How to create an SMSF investment strategy (including examples)

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.

A person in accumulation stage’s investment strategy target may be as simple as:

• The fund will target a return of 3% above CPI each year.

A brief description of an asset allocation strategy such as the below could follow:

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

SMSF trust deeds also need to allow for the fund to make international investments. And if the fund is considering a limited recourse borrowing arrangement, the trust deed needs to allow for that too.

An attractive feature for some trustees of SMSFs is their ability to hold a business property, but if it is the only investment in their SMSF, their investment strategy will need to state how and why an illiquid investment meets the needs of the trustees. A single asset SMSF with a business property would not be the desired investment strategy of a retiree paying a pension, for example.

Pensions are not the only cash flow issue that SMSF trustees need to give consideration to. There will also be day-to-day expenses of the fund – such as auditor fees etc., tax requirements and potentially insurance premiums to pay for the fund’s trustees.

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

More complex issues arise when different trustees want to have different approaches to risk, such as a conservative approach for older members and a more growth-oriented approach for younger members.

For example, John and Jane are both 55 and trustees of an SMSF of which their two daughters, Sally (26) and Sandra (28) are also members. Understandably, the older couple have a more conservative approach to investments, whereas the daughters have a slightly more aggressive approach.

However, unless the assets have been segregated into accumulation and pension purposes (which would only happen upon the retirement of either or both John and Jane) the investment strategy would have to incorporate both their approaches to risk and combine that in a more “balanced” asset allocation of all the assets in the fund. The fund would not be able to have two separate investment strategies for accumulation funds.

Considering insurance

A newer requirement of an SMSF investment strategy is the requirement to consider insurance. Although a simple statement that the trustees have considered it and decided it is not necessary is probably sufficient, documents supporting why this is the case will offer more legal support if the initial statement is ever questioned.

“It should be backed up with documents justifying why that’s the case,” Graeme Colley, executive manager, SMSF technical and private wealth at SuperConcepts says.

“If it’s not truly considered you may get other parties come in and say the trustees haven’t truly considered [insurance] because we ended up with all these liabilities.”

How do I create an SMSF investment strategy document?

An SMSF investment strategy needs to be a document that sufficiently covers the five things it is required to acknowledge. It can be a one-page document in word written up by the trustees. Many SMSF platform providers have templates, as do advisers. Depending on how complex your SMSF is, shorter may be better.

“You can certainly draw one up for yourself. Provided you’ve considered each of those aspects and you’ve got reasons why you’ve gone ahead as you have there’s no reason why yours is better or worse than an adviser’s,” Colley says.

Example 1

Here is a simple example.

Smith SMSF Investment Strategy

The following document details the investment strategy of Smith SMSF.

The members of the fund are John Smith (aged 48) and Jane Smith (aged 42). Both members of the fund are in accumulation stage and the fund has combined assets (as at 1 January 2019) of $505,000.

OBJECTIVES

The fund will target an annual return of CPI (currently 1.9 per cent) plus 3 per cent per annum.

The overall composition of the fund’s assets and their diversification will be given appropriate consideration. When doing so, members’ assets held outside of the SMSF will also be taken into consideration.

The fund can invest in equities (both Australian and global), fixed income and cash and property.

The fund may, depending on the opportunity, consider alternative-type investments for a small portion of the balance, or derivatives. When investing in derivatives a derivative risk statement outlining the expertise of the trustee will be attached.

After consideration of the expected risk and return of investments, appropriate diversification, the liquidity of certain investments with regard to the fund’s expected cash flow requirements and the fund’s ability to discharge its liabilities, the trustees have agreed on the following asset allocation targets.

• Equities 0 – 70%
  • Australian 0 – 60%
  • Global 0 – 20%
• Cash or fixed income 0 – 20%
• Property 10%
  • Listed property trusts 5%
  • Unlisted property trusts 5%
• Alternatives 0 – 5%

If, due to significant market movements, any asset class becomes over allocated, the trustees will rebalance the portfolio at the earliest opportunity or the next trustee meeting, whichever occurs first.

POLICIES

The kind of investment vehicle chosen for an asset class e.g. managed fund, direct investment, exchange-traded fund (ETF) etc, will be at the discretion of the trustees.

The fund will be sufficiently diversified across asset classes and where investing directly in an asset class, such as equities, will invest in between 10 to 20 equities.

The fund has no intention of investing in real property at this stage.

