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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 also needs to 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 recently said 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.
What is an SMSF investment strategy?
An investment strategy needs to take into account the following things:
- 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 it has considered the insurance requirements of members and taken out policies, where required, if insurance outside of superannuation 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.
The current high rate of inflation highlights how important it is to review an investment strategy annually or when major events happen. When inflation was low, it was not uncommon for an investment strategy to include a target return of 3% above CPI. At the recent CPI level of 7%, this would translate into a return of 10% which is a high, and potentially unrealistic, performance hurdle to attain.
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:
When formulating your investment strategy, it is not a valid approach to merely specify investment ranges of 0 to 100% for each class of investment. You also need to articulate how you plan to invest your super or why you require broad ranges to achieve your investment goals to satisfy the investment strategy requirements.
The percentage or dollar allocation of the fund’s assets invested in each class of investment should support and reflect your articulated investment approach towards achieving your retirement goals. If you choose not to use allocated portions or percentages in your investment strategy, you should ensure material assets are listed in your investment strategy. You should also include the reasons why investing in those assets will achieve your retirement goals.
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 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 (see case study below).
What to do following a market correction
There are certain significant events that should prompt a review of an 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 interest) 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.
A newer component 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.
How do I create an SMSF investment strategy document?
An SMSF investment strategy document needs to cover all areas specified by the ATO and detailed in this article.
It can be a Word document written up by the trustees. Many SMSF platform providers have templates, as do advisers. Depending how complex your SMSF is, shorter may be better.
As the updated ATO information suggests, if you use percentage investment ranges you need to explain why you have chosen those ranges and how you plan to invest the funds in those asset classes. This would mean the inclusion of a paragraph like the following:
The trustees have agreed that at this stage of their lives a relatively high allocation to growth assets such as equities will help maximise their superannuation to achieve a beneficial retirement outcome. Within the allocation to Australian equities, the fund will also seek a significant portion of quality companies that prioritise dividends to maximise the fund’s income as well as capital gains.
What do I do with the investment strategy?
The first thing you need to do is act on it. It’s not enough for a strategy document to say it will be able to pay a pension when it’s due while the fund remains invested in illiquid assets and is unable to access any cash flow.
An investment strategy also forms part of your SMSF’s annual review and audit, along with the trust deed. An SMSF auditor might suggest, for example, that an investment strategy be more specific where it relates to a complex investment product such as cryptocurrency or futures. An SMSF is only allowed to invest in such assets if the trustee can justify the reason for doing so.
In such a case, an investment strategy document could attach a derivative risk statement outlining the trustee’s expertise in the area and how the investment would benefit the fund.
You need to review the investment strategy at least annually, according to the ATO, and it is also a good idea to review it following 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.
SMSF investment strategy templates
To create your own investment strategy, you can use a template provided by your financial adviser or SMSF platform provider or use our examples below as a guide.
Template 1: A standard investment strategy document.
Template 2: An investment strategy document for an SMSF with a business real property asset.