for higher yield against likely capital losses. Banking shares might prove more resilient than property trusts did earlier – but that assumes no further catastrophic conditions.

Even now, investors will need to consider another change – upward pressure from US bond yields. At this stage no one can be sure of the length and severity of rising interest rates. As always, the key will be timing. For investors who hold onto their bank shares, there may be plenty of uncertainty – even anxiety – before this is resolved.

Defensive leanings

While current bank share yields, currently between 6% to 7%, might look enough to compensate for coming uncertainty, it might be prudent for SMSF investors to increase their defensive holdings of cash – no matter the low current yields – and consider some diversification into alternative forms of fixed income, however sparse these may be.

And, with the US share market starting to look expensive and with potential trade wars and American mid-term elections looming, investors then may need to be prepared to hold their nerve for some time.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.


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