SMSF Auditor -Epping ….investment strategy
The recent SMSF investment strategy guidelines provided by the Australian Taxation Office (ATO) shows they consider the fund’s investment strategy to form part of a fund’s specific compliance documentation. As such, the investment strategy should be tailored to individual fund circumstances and should not be a document merely repeating standard verbiage.
Each fund member has a unique set of circumstances and given the sole purpose of superannuation is the provision of retirement benefits, the investment strategy should explain how fund assets will meet each member’s retirement goals.
Whilst many industry pundits see the ATO guidelines as being beyond their ambit, under superannuation law, factors must be considered regarding how SMSF trustees are going to achieve member objectives, given the whole circumstances of the fund. Therefore, the investment strategy should include (but is not limited to):
The risk vs return profile of the asset classes
Liquidity needs (how easily and quickly the assets can be converted to cash)
Ability to discharge liabilities as they fall due
Insurance needs of the members.
The ATO make the point in their guideline, formulating the fund’s investment strategy is not achieved by specifying investment ranges of 0 to 100 per cent for each class of investment. Whilst we at Northcity Accountants rarely see trustees put together such generic asset class ranges, it appears the strategy of using broad template ranges to ensure the investment strategy covers almost every fund asset allocation without much member input is a thing of the past. The ‘set and forget’ template is dead.
The guideline states trustees need to articulate how they plan to invest superannuation monies; rather than just use percentage ranges in each asset class, the investment strategy should state reasons why and how investing in those assets will achieve retirement goals. However, there is nothing in the legislation that states trustees must use asset allocation ranges. The guideline states in these circumstances, where asset ranges are not used, trustees should list specific assets and include the reasons why investing in those specific assets will achieve retirement goals.
So, what does the ATO suggest a compliant investment strategy should look like?
Unfortunately, they provide no actual examples of what might constitute an ATO ‘approved’ investment strategy. They do outline a couple of key points trustees must consider. The first is having regard to diversification, which, not surprisingly, is one of the elements of Regulation 4.09 of the Superannuation Industry (Supervision) Regulations 1994 (SIS Regulations). This seems to be off the back of the ATO’s previous targeting of funds where more than 90 per cent of the fund’s assets were held in property and the fund reported having a Limited Recourse Borrowing Arrangement. Whilst a fund is not required to be diversified and it may be completely reasonable to have either 100 per cent cash allocations or 90 per cent held in one asset or one asset class, the ATO state trustees must justify how this lack of diversification is going to achieve the fund’s investment objectives and cash flow requirements. What is the rationale behind the lack of diversification? How is the fund going to satisfy its sole purpose for being in existence – that being the provision of retirement benefits for members?
Again, many pundits have pilloried the ATO for mentioning diversification or what asset classes a fund should invest in. Personally, I think the ATO is not taking a stance either way. They are simply saying “Justify your decision.” If trustees can justify such a decision, by saying “We are heavily invested in cash, because we are going to retire soon and a massive drop in capital value in the short term will severely impact the member’s ability to survive 25 years of retirement” would, to my mind, placate any scrutiny by the ATO.
In fact, it turns the trustee’s mind to other factors, such as longevity risk and the need for capital growth. The trustees may in fact state in the investment strategy they take short-term Tactical Asset Allocation decisions that differ markedly from the longer-term Strategic Asset Allocation position of the fund. The ATO is saying there is nothing wrong with that. What they are saying is, what is the rationale behind it.
The ATO also refer to “giving effect” to an investment strategy in the guideline. This is referred to in the operating standard in SIS Regulation 4.09. Interestingly the ATO decided to interpret this statement in the Regs, saying it means the fund’s investments are in accordance with the investment strategy, so the trustees are on track to meet member retirement goals. Again, the ATO emphatically states ranges of 0 – 100 per cent in a broad range of asset classes does not reflect proper consideration in satisfying the investment strategy requirements.
Again, the punditry disagrees with the ATO. Saying they have no right to dictate what is an appropriate level of diversification on what asset classes funds should invest in. I do not think the guideline is doing that. Having asset ranges of 0 – 100 per cent does not clearly articulate how trustees plan to invest super monies to meet retirement goals. To clarify the point, the ATO goes on to say they do not consider short-term variations to the fund’s investment approach, including specified asset allocations, constitute a variation of the investment strategy. I could be wrong, but I read this to mean – again – Tactical Asset Allocation ranges, even 90 per cent in one asset class, will not be an issue for the ATO. It always comes back to a requirement to justify the decision. If trustees can do that, the ATO in my view would not be concerned at all.
The point the ATO raise in the guideline is that of regular review; another requirement of SIS Regulation 4.09. Given the COVID-19 hysteria sweeping the globe, regular reviews of the investment strategy would be a logical course of action. Review in this context does not necessarily mean re-writing the whole document. It could be done as part of the annual trustee minutes, which could then be provided to the fund auditor to show the trustees have met the requirement to review regularly and, where necessary, revise the investment strategy.
As with recent case law and ATO initiatives, the role of the fund auditor is brought into sharp focus. Trustees are warned if they do not comply with the investment strategy requirements under superannuation law, the auditor may notify the ATO by lodging an auditor contravention report (ACR). Given recent announcements by the ATO regarding the imposition of administrative penalties (which can be significant and must be paid by the trustees themselves) for breaches of super law, the ramifications are severe. However, failure to address the factors mentioned above (such as the risk of a lack of diversification) can be remedied by attaching a signed and dated addendum to the strategy or a trustee minute which adequately addresses the requirements. This should then be shown to the auditor prior to the finalisation of the audit.
If trustees have not invested in accordance with the investment strategy, they can revise the strategy to ensure it reflects the fund’s investments and how those investments will meet retirement objectives.
What is crystal clear from the ATO’s investment strategy guidelines is that using investment strategy templates with standard paragraphs, that have no regard to the individual circumstances of the fund, is not an appropriate approach when formulating an investment strategy for the fund. Standard investment strategy templates may be a good way of providing guidance, and as a conversation starter, but they should be relied on alone as justification for the trustee’s investment decisions.
Whilst we are not licensed financial planners and cannot provide investment advice or product recommendations, Northcity Accountants has produced a range of tools, including guidance notes and addendum to assist trustees and their intermediaries with their investment strategy compliance requirements. The Northcity Accountants Technical Services and Education team is always on hand to help trustees, accountants and financial planners navigate the maze that is our superannuation system.
Northcity Accountants offers a choice of different administration service solutions, depending on the level of fund complexity and investment structure. For further information on how Northcity Accountants can support your SMSF, get in touch today!
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