The poor old investment strategy has for far too long been a document largely disrespected by SMSF trustees and their advisers but that attitude needs to change.
The dissection of the investment strategy by the barristers and Judge Walton in Ryan Wealth Holdings v Baumgartner 2018 highlighted to me that many of the investment strategies we review each year, (and let's face it most of them are just standard templates) would not pass muster when scrutinised against the requirements of regulation 4.09 of the Superannuation Industry (Supervision) Regulations 1994 (the Regulations) in a court of law.
Disturbingly for SMSF auditors, the Baumgartner case found that it is the auditor who will have to shoulder the majority of the responsibility where an investment strategy is deficient or hasn't been given effect to by the trustees. This is despite the SIS Act clearly outlining it is a responsibility of the trustee and also the fact the accountant provided the template to the trustee for signing.
Alarmingly for me and the rest of the SMSF auditor community, the more I consider the requirements of the legislation, the less confident I am about many investment strategies being of a standard to allow me to issue an unqualified opinion. Consider the following issues the SMSF auditor has to navigate:
1. The auditor has to ensure the investment strategy has been formulated with regard to the whole of the circumstances of the SMSF.
How can the SMSF auditor be sure they are aware of all the circumstances of the SMSF? Surely this involves the auditor collecting a lot more information than they currently do for each SMSF to better understand the entity.
2. In the Baumgartner case, it was stated that because the sole member was a homemaker whose only source of income was the pension from the SMSF, the investments adopted by the fund were inappropriate to meet the SMSF's objective of providing retirement benefits.
This thinking is starting to move the obligations of the SMSF auditors towards an area they previously thought they didn't have to venture due to the following wording contained within the audit report:
"no opinion is made on its appropriateness to the fund members."
3. When formulating an investment strategy a trustee must have regard to the composition of the entity's investments as a whole, including the extent to which they are diverse or involve exposure of the entity to risks from inadequate diversification.
This requirement raises an interesting issue, namely when is a portfolio adequately diversified and do the trustees know when it is?
There has been a lot of discussion of late about diversification in SMSFs and varying thoughts on what is diversification. Is it a mix of investments in cash, equities (both local and overseas) and property (both direct and indirect)? What about the vast number of SMSFs that would argue that cash and 20 different listed Australian equities are diversified?
With so much discussion about diversification and when it is achieved, how are SMSF auditors supposed to assess whether the appropriate level diversification has been attained as an investment strategy might require?
Additionally, in relation to diversification, the Investment Trends 2018 SMSF Investor Report found that only 47% of trustees believe they were sufficiently diversified (refer to SMSF Investor Insights - Discussing key myths surrounding SMSFs). Therefore, considering the requirement that investment strategies must have regard to the extent to which an SMSF's investments expose it to risks from inadequate diversification, I wonder how many of the 53% of trustees who don't believe they are sufficiently diversified, have an investment strategy which complies with the requirements of regulation 4.09.
So what to do with the challenge of auditing the SMSF's compliance with the requirements of regulation 4.09? A simple solution to address this issue would be to remove all the responsibility for investment strategies from SMSF auditors by discarding the SMSF auditors' requirement to report on it from the ATO's audit report template. This action would reduce audit time and cost and is something that would be well-received by SMSF trustees and their advisors. However, the chances of this course of action coming to fruition appear to be slim because the industry knows trustee compliance with regulation 4.09 would diminish. Therefore, on the basis that removing regulation 4.09 from the auditor's report will not happen, look out for some guidance on investment strategy compliance from us in the new year.
David's wealth of business experience and a clear vision for the future has enabled Baumgartner Super to establish itself as a market leader.