An investment strategy is a plan for making, holding and realising assets consistent with the investment objectives adopted by an SMSF trustee.

An investment strategy should be tailored and specific to the relevant SMSF’s circumstances. It should explain why the SMSF trustees invest the way they do. It should explain how the trustees intend to achieve the fund’s sole purpose (i.e. the provision of benefits for each member of the fund upon retirement etc).

SISA and SISR requirements

Every SMSF must have an investment strategy to comply with the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA) and the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SISR).

The SISA and the SISR require SMSF trustees to formulate, regularly review and give effect to an investment strategy. The strategy must have regard to the whole of the circumstances of the fund. This includes, but is not limited to, the following matters:

• the risk involved in making, holding and realising, and the likely return from, the fund’s investments, having regard to its objectives and its expected cash-flow requirements;
• the composition of the fund’s investments as a whole including the extent to which the investments are diverse or expose the fund to risk from inadequate diversification;
• the liquidity of the fund’s investments having regard to its expected cash-flow requirements;
• the ability of the fund to discharge its existing and prospective liabilities; and
• whether the trustees of the fund should hold a contract of insurance that provides cover for one or more members of the fund.

Formulating, reviewing regularly and giving effect to an investment strategy is an operating standard [SISR reg 4.09(1)(a)]. Accordingly, an SMSF trustee or director who intentionally or recklessly does not do so is guilty of an offence punishable on conviction by a significant fine. A penalty of 20 penalty units can be imposed on each individual trustee or corporate trustee (i.e. 20 x $210 = $4,200; each penalty unit is $210 as at 1 July 2019) under the administrative penalty regime in section 166 of the SISA. The directors or an SMSF corporate trustee are jointly and severally liable.

State and territory law

Moreover, unless the particular SMSF’s deed expressly excludes the application of state and territory trustee legislation, there are also specific investment criteria in the various state and territory trustee acts that are likely to apply to SMSFs.

In Victoria, for example, executors and trustees are subject to the “prudent person” test in the Trustee Act 1958 (Vic). Under section 8 of the Trustee Act 1958 (Vic), a trustee must, unless the trust instrument (e.g. the SMSF deed) provides otherwise, consider 15 discrete criteria when making each discrete investment. In contrast, the investment strategy covenant in section 52B(2)(f) of the SISA is in respect of an SMSF’s overall investment portfolio.

Moreover, under section 6(3) of the Trustee Act 1958 (Vic), a trustee must, at least once in each year, review the performance (individually and as a whole) of trust investments unless the SMSF deed provides otherwise.

The prudent person criteria in section 8 of the Trustee Act 1958 (Vic) (and in most other state and territory trustee legislation) differs markedly to the criteria reflected in section 52B(2)(c) of the SISA and reg 4.09(2) of the SISR.

The SISA and SISR provisions are more reflective of a modern portfolio theory of investing with a diversified portfolio where a risky investment can be justified. In contrast, a risky investment may be difficult to justify under the “prudent person” test in section 8 of the Trustee Act 1958 (Vic) as there are 15 discrete criteria to be examined by a trustee before making such an investment.

The DBA Lawyers’ SMSF deed excludes the Trustee Act’s prudent person investment criteria to ensure SMSFs only need to comply with the more modern and streamlined SISA/SISR criteria.

Insurance

Regulation 4.09 of the SISR requires SMSF trustees to consider “whether the trustees of the fund should hold a contract of insurance that provides insurance cover for one or more members of the fund”. An investment strategy should therefore include a review of whether life, permanent incapacity or temporary incapacity insurance is appropriate for one or more members.

ATO and audit reviews

The ATO in September 2019 notified around 18,000 SMSF trustees that were invested predominantly in one asset or a single asset class (i.e. 90 per cent or more) of the potential for an administrative penalty that might be imposed if the requirements in reg 4.09 are not satisfied.

The ATO also notified SMSF auditors to check whether SMSFs’ investment strategies satisfy reg 4.09 requirements. The ATO stated that auditors should expect to see documented evidence from an SMSF trustee that demonstrates that each of the five criteria in reg 4.09 is considered. The ATO encouraged auditors to lodge an auditor contravention report if they are not so satisfied.

