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RBA warns on property and hybrid securities

In its bi-annual Financial Stability Review, the Reserve Bank of Australia has warned trustees of self-managed super funds (SMSFs) to be fully aware of the risks of investing in property and hybrid securities.

Changes to legislation in recent years have permitted superannuation funds, including SMSFs to borrow for investment, such as buying property. Since then, property holdings by SMSFs have increased and has been heavily promoted, which could lead to speculative demand – and a housing bubble.

What SMSF trustees need to understand is that in many cases, they are personally liable for making repayments on the property loan in the SMSF. Additionally, if there is a large downturn in the property market, not only will SMSFs be hit by falling asset values, but if they also hold shares in the banks, sliding bank share prices could deliver a double-whammy hit to their portfolio.

THE RBA has also warned SMSFs and retail investors to make sure they fully understand the risks embedded in complex hybrid securities. Many companies including ANZ Bank (ASX: ANZ), Commonwealth Bank (ASX: CBA), National Australia Bank (ASX: NAB) and Westpac Banking Corporation (ASX: WBC) have discovered that they could issue hybrid securities with potentially mis-leading returns, with buyers accepting most of the risk if anything should go wrong. For example, interest payments can be withheld, the issuers have a large degree of flexibility in buying them back and in some cases interest payable was lower than the return available on the normal shares.

The RBA also warns that banks are being forced to adapt to an environment where balance sheets grow more in line with borrower’s incomes and the economy. A return to the double-digit growth rates of the 1990s and 2000s is highly unlikely says the central bank. That could see the banks underperform other sectors of the economy over the longer term.

Foolish takeaway

If your SMSF holds bank shares and property as well as hybrid securities issued by the banks, your portfolio is not as diversified as you may think it is. A falling property market could affect all three asset classes, and cause major damage to your retirement plans.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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