Kristian Wangvisutkul answers some commonly asked SMSF investment strategy questions, and outlines the Stronger Super announcements that could impact future requirements.
Self-managed superannuation fund (SMSF) trustees are required under section 52(2)(f) of the Superannuation Industry Supervision (SIS) Act to formulate and give effect to an investment strategy that has regard to the whole circumstances of the fund.
The overriding purpose of the investment strategy is to ensure the trustees make informed investment decisions that satisfy the sole purpose test. This generally means the fund must be maintained primarily for the purpose of providing retirement benefits to members, or to their dependants if a member dies before retirement.
What factors should trustees consider?
The key factors SMSF trustees should consider when formulating the investment strategy include the:
- Members’ ages, years until they plan to retire, retirement income goals, risk profiles and assets in and outside super;
- Potential risks and returns from different investments;
- Fund expenses and liabilities that need to be met; and
- Benefits of diversification.
Is there a prescribed format?
While there is no strict template that needs to be followed, the investment strategy should:
- Reflect the purpose of the fund and the member’s circumstances;
- Set out the fund’s investment objectives; and
- Detail the investment methods that will be adopted to achieve the objectives.
It also needs to be in writing, and should be reviewed periodically.
What should an investment objective look like?
The trustees should set an objective for the fund that is both measurable and achievable. Ideally, the objective should include a long-term return target, which may be expressed in percentage or dollar terms.
It should also reflect members’ willingness to accept any short-term fluctuations in the value of the fund’s investments should they occur.
Should the investment strategy prescribe an asset allocation?
While this is not a legal requirement, best practice would be to specify a percentage (or range of percentages) that the fund can invest in each asset class.
The asset allocation should reflect the fund’s investment objective. Where range-based asset allocations are used, they should not be so wide that they are neither measurable nor meaningful.
Can the fund invest in a single asset?
Some SMSFs invest entirely or primarily in a single asset (or asset class). A common example is where an SMSF acquires the trustees’ business premises.
Where an SMSF has a single asset, it should be reflected in the investment strategy and the trustees should consider the lack of diversification such a strategy could provide, as well as the liquidity issues that could arise.
The investment strategy should also outline how the fund will address these issues. For example, the fund could use earnings from the single asset or new contributions to meet expenses and diversify the portfolio over time.
Can the fund have more than one investment strategy?
If there are two or more fund members with significantly different situations (eg, different ages, investment balances or risk profiles) it may be appropriate to have a separate investment strategy for each fund member.
Alternatively, the fund could have one investment strategy that takes into account the collective needs and preferences of all fund members, which will be easier to administer.
How frequently should the investment strategy be reviewed?
The legislation doesn’t prescribe a frequency for reviewing the investment strategy. However, best practice would be to conduct a comprehensive review at least annually, or more frequently if required.
There are a range of events that could trigger the need for the investment strategy to be reviewed and amended accordingly. Examples include when:
- A new member joins the fund;
- Existing members make significant contributions;
- The fund needs to pay a benefit to a member;
- A member’s circumstances change;
- There are significant movements in investment markets;
- The fund doesn’t meet its stated investment objectives during a particular period, or
- The legislation changes.
Stronger Super
Late last year, when the Government released its ‘Stronger Super’ response to the Cooper Review, it made some announcements that have the potential to impact SMSF investment strategies, if legislated.
Additional factors for trustees to consider
The Government has provided ‘support in principal’ for the recommendation that trustees take into account additional factors when formulating their investment strategy. These include:
- The expected costs of the strategy, including those at different levels of any interposed legal structures and under a variety of market conditions;
- The taxation consequences of the strategy, in light of the circumstances of the fund, and to ensure that trustees consider those taxation consequences when giving instructions in mandates to investment managers; and
- The availability of valuation information that is both timely and independent of the fund manager, product provider or security issuer.
The Government will consult with relevant stakeholders regarding the design and implementation of these additional factors.
Insurance in superannuation
The Government has announced it will ‘support’ the recommendation that the investment strategy operating standard be amended so that SMSF trustees are required to consider life and total and permanent disability insurance for SMSF members as part of their investment strategy.
Borrowing in superannuation
The Government will undertake a review of leverage in two years, covering all types of super funds. This review will determine what impact leverage has had on the super industry and whether such arrangements should be permitted to continue.
In-house assets
The Government has agreed that SMSFs can maintain an in-house exposure of up to 5 per cent of the fund’s total market value. The Cooper Review had recommended that in-house assets be prohibited.
Collectables and personal use assets
The Government has announced it will continue to allow SMSFs to invest in collectables and personal use assets, provided they are held in accordance with tightened legislative standards.
These legislative standards will be developed in consultation with industry and will apply to new investments from 1 July 2011, with all holdings of collectables and personal use assets to comply by 1 July 2016.
Kristian Wangvisutkul is a technical consultant with MLC Technical Services.