SMSF auditors are required to review the investment strategy of each SMSF they audit each financial year. Unless an SMSF has an investment strategy and evidence that the strategy has been regularly reviewed, the auditor may be bound to lodge an auditor contravention report (ACR) with the ATO. A likely result of an ACR being lodged is the possibility of additional ATO scrutiny of the fund and penalties being applied on the SMSF trustee if it has not satisfied its obligations.

The recent decision of Ryan Wealth Holdings Pty Ltd v Baumgartner [2018] NSWSC 1502 (“Ryan case”) is relevant in understanding the operating standards for SMSF investment strategies under reg 4.09 of the SISR. Though the case was concerned with whether an SMSF auditor had exercised reasonable care and skill in regard to, among other things, reg 4.09 being satisfied, the case sheds light on the substantive requirements for investment strategies.

In this case, Ms Crittle received a large sum from a family law settlement. At the advice of her lawyer, Ms Crittle engaged a financial planner, Mr Moylan. In 2006, Ms Crittle established an SMSF, and transferred $7.3 million to be invested in accordance with Mr Moylan’s advice. These investments included a number of unsecured loans that were high risk in nature. An extract of the SMSF’s 2007 investment strategy is set out below:

Diversification and asset allocation

A normal investment range for each type of investment shall be:

- Australian equities 0 to 100 per cent

- Australian property 0 to 100 per cent

- Australian fixed interest 0 to 100 per cent

- Cash and short-term securities 0 to 100 per cent

The court held that the SMSF’s auditor should not have accepted that the investment strategy had satisfied reg 4.09. In particular, the court held that usage of a wide range or band (i.e. 0–100 per cent) in relation to all asset classes in the Ryan case did not negate the requirements that the investment strategy had to have regard to diversification.

Note that the above investment categories and ranges (i.e. 0–100 per cent) are relatively popular and are probably still used by many SMSFs. However, as noted in the Ryan case, this type of strategy contravened regulation 4.09. The court noted the following at [472] and [984]:

[472] I also consider that, had reasonable care and skill been exercised, the defendants would have:

(1) formed the opinion that a contravention of reg 4.09 may have occurred or may be occurring, and therefore would have been under a statutory obligation under s 129(3) of the SIS Act to report the suspected non-compliance to the plaintiff and to the regulator; and

(2) qualified their audit report appropriately to refer to the non-compliance with reg 4.09.

[984] Had the auditor performed their role competently, the deficiencies in the accounts and operations of the super fund would have been exposed. The defendants’ failure to undertake this task was, to accept further submission of the plaintiff, “the immediate, patent cause of the loss”.

Moreover, in addition to auditors being held liable for damages for deficient investment strategies, the ATO is applying more pressure to SMSF auditors to encourage them to seek evidence confirming that all the criteria in reg 4.09 are satisfied or the auditor should lodge an ACR.

Ongoing monitoring, review and amendment

The investment strategy should not be a “set and forget” document. Instead, it should be treated as a living document that is regularly monitored, reviewed and, if necessary, amended. Indeed, regular review of the investment strategy is a requirement for all superannuation entities [SISR reg 4.09(2)]. Moreover, as noted above, if the SMSF deed does not expressly exclude the Trustee Act of the applicable state or territory, then an at least annual review of each investment is required.

Australian Financial Services licence (AFSL) regime

Accountants and other SMSF advisers who are not covered by an AFSL are not permitted to provide financial product advice or related financial services under the Corporations Act 2001 (Cth).

Broadly, non-licensed advisers should not prepare SMSF investment strategies for their clients. Non-licensed advisers can, however, refer their clients to appropriate resources or to an adviser who is covered by an AFSL in relation to assisting an SMSF with its investment strategy obligations. Another alternative is for a non-licensed adviser to refer their SMSF client to a supplier that provides documentation that can assist SMSF trustees to prepare their own investment strategy.

Conclusion

SMSF trustees need to ensure that they comply with the relevant investment strategy criteria on an ongoing basis. This may mean for many a fundamental review of their SMSF’s investment strategy.

This is a complex area of law and, where in doubt, expert advice should be obtained.

Daniel Butler, director, DBA Lawyers