7 steps to an ATO compliant SMSF investment strategy

Our work administering 4,000 funds and helping other practitioners with their SMSF queries has given us a useful insight into the key points an investment strategy needs to include to pass audit each and every year.

The superannuation law requires all self managed super fund (SMSF) trustees to “formulate, regularly review and give effect to” an investment strategy for their fund. With the ATO able to impose penalties on trustees who fail the investment strategy requirements, it is important for all trustees to understand what is needed to develop an ATO compliant investment strategy.

There is no prescribed format for an investment strategy and the law does not dictate precisely what should be included. However trustees must consider six key factors:

1. the risk involved in making, holding and realising the fund’s investments, taking into account the trustee’s objectives and expected cash flow requirements,
2. the likely return from the fund’s investments taking into account the trustee’s objectives and expected cash flow requirements,
3. the composition of the investments as a whole, including the extent to which they are diversified or involve the fund being exposed to risks from inadequate diversification,
4. the liquidity of the investments taking into account the fund’s expected cash flow requirements,
5. the ability of the fund to meet its existing and prospective liabilities, and
6. whether the trustees should hold insurance that provides cover for one or more members of the fund.

So, after I’ve decided on my strategy taking into account the factors above, how do I go about putting my strategy into a document acceptable to the ATO and my fund’s auditor?

It is actually relatively easy - neither the fund’s auditor nor the ATO can review what is in your head so they simply need you to write down what you considered. And what they are interested in is the fact that you actively considered all these things, not second guessing the choices you made.

Step 1 – Take into account your fund’s circumstances

Blindly following a template which simply repeats the six factors above will not be sufficient.

Make sure your strategy is tailored and takes into account the specific circumstances of your fund. For example, the age and expected retirement date of the members, their overall risk profile, the asset allocation of the members outside superannuation, the fund’s expected liquidity needs etc.

Step 2 – Include asset allocation ranges

Trustees need to provide a way of demonstrating that their strategy has been implemented. Usually this means including target asset allocation ranges. Doing so provides a quick way for you (and the fund’s auditor) to check that the fund’s investments are in line with its strategy.

We include them in our investment strategy document to demonstrate that the trustee not only has an aim (the objective) but also has a plan to achieve it. The target asset allocations provide some information about that plan.

Step 3 – Make sure the ranges aren’t too wide

You need to make sure the asset allocation ranges are wide enough to allow for normal market fluctuations but not so wide to be meaningless. Ranges of 0 to 100% for each asset class would not normally be appropriate without also explaining why you needed such broad ranges to achieve your investment goals.

Step 4 – Explain your diversification decision

The superannuation law does not require your fund’s investments to be diversified, but you do need to have considered diversification. There may be circumstances where, after considering all the appropriate factors, you decide to invest in a single asset class or even a single asset. In this case, to demonstrate you have given due regard to diversification, you should acknowledge the risks associated with a lack of diversification and explain why you believe the potential fund returns will provide appropriate recognition of that risk. Merely saying you have considered diversification is not enough.

Step 5 – Explain your liquidity decision

In developing your investment strategy, you need to ensure the fund’s assets will be sufficiently liquid to allow for payment of the fund’s liabilities as and when required.

Things you will have thought about and explanations you need to document include:

• What level of cash is needed to cover the fund’s regular operating expenses, loan repayments or investment commitments?
• If the fund’s cashflow from contributions reduces or ceases (eg due to Government changes to contribution limits or changes to a member’s personal circumstances), how will that impact the fund’s liquidity?
• If the members commence pensions with all or part of their balance, will the assets of the fund be sufficiently liquid to allow at least the required annual minimum pension amount to be paid?
• How will the fund finance a death benefit, particularly if the law says the death benefit must be paid as a lump sum and the fund’s assets are not easily converted to cash? For example, trustees in this situation may decide to pay death benefits in-specie (ie by transferring all or part of a fund asset to the deceased’s beneficiaries) rather than making payment in cash.

Step 6 – Don’t set and forget

Your investment strategy should not be a “set & forget” document. It is not sufficient to only formulate an investment strategy; you must also implement it. That is, you must also invest the fund’s assets in accordance with your documented strategy. Your auditor will be able to easily assess this if you include target asset allocation ranges.

Having said that, it is worth highlighting that it is not illegal to invest outside the asset allocation ranges in your strategy. 

Many funds will be in this position from time to time – particularly if (say) there are large falls across the board in a major asset class such as Australian shares. The important part is acknowledging that it is happening and what action you are going to take, which could include choosing to make no changes to either the fund’s investments or the strategy in the short-term.

Which leads me to the final step – reviewing your strategy.

Step 7 – Regularly review

You are required to regularly review your investment strategy to ensure the strategy remains appropriate for the fund’s circumstances and your documented investment objectives are being met.

The approach we generally take is to ensure trustees review their strategy at least annually (as part of the normal year end process of signing accounts and tax returns) and also whenever there is a major change to the fund’s circumstances. For example, when:

• the fund starts or stops providing pensions,
• a new member joins the fund or a member leaves the fund,
• new classes of investment are made,
• the fund’s risk profile changes, or
• the fund borrows via a limited recourse borrowing arrangement.

This review should be documented in the form of a trustee minute or resolution, detailing whether the strategy remained appropriate or changes were made, which can then be provided to the fund’s auditor.

Need more help?

The Heffron Super Toolkit’s Investment Strategy is a quick and easy-to-use guided tool which will step you through the things you need to consider and articulate to produce a document that will withstand ATO and auditor requirements. It is designed so your fund accountant or adviser kicks off the process, then shares it with you to finalise and complete or simply review and confirm. Your accountant or adviser can register for a demonstration or subscribe here: https://www.heffron.com.au/services/super-toolkit