Investment strategies Part 1 - The “Musts” and the “Shoulds” of the ATO’s guidance

Raising the standard of SMSF investment strategies

The ATO's investment strategy guidelines for trustees published in February 2020 were a timely and necessary follow up to their unexpected direct trustee communication on the risks from inadequate diversification in the second half of 2019.

The guidelines provide many interesting insights into the regulator's thoughts on how trustees should be compiling their strategies which should be used to strengthen strategies so they not only pass muster from a compliance point of view, but also so they assist in meeting the retirement objectives of SMSF members.

The main focus for us, and for the majority of our clients, is ensuring the investment strategy passes the audit and therefore we have analysed the guidelines with a particular focus on the ATO's use of the words 'must', 'should', and 'could'.  The 'must' requirements could be seen as the minimum baseline requirements necessary to meet the requirements of the legislation; in other words, they are the non-negotiables for compliance.

Must

Unsurprisingly the ATO states that strategies must consider the specific requirements of the legislation.  This includes that the trustees must formulate, review regularly and give effect to an investment strategy that has regard to the whole of the circumstances of the fund which includes, but is not limited to, the following.

• risks involved in making, holding and realising, and the likely return from your fund’s investments regarding its objectives and cash flow requirements
• composition of your fund’s investments including the extent to which they are diverse (such as investing in a range of assets and asset classes) and the risks of inadequate diversification
• liquidity of the fund’s assets (how easily they can be converted to cash to meet fund expenses such as the cost of managing the fund and income tax expenses)
• fund’s ability to pay benefits (such as when members retire and require a lump sum payment or regular pension payments) and other costs it incurs
• whether to hold insurance cover (such as life, permanent or temporary incapacity insurance) for each member of your SMSF.

In addition, the ATO states your strategy must articulate how you plan to invest your super in order to meet your requirement goals.  You must give effect to an investment strategy, which means ensuring your fund's investments are in accordance with your investment strategy.

Further to their 'must' statements, the ATO has some other definitive views of asset allocation ranges of which trustees and their advisors need to be aware:

• It is not a valid approach to merely specify investment ranges of 0-100% for each class of investment.  Broad investment ranges between 0-100% in a broad range of assets do not reflect proper consideration in satisfying the investment strategy requirements.
• 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.  So "broad" ranges are ok but just needs to be explained.  What is "broad?"

Should

The 'should' requirements could be viewed as borderline compliance issues but certainly represent a best practice approach.  It is up to each trustee to determine how they interpret the legislation as to whether a "should" means a "must" in their eyes.

We will not provide comment on each requirement here, instead, we are simply highlighting the ATO's thoughts in relation to investment strategies so trustees are aware of the ATO's position on many topical issues. For an in-depth analysis of thoughts on investments strategies, look out for our Part 2 article.

The 'should' requirements listed:

• An investment strategy should be tailored and specific to the relevant circumstances of your fund rather than a document which just repeats the words in the legislation.
• An investment strategy should explain how your investments meet each member's retirement objectives.
• 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.
• In relation to concentration risk, your investment strategy should document that you considered the risks associated with a lack of diversification.  It should include how you still think the investment will meet your fund's investment objectives including your fund's return objectives and cash flow requirements.
• You should review your strategy at least annually and document that you have undertaken this review and any decisions made arising from the review.  Minutes or other evidence of a review should be provided to your auditor.
• Certain significant events should also prompt you to review your strategy such as:

           - A market correction

           - When a new member joins the fund or departs a fund

           - When a member commences receiving a pension.  This is to ensure the fund has sufficient liquid assets and cash flow to meet minimum pension payments prior to 30 June each year.

Additional helpful guidance

Elsewhere in the ATO's investment strategy guidance, they also provide the following useful insights into their position on various issues pertinent to investment strategies:

• We don't consider that short term variations to your articulated investment approach, including to specified asset allocations, constitute a variation from the investment strategy.
• Review of the strategy can be part of the annual trustee meeting minutes.
• Relevant circumstances may include (but are not limited to) personal circumstances of the members such as their age, employment status, and retirement needs, which influence your risk appetite.

Conclusion

As SMSF auditors, we audit to our assessment of the 'musts' of the legislation and no more than that.  Whether an investment strategy is any good or not is not something we will consider and form an opinion on.  However it is important that trustees are aware of the ATO's position as just because an investment strategy passes an audit of an SMSF auditor, it does not necessarily mean it will pass a review by the ATO.

I applaud the ATO's attempt to provide guidance for the industry and raise the standard of investment strategies for SMSFs.  However my experience from 20 years of auditing SMSFs is that there are not many trustees who consider this an integral document to their operation of the fund and will therefore still look to apply a minimum compliance approach rather than a best practice approach. A best practice approach is probably long overdue in the sector, however the journey to reach that ideal still has a long way to go.

Please call me on 1300 047 473 to discuss your needs in respect of SMSF audits. Please note that our office will close from 25 December 2020 and will reopen on 4 January 2021. Wishing you a Merry Christmas and a Happy New Year!