Having a future-proof investment strategy is not only legally compulsory, but also one of the best ways to enhance retirement savings. Amid volatile markets, how can self-managed super funds get the right settings in place? Recent market volatility suggests a review of investment strategy is advisable, particularly ahead of the approaching new financial year. The Australian Taxation Office says the strategy must be reviewed at least annually, and when “significant events” occur including a market correction. The strategy should be in writing and must be tailored to the specific circumstances of each fund, “rather than a document which just repeats the words in the legislation,” the ATO says. Relevant circumstances include member ages, employment and retirement goals, including risk appetite, with the strategy required to explain how investments meet each member’s objectives.

What to keep in mind

Key factors to consider include:

• Risks and likely returns from the fund’s investments regarding its objectives and cash flow needs
• Composition of the fund’s investments, including the extent of diversification
• Liquidity of the fund’s assets
• The fund’s ability to pay benefits when members retire, as well as other costs
• Insurance cover for members—while not essential, it must be considered.

The ATO says it is not enough just to specify investment ranges of zero to 100 per cent for each class of investment. Instead, the strategy should state how the percentage or dollar allocation in each class supports stated retirement goals. For example, a balanced SMSF could construct a portfolio targeting a return 2 to 3 per cent above inflation. The growth allocation could include:

• Australian equities (10 to 25 per cent)
• property (5 to 10 per cent)
• and international equities (10 to 25 per cent)

The defensive allocation might comprise:

• domestic fixed interest (15 to 25 per cent)
• international fixed interest (15 to 25 per cent)
• and cash (3 to 10 per cent)

SMSF investments are restricted to those permitted by the fund’s trust deed and must meet the sole purpose test as well as abiding by the super laws, such as related party rules. The ATO’s preference is for a diversified range of assets which minimise investment risk, since having the bulk of retirement savings in a single asset or asset class (whether property or equities) can result in “concentration” risk as well as liquidity risk. For example, a single asset SMSF with a business property would not be the desired strategy for a retiree paying a pension, while blue chip stocks have lower liquidity risk than small-cap stocks or residential property. It is important to document how cash flow and liquidity risk will be managed, should dividends be lowered or tenants vacate an investment property. The strategy is also required for the fund’s annual audit, with the auditor required to determine whether the fund has delivered on its investment strategy. Should the worst case scenario occur and the auditor lodge an auditor contravention report, penalties of up to $4,200 can be applied on each individual or corporate trustee for breaching strategy requirements. Fortunately, SMSFs needing assistance with their investment strategy can seek help from an SMSF adviser or licensed financial adviser. Although standard templates are available, the ATO warns that they must be tailored to each fund’s circumstances.

Increased scrutiny

The ATO has increased its compliance activity recently regarding SMSF investment strategy, amid concerns of a lack of diversification and an overreliance on basic templates. In 2019, letters were sent to nearly 18,000 trustees asking whether their investment strategy satisfied diversification requirements. The ATO also warned certain trustees regarding property investments, particularly where the property was purchased under a limited recourse borrowing arrangement. In February 2020, the ATO followed up with further guidance, stating that the investment strategy needed to be tailored and specific to fund circumstances. These moves may have served as a wake-up call to trustees and auditors, according to SMSF specialist adviser Liam Shorte. “Auditors are now scrutinising the SMSF investment strategy in greater detail, whereas previously it was often a template left with blank spaces and just signed off by trustees without consideration,” says Shorte, director at Verante Financial Planning. “As an adviser I find it a great and simple tool for highlighting to trustees their duties to consider liquidity, risk and diversification. Often many trustees get caught up on one type of asset or sector that they are knowledgeable or interested in and fail to consider the true risk and need for diversification. “The SMSF investment strategy ensures they look at the broader picture to ensure they think about and put in place a well-reasoned and researched portfolio for their fund and if they are focusing on one asset or sector that they address the pros and cons of doing so and the additional risk that raises.” Shorte adds: “Because of past attitudes to the document it is a steep learning curve for many trustees, and they get a jolt when the auditor who has often been the fund’s auditor for many years suddenly asks for a much more in-depth investment strategy. “However, the ATO has now given clear guidelines on what is expected to be considered and included and that forms the new baseline for the strategies. Anything that encourages trustees to be more considered in their investment decisions is a positive move. “Nothing is locked in and if the trustees wish to explore other investment opportunities not covered in their current strategy they can simply meet and review the strategy and alter it to accommodate the new investment, but at least they are reminded to consider the new investment in terms or risks, diversification, liquidity needs and ability to pay benefits as well as any need to review insurances on them personally or the proposed assets.” With stock market volatility seemingly set to continue, reviewing investment strategy could prove worthwhile for trustees, particularly as rising bond yields spark fears of a broader market correction.