Building a value share strategy for your SMSF

You need to have a solid strategy and find value stocks. Share Analysis already helps thousands of SMSF investors.

In March 2013, the ATO received over 500 applications for new SMSFs on one day. There will soon be over half a million SMSFs in Australia, as people take advantage of the flexibility that managing their own retirement funds gives them. But there are also pitfalls when you take control of your post-work funds.

A value investment strategy

Every SMSF must have an investment strategy, and you may already have created one, perhaps with advice. But does it give you the best possible chance of retiring with enough? How can you become the kind of expert you need to be, in a reasonable amount of time?

One way is to find the right tools. Think about the share portfolio in your SMSF. How do you know it contains the best value stocks for your future? There are a lot of share analysis tools on the market, but many are aimed at professional investors, day traders and the like – people who likely have much shorter term goals than SMSF investors.

Value stocks for the long term

When you are investing for the long term, you need to find value stocks – “outstanding companies at sensible prices”, as described by Warren Buffett, perhaps the planet’s most famous value investor. His principle of buy and hold minimises transaction costs and aims at long term returns. Buying stocks with strong assets and business models is also generally safer than betting on growth. And with your retirement on the line, safety is a prime consideration.

Stock research tools

But if you are researching with tools designed for the day traders and short term investors, you won’t easily find the long term prospects that you need. Look for tools that focus on value investing, seeking the ‘buy and hold’ stocks that will build value for your SMSF over a longer time horizon.

The online brokers promote their free and paid tools very heavily, but many of these are hard to use. Look for tools with easy-to-use interfaces, so you can see at a glance which companies fulfil your specifications. Comparing prospective investments side by side, using metrics appropriate for their industry, can help you decide what to avoid and what to buy.

If you are investing in international companies, look for tools that include global companies and are regularly updated. Keeping all your domestic and international stock information in one application makes it easier to manage a geographically diversified portfolio.

Mobile access is also growing in importance. Make sure your stock research tool has a mobile app so you can keep up to date when you are out and about. Most tools also provide alerts via SMS or email so that you don’t miss opportunities.

Making it easy to invest

Stock markets produce a flood of information and even the canniest investor needs ways to filter, sort, tabulate, compare and evaluate it without sifting through long analysis documents or columns of confusing figures. The best tools provide information in easy-to-read graphics and visualisations, so that daily information flow is condensed into clear visuals and concise company profiles. That way, you can discover quality companies and manage your share portfolio confidently.

How to build your SMSF share portfolio

Striking the right balance between income and capital growth-producing assets is essential.

Running a self-managed super fund (SMSF) should not mean shelling out thousands of dollars each year for expensive managed funds, platforms and strategic advice, or accepting mediocre returns.

It’s a matter of knowing how to bypass expensive managed funds and financial advisors by investing directly in shares.

Investing for income or growth?

Striking the right balance between income and capital growth-producing assets is essential.

Maximising capital growth will be your first concern if you are decades away from retirement. Sound income-producing investmentsobviously become more important if you are in pension phase and need to be able make the minimum annual pension drawdowns to ensure your SMSF stays compliant. However, some capital growth is necessary, even in pension phase, to ensure investments can keep delivering the desired income and stay ahead of inflation.

Share portfolios of Australian SMSFs

Australian SMSF investors love shares. ATO statistics indicate that 30 per cent of the $500 billion invested via SMSFs is in shares, most of it in Australian shares.

The share portfolio of SMSF investors also tend to be overweight in the resource companies and banks that dominate the local bourse and significantly underweight in sectors such as healthcare, technology, luxury goods and consumables – which are easier to find in overseas markets.

SMSFs wising up to value investing

Short-term trading within an SMSF contradicts the core reason for investing in super, and also drives up transaction costs.

Increasing numbers of SMSF members are “wising up” about how to find value in both the Australian and overseas equities markets.

Share Analysis has developed a stock selection system based on the theory of “value investing” as espoused by Berkshire Hathaway chairman Warren Buffett.

The aim is to buy stocks at prices lower than their “intrinsic value”.

The value investing philosophy is based on the principle that all great-quality companies display similar distinguishing characteristics, which contribute to that “intrinsic value”.

Share Analysis’s automated process of rating and valuing stocks uses filters based around five distinguishing characteristics of top stocks:

• Good management with a proven track record of delivering value for shareholders.

• Return on equity greater than 15 per cent.

• A net debt to equity ratio of less than 40 per cent.

• Strong earnings per share growth.

• Positive future intrinsic value growth.

The greatest advantage of following a long-term value investing approach when building the share component of your SMSF portfolio is that it is cheap and relatively low-maintenance.

Building your SMSF share portfolio

Depending on how many stocks you want in your portfolio (most analysts say 20 to 30 is optimal), you can build an excellent portfolio of top value domestic stocks with as little as $50,000. You will need $100,000 if you want to invest offshore.

$5000 in each of 10 stocks is quite a decent domestic portfolio, however with more funds it is worth diversifying your SMSF share portfolio into overseas markets.

Direct overseas share investing, if you have a long-term time frame, is becoming much cheaper and easier than it used to be. Most of the major online brokers all offer online trading facilities for the major offshore markets and you can expect to pay from $50 per trade for brokerage. You no longer need to rely on expensive managed vehicles to gain your overseas equity exposure.

If you take a long-term investment time frame you also don’t need to worry about the cost of hedging against currency risk.

If you are investing in an SMSF you may well have a 20- to 25-year time frame. During that time the currency is going to jump all around. Think about your US stocks as a US dollar portfolio, for example, and then when it is time to sell, that’s when you need to think about the optimum time to bring your funds back into Australian dollars.

Focus on growth stocks to secure outperformance

Unless your SMSF is in pension phase, your focus should be on stocks primed for growth. Don’t fall victim to the common mistake of placing too much emphasis on high dividends and franking credits at the expense of getting better investment outcomes.

If you invest in a profitable business that’s making a 15 per cent return on investment as measured by return on equity, if it pays out a high dividend and gives it to you, you will put it in a bank account and earn 2 per cent. If those earnings were kept by the company and reinvested in the business a further 15 per cent could have been generated, so you as an investor and owner are better off leaving it to the managers to invest the profits.

Cash and Aussie shares: are they right for your SMSF?

Don’t get caught up in the hype and misconceptions.

When it comes to running your own SMSF, some people would have you believe it’s only for the super wealthy or ultra brainy. Nothing could be further from the truth.

According to Australia’s premier body for SMSF investors, the SMSF Association, here are the most common myths and misconceptions about SMSFs that you should regularly question and discuss with your SMSF advisor:

1. SMSFs only invest in cash and Australian shares

2. SMSFs are for rich, older people

3. SMSFs are all using gearing to invest in property

4. SMSFs have tax advantages over other super funds

To download the SMSF Association’s latest Trustee document click here.

About The SMSF Association

The SMSF Association exists to improve the quality of advisors, the knowledge of trustees and the credibility and health of the vibrant SMSF community.

As part of their commitment to improving the knowledge of trustees they create complimentary information documents for Trustees discussing common misconceptions around SMSFs. Click here to view the latest document.