Superannuation legislation¹ requires SMSF trustees to “… formulate, review regularly and give effect to an investment strategy that has regard to the whole of the circumstances of the entity including…” with a detailed list of considerations provided.

An indication of the importance of an investment strategy in the eyes of the ATO is found in the ATO Tax Ruling TR 2008/9², which covers the meaning of an Australian super fund.

In that ruling, the ATO looks at what it considers to be certain “strategic and high-level decision-making processes and activities, which includes (among others):

• formulating the investment strategy for the fund, and
• reviewing and updating or varying the fund’s investment strategy

While it may have been considered as little more than a “compliance document”, recent ATO guidance has elevated the formerly humble investment strategy to a higher status in 2020 and beyond.

The ATO’s requirements

The guidance and requirements from the ATO have effectively been provided in two parts.

Extent of Diversification

Initially, in August 2019, the ATO wrote to about 17,700 SMSF trustees, as well as the auditors of those funds, regarding the limited diversification of investments of those SMSFs.

The intent of the ATO correspondence was to remind trustees and auditors that the lack of diversification should be formally considered as part of the review of an investment strategy for their SMSF.

In particular, the ATO was reminding trustees that, in reviewing the investment strategy, as well as considering the overall circumstances of the fund, they must also drill down to specific issues, one being to consider the extent to which the fund investments are diverse and the risks which could apply from a lack of diversification.

In other words, while there is little stopping the SMSF trustee from lacking diversification in the investments of the SMSF, the trustee needs to have considered the various risks that may arise from that lack of diversification.

Tailored and specific

From the second part of the ATO guidance³, released in February 2020, it became clear that an investment strategy permitting a range of investments, for all investment categories, of 0–100 per cent would generally not be acceptable, as it would indicate a lack of proper consideration by the trustee.

In fact, the ATO release noted the investment strategy needed to be tailored and specific to the fund circumstances, not merely repeat words in the legislation.

Further, it should, according to the ATO, consider the personal circumstances of the fund members, including their:

• age
• employment status
• retirement needs

and explain how the investment strategy meets the retirement objectives of each member.

Although including a range of 0–100 per cent for all investment categories would generally not be acceptable, there is nothing in the legislation prohibiting that.

However, the ATO expects, in the instance of the trustee nominating 0–100 per cent for some or all investment categories, that the trustee should articulate, in the investment strategy, why a broad range is required.

In doing so, the trustee will be seen to have given consideration to formulating the investment strategy.

In other words, regardless of the eventual asset mix, the investment strategy resulting from the deliberations should be tailored and specific for the benefit of the fund and its members, rather than in kit form.

Eggs in one basket

In the ATO correspondence to trustees and auditors of specific SMSFs in August 2019, it became apparent the main focus of the ATO was on SMSFs with investments predominantly in one asset class, usually property.

What particularly concerned the ATO was where the asset was purchased with funds obtained under a limited recourse borrowing arrangement.

The ATO expressed concern that, if the investment suffered a sharp fall in value, the SMSF would not only suffer as a result of the investment fall, but would still have a liability to service.

Although the loan would have been limited in its recourse, of further concern was the fact that members may have provided a guarantee to the lender.

So, although the SMSF may invest in a single asset, the ATO is concerned to ensure that the trustee of the SMSF has, as part of the creation or review of the investment strategy, provided adequate consideration to:

• the extent to which the fund investments are diverse, and
• the risks, including potential liquidity issues, from limited diversification.

Effectively, for trustees to be able to prove they have considered the potential risks of limited diversification, they will need to have written confirmation that the lack of diversification, and resultant risks, have been considered and accepted.

Investment strategy compliance

To ensure a fund’s investment strategy meets the requirements of the ATO, we recommend that the trustee:

• have a current investment strategy in place;
• review it regularly (at least annually), and in doing so:
  • document the personal circumstances of the members including their ages, retirement plans, likely future contributions and employment status;
  • consider the likely risk and return of the assets invested in;
  • consider the liquidity and cash-flow requirements of the fund;
  • consider the ability of the trustee to discharge the liabilities of the fund;
  • consider the degree of diversification of the assets invested in; and
  • consider whether insurance should be held for the members.

Conclusion 

Although trustees may consider the investment strategy to be a compliance document, the ATO places significantly greater emphasis on it and, in 2020 and beyond, requires the attention of SMSF trustees and auditors to the document, its tailoring and its applicability to that SMSF.

Michael Harkin, national manager for training and advice, Topdocs

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