Writing your SMSF investment strategy (including templates)

One of the many responsibilities of self-managed superannuation fund (SMSF) trustees is to compile and review an investment strategy for their fund.

The Australian Taxation Office (ATO) describes an investment strategy as “your plan for making, holding and realising assets consistent with your investment objectives and retirement goals”.

It should also set out why and how you’ve chosen to invest your retirement savings to meet the goals outlined in the strategy.

From time to time the ATO releases information about what it expects to see in an investment strategy. For example, it said recently that simply providing broad investment ranges of between 0 to 100% for each class of investment was not a valid approach and trustees needed to articulate how and why they intended to invest their super.

SMSF auditors have also increased their scrutiny of investment strategies in recent years, with a particular focus on the trustee’s obligation to regularly review these strategies.

What is an SMSF investment strategy?

An investment strategy needs to take into account the following:

• The risk involved in making investments and their likely return
• The overall composition of the fund’s investments and their diversification
• Liquidity of the investments, in respect of the cash flow requirements of the different members
• The ability of the fund to discharge its existing and prospective liabilities.

It also must show that it has considered the insurance requirements of members and taken out policies, where required, if insurance held outside super is inadequate.

“Your SMSF investment strategy should be in writing and be tailored and specific to your fund’s circumstances. It should not be a repeat of the legislation”, the ATO says.

It is not the same as a financial plan or a statement of advice. It is a document that shows the trustees of the fund have considered how the SMSF investments will be managed, as they are required to do so by law.

What to consider

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.

Trustees will want to consider their different approaches to risk and diversification. Asset allocation is an important consideration, but it is not legally required to be part of an investment strategy.

The investment strategy target for someone in accumulation phase may be as simple as “The fund will target a return above CPI (inflation) each year”.

When inflation is low, it is not uncommon for an investment strategy to include a target return of 3% above CPI.

However, where the CPI level is 7%, this would translate into a target return of 10% (7% plus 3%), which is a high and potentially unrealistic performance hurdle to attain. That’s one of the reasons why it is important to review an investment strategy annually or when major events happen. 

A brief description of an asset allocation strategy might begin with targets such as:

• Equities 0–60%
  • Australian equities 0–45%
  • Global equities 0–15%
• Fixed income and cash 0–25%
• Property 0–15%

But that is not sufficient. The ATO has updated its guidance to include:

It is essential that you consider the requirements, rules and restrictions that are set out in your SMSF trust deed when you are preparing and reviewing your investment strategy. There may be specific rules or restrictions on holding certain assets, like international investments. And if the fund is considering a limited recourse borrowing arrangement, the trust deed nust allow for that too.

An attractive feature for some trustees is their ability to hold a business property in their SMSF. But if it’s the only investment in your fund, your investment strategy will need to state how and why an illiquid investment meets the needs of the trustees, especially those in retirement phase.

Pensions are not the only cash flow issue that SMSF trustees need to consider. There will also be day-to-day expenses of the fund (such as auditor fees), tax requirements and potentially insurance premiums to pay.

The investment strategy of a trustee entering retirement, for example, might detail how that fund is considering selling down some illiquid assets and investing the proceeds in something more liquid, such as shares, to prepare for ongoing pension payment requirements.

More complex issues arise when trustees have different approaches to risk, such as a conservative approach for older members and a more growth-oriented approach for younger members. In these situations, the fund trustees must consider the investment needs of all the fund members. They may be required to adopt a segregated investment approach for different classes of members or take a more balanced approach overall.

What to do following a market correction

There are certain significant events that should prompt a review of your investment strategy. While these include the addition of a new member or a member starting a pension, the ATO also classifies a market correction as a significant event.

Market volatility and a market correction shouldn’t create panic, or a complete switch from equities into cash, but it does warrant consideration of asset allocations and the growth (equities, property, alternatives) versus defensive (cash and fixed income) split in a portfolio.

If, for example, a fall in your fund’s balance reveals your growth allocation was much higher than you realised, you might decide to reduce the asset allocation target for equities in your investment strategy.

Considering insurance

A further component of an SMSF investment strategy is the requirement for the trustees to consider the insurance needs of members. Although many trustees simply provide a statement that they have considered the insurance needs of the members and decided it is not necessary, it is probably more appropriate to provide additional supporting statements or documents detailing why this is the case. This can then be referenced if the initial statement is ever questioned.

How do I create an SMSF investment strategy document?