A sufficient liquid balance will be maintained to meet regular cash-flow requirements of administration expenses and tax. As the members are in accumulation mode (and will be for some time), there are no current requirements for member benefits to be made. When one, or both of the members, reach retirement or passes away, member benefits and liquidity will be considered as required.

This document will be reviewed annually in June and reviews will be minuted.

INSURANCE

The insurance requirements of the members have been considered to be adequate without taking out a contract of insurance within Smith SMSF with respect to one or more members of the fund.

In reaching this conclusion the following factors were considered:

• The current insurance levels held by members outside the fund (including within other non-SMSF superannuation funds); and
• The impact on Smith SMSF of providing additional enhanced insurance within the fund.

See attached documents of personal policies of both members plus the insurance attached to John Smith’s industry super fund in which he still maintains a small balance.

Executed by the Trustees (sign here)

 

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(Trustee 1)

 

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(Trustee 2)

Example 2

Here is a more complex example where a fund invests in a business real property.

Jones SMSF Investment Strategy

The following document details the investment strategy of Jones SMSF.

The members of the fund are John Jones (aged 48) and Jane Jones (aged 42). Both members of the fund are in accumulation stage and the fund has combined assets (as at 1 January 2019) of $505,000.

OBJECTIVES

The fund will target an annual return of CPI (currently 1.9 per cent) plus 3 per cent per annum.

The overall composition of the fund’s assets and their diversification will be given appropriate consideration. When doing so, members’ assets held outside of their SMSF will also be taken into consideration.

The fund can invest in equities (both Australian and global), fixed income and cash and property.

It may, depending on the opportunity, consider alternative investments for a small portion of the balance, or derivatives. When investing in derivatives a derivative risk statement outlining the expertise of the trustee will be attached.

The trustees have considered the expected risk and return of investments, appropriate diversification, the liquidity of certain investments with regard to the fund’s expected cash flow requirements and the fund’s ability to discharge its liabilities.  They have agreed that the fund will invest directly or indirectly in a commercial property.

The trustees have agreed that although the business real property investment is a significant allocation of the Jones SMSF, the advantages to the retirement outcomes of both the trustees of holding the business within the superannuation fund outweigh any risk of concentration of assets.

The following overall asset allocations have been agreed upon.

• Equities 0 – 10%
  • Global 0 – 10%
  • Australian 0 – 5%
• Property 0 – 85%
  • Direct (single asset) 85%
• Cash or fixed income 0 – 5%

POLICIES

As both members are still in accumulation mode (and will be for some time), there are no current requirements for member benefits to be made. When one, or both of the members, reach retirement or passes away, member benefits and liquidity will be considered as required and it is expected the business real property will be sold.

This document will be reviewed annually in June and reviews will be minuted.

INSURANCE

The insurance requirements of both members have been considered to be adequate without taking out a contract of insurance within Jones SMSF with respect to one or more members of the fund.

In reaching this conclusion the following factors were considered:

• The current insurance levels held by members outside the fund (including within other non-SMSF superannuation funds); and
• The impact on Jones SMSF of providing additional enhanced insurance within the fund.

See attached documents of personal policies of both members plus the insurance attached to John Jone’s industry super fund in which he still maintains a small balance.

Executed by the Trustees (sign here)

 

————————-

(Trustee 1)

 

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(Trustee 2)

What do I do with the investment strategy?

The investment strategy is as important as the SMSF’s trust deed. Both documents are audited annually. But the first thing you need to do is put it in place and actually act on it. It’s not enough for a strategy document to say it will be able to pay a pension when it comes due when the fund is invested in illiquid assets and is unable to access any cash flow.

“That is considered not to be consistent with the investment strategy,” Colley says.

An investment strategy forms part of the SMSF’s annual review and audit. An SMSF auditor might suggest, for example, that an investment strategy be more specific as it relates to a complex investment product, such as crypto currency or futures, if a fund is investing in those assets. An SMSF is only allowed to invest in such assets if the trustee can justify the reason for these investments.

In such a case, an investment strategy document could attach a derivative risk statement, outlining the trustee’s expertise in the area, and how it would be of benefit to the fund.

You need to review the investment strategy at least annually, according to the Australian Taxation Office, and it is also a good idea to review around life-changing or significant events.

Any reviews need to be documented in a minute, which details how the trustees have considered the investment strategy and propose no change, or detailing changes if they have been proposed.