A question of leverage

While the rules apply across the entire spectrum of superannuation funds, the focus has naturally centred on SMSFs because of the use of limited recourse borrowing arrangements (LRBAs).

Leverage is a hotly debated issue, and if you got a room full of accountants, financial planners and stockbrokers together you would get the full spectrum of arguments for and against.

The reason why this debate is heating up comes from two quite different directions.

The Financial System Inquiry has a very broad mandate to consider how the financial system can be positioned to best meet Australia's evolving needs and support its growth. The subtext is to consider how well the Australian system would cope with the next global financial crisis.

From that very macro-level, the appeal of having a large, unleveraged pool of savings is clear. If the super system had been highly leveraged at the time of the GFC then the losses would have been magnified dramatically.

Because it was largely unleveraged, the super sector had a stabilising influence on the financial system during the depths of the global crisis and, according to the Financial System Inquiry interim report, also provided valuable equity funding to the banking system in 2009.

The concern the Financial System Inquiry is raising is that while there was a general prohibition on leverage within super when the system was initially set up, it has been incrementally changed, initially to legitimise the use of instalment warrants in 2007, with further changes in 2010 to clarify borrowing arrangements.

"The ability of funds to borrow may, over time, erode this strength and could contribute to systemic risks to the financial system," the Financial System Inquiry interim report says.

Any number of professional financial advisers will argue that leverage is a legitimate approach to building wealth over the longer term, provided it is done in a considered way with a clear understanding of the risks involved.

No argument there, but what about the situation where the advice given to borrow via an SMSF is far from professional – where the 'advice' is little more than a property developer's sales spiel using an SMSF as a convenient tax structure?

So there are two quite different levels of concern: the high-level system review concerned about the long-term growth in leverage undermining system stability versus the risk that individuals will be poorly advised and end up with an inappropriate property investment in an SMSF structure they may not need.

Professional, well-qualified advisers in the SMSF sector will understandably rail against the fringe players that are driving much of the media commentary on super fund borrowings.

But it may be that the Financial System Inquiry big-picture question can answer both questions.

Robin Bowerman, principal of market strategy and communications, Vanguard Australia
Robin Bowerman is a member of Vanguard's executive team and plays a pivotal role in Vanguard's market and product strategy development. He is a key spokesperson and presenter for Vanguard, with expertise in investor education, funds management, product development, industry and regulatory-related topics.

He writes a weekly column with more than 50,000 readers. prior to joining Vanguard, he was a leading financial services writer, communicator and editor for over 15 years.