Formulate, Review Regularly and Give Effect to an SMSF Investment Strategy

SMSF investment Strategy

The SMSF investment strategy is to be regularly reviewed as required by SIS Act s52B(f) and SIS Reg 4.09.

Reg 4.09 Operating standard – investment strategy

(2)  The trustee of the entity must formulate, review regularly and give effect to an investment strategy that has regard to the whole of the circumstances of the entity including, but not limited to, the following:

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

As ‘regularly reviewed’ is not defined by the section it would be appropriate to review the document annually and take into account factors such as the changing circumstances of the fund and its members. For example, when a pension is commenced , a member leaves a fund or a new member joins the fund. It’s not necessary to change the SMSF’s investment strategy at each review.

We recommend the following sections be included in the investment strategy document.

(1) Background and Scope

A a short legislative background and scope of what is covered in the document that is dated at the agreed date of the members to the trustee.

(2) Objectives

The strategy needs to outline the objectives of the fund to create the parameters of what the fund realistically aims to achieve in the short, medium and or long term. This is done by considering the many factors affecting circumstances of the fund. The factors may include:

  • The age, number and retirement plans of individual members as well the plans to access superannuation benefits at retirement
  • The current and foreseeable liabilities as well as contingent plans of the fund
  • The nature of the investments already held by the fund and their exposure to risk
  • Economic factors and risk exposures
  • Anticipated member contributions into the future

Examples of what specifically should be included in the objectives of the fund include and are not limited to:

  • Increase benefits to members upon their retirement, or death benefits to their dependents
  • Maintain investments that have been chosen with consideration of diversification to achieve the risk tolerance of the fund
  • Achieve appropriate liquidity of the investments to meet its liabilities
  • A benchmark for return over an annual period and longer as a percentage such as a percentage above CPI or a comparable rate to annual cash rates

(3) Strategy

The trustees need to follow the objectives of the fund to formulate the strategy to achieve the goals of the fund. This is done by specifying the different asset classes that will be chosen and the risk exposure to these assets. The asset classes are:

  • Cash;
  • Fixed interest, debentures and bonds;
  • Australian equity, international equities and derivatives;
  • Holdings in managed fund;
  • Property;

It is recommended that the strategy consider the range or percentage of each asset class that will be held by the fund. Although this is not a legislative requirement, it is a way of showing how the fund aims to achieve its objectives. This benefits the fund in assessing its risk tolerance to particular investments to ensure optimal diversification of investment choices to reach the benchmark prescribed in the objectives of the fund.

The strategy should outline the risk profile of fund to the expected returns of the investments to meet its obligations and cash flow requirements to members. It’s important to note that as part of the “review regularly” requirement the return of investments can alter as time goes on from changing economic conditions and as such this should be reflected in the investment strategy.

(4) Insurance

The Trustees of the SMSF are required to consider whether insurance policies are appropriate for one or more members of the fund. SMSFs are only permitted to hold specific types of insurance policies, including life insurance, total and permanent disability insurance as well as income protection insurance.

  • The factors that should be considered in making insurance decisions include:
  • Current insurance held by members outside the fund
  • Health and age of the member
  • Personal circumstances relating to current financial risks

(5) Other items to consider

SMSF borrowings: SMSF borrowing arrangements should be reflected in the investment strategy if the borrowing is permitted by the SMSF trust deed. Borrowing to invest can magnify and losses associated with an investment. If the investment strategy states that the fund members are risk adverse or investing for a short period of time then the investment strategy has to be reviewed.

The trustee(s)will also need to consider the ability of the SMSF to service the loan giving consideration to the contribution caps and age of the members.

SMSF Reserves: When reserves are permitted by the SMSF trust deed, a separate investment strategy for the reserve should be formulated and implemented.

Signing the Investment Strategy: The investment strategy needs to be signed by the trustee(s) and dated appropriately to ensure requirement to be regularly reviewed is maintained.

Audit of SMSF Investment Strategy

As SMSF auditor, we need to ensure each fund being audited has an appropriately documented investment strategy. As a minimum the auditor should ensure the strategy has regard to risk