A SMSF is required under the Superannuation Industry (Supervision) Act 1993, “to formulate, review regularly and give effect to an investment strategy.”
Depending on the make-up of the SMSF, and the ages of the different members, there will be different factors to consider. An SMSF with one member in accumulation stage, for example, will have a very different investment strategy to one that has two members, one in late accumulation stage, and the other in early retirement.
An investment strategy needs to take account of the following factors:
Diversification
Diversification relates to a consideration about the spread of different investments you might have, or thinking about ensuring you don’t end up with all your eggs in one basket. However, there isn’t a requirement that a SMSF’s investments must be diversified, and there are some SMSFs that have large investments in a single asset (or asset class). Most commonly this occurs where the SMSF has a direct property investment, with a comparatively smaller investment in cash in order to make any relevant payments as necessary.
The ATO is in the process of contacting about 17,700 SMSF trustees and their auditors where their records indicate the SMSF may be holding 90% or more of its funds in one asset or a single asset class. The ATO are concerned that some trustees haven't given due consideration to diversifying their fund’s investments and this can put the fund’s assets at risk.
The ATO will ask trustees to review their investment strategy and clearly document the reasons behind the investment decisions.
Risk and return
The risk involved with, and the likely return from, the investments are also important considerations, and ties back into the issue of diversification of investments.
What can sound like an exciting possible return on any particular investment, should always be balanced against a consideration of any risks involved with that investment. The difficulty is that both risk and return are assessments of what may happen in the future. It’s important to remember that while it can be useful having historical data available, this reflects past performance and is not necessarily reflective of how the investment will perform in the future.
Trustees should not look at any investment in isolation, and always compare their performance against peers and over multiple periods of time. For example, whilst a share fund that provided an 8% return in the last 12 months might sound relatively good, it’s not if all other comparable share funds were returning in excess of 10%.
In addition to pure investment risk, you need to consider how much risk the members of the SMSF are willing to take on. The answer may be different for each member of the fund, so you also need to think about whether each member has their own investment portfolio in the fund, or whether everything is pooled together.
Liquidity
Trustees need to ensure that the SMSF is able to pay its liabilities as and when they fall due. Doing this for the ongoing running costs of your fund, sounds relatively easy. But you can’t forget about the additional liquidity required as members of the fund approach retirement and start to draw on a pension from the fund.
Insurance
Trustees are also required to consider the insurance needs of members. This doesn’t mean that the fund has to hold insurance for the members, but this is actually an important consideration. Given that the trustees of an SMSF are also the members, this is about considering whether you have enough insurance of your own, and if not, should you acquire more coverage through your super. But don’t constrain yourself to personal insurance considerations, even though that’s all that’s technically required. Depending on the type of investments in your SMSF, you should also consider if you need the fund to take out other types of insurance. This could be a vitally important consideration if you hold property.
Documentation
Its preferable to document the investment strategy. The actual document can be long or short, but you need to show you have considered the above elements. Most good investment strategies will have two key positions within them.
- An overall goal that the investments of the fund are trying to deliver. For example, the fund could be targeting an overall return 2% above Consumer Price Index on a 5 year rolling basis.
- Second, its sets out acceptable investment parameters. For example, it may say the fund is happy to hold between 30% and 60% of its investments in Australian shares, but is targeting a holding of 45%.
These elements taken together give the trustees something to measure performance against. If the SMSF isn’t meeting these objectives, or its investments fall outside of the expressed permitted range, then the trustees need to be doing something to bring it back in line.
