With the increased compliance focus on SMSF investment strategies, we announced the launch of our investment strategy solution in April. In his article, Mark also outlined what the requirements are for an investment strategy and the role the auditor plays in ensuring it is compliant. Since then, we’ve found some key areas trustees have had to address and what they have had to consider.
As part of preparing and reviewing an SMSF investment strategy, liquidity needs to be considered. ATO data suggests a lot of trustees may not be taking this requirement seriously as they seem to be focused on one or two asset classes.
Whilst this isn’t a problem, it still needs to be documented in the strategy the reasoning for this. We have found with some of our clients in this situation, liquidity has become an issue, particularly where they have ongoing costs such as paying pensions or funding an LRBA.
Based on multiple reports, we are seeing a change in trustees’ investment choices with an increase to riskier investments, given the current low yields on defensive assets.
We’ve often seen retirees rely on investment generating regular income streams to fund their retirement however, with low interest rates, traditional defensive assets such as term deposits and bonds, may no longer provide the desired level of income.
With this trend towards more aggressive investments, trustees still need to consider the appropriate level of risk to meet their desired returns.
Diversification relies on assets in the portfolio reacting differently to market forces. However, with changing markets, certain asset classes may longer be effective in offsetting potential losses incurred on other investments. For example, term deposits and bonds have generally been considered defensive assets, used to offset the risk associated with growth assets. With interest rates at record lows, the return on these defensive assets is minimal and may not be enough to offset losses from other investments.
When considering diversification, the short, medium and long-term goals should be considered along with how the portfolio can be constructed to meet those goals.
Check out our example investment strategy
We find one of the main reasons trustees need to update their investment strategy is because the asset allocation in their SMSF does not match the asset ranges specified in their strategy.
It may be worth considering a more flexible portfolio allocation, allowing for fluctuations in market prices as well as changes in investment choices throughout the year.
This doesn’t mean an asset range of 0% to 100% should be applied to all asset classes, as the ATO has specifically indicated they will not accept this. There still needs to be some focus in the strategy.
If the SMSFs asset allocation falls out of the ranges specified in the investment strategy trustees could update it or, they may consider adjusting the portfolio of assets in the SMSF to better reflect the strategy.
As part of the regular review, insurance also needs to be considered, especially in our current environment. Any significant changes that have occurred or could potentially occur, need to be considered to ensure the member’s needs will be met.
This also includes situations where members do not require insurance in their SMSF. The auditor will expect that the reasoning for this is documented in the strategy.
The SIS regulations make it clear that investment strategies need to be reviewed regularly. Often, this review is simply noted in a document that the strategy was reviewed but nothing was changed.
We are finding auditors now review the strategy in much more detail and will raise any issues in their management letter, or even report it to the ATO if it has been an issue for multiple years.
Where the auditor notes this as an issue, the trustees should review it and take the appropriate action. Simply documenting that it was reviewed but nothing has changed is not acceptable.
Our SMSF investment strategy solution has simplified this process for trustees, walking them through each step of the formulation of their strategy, before generating a formal document based on their responses.
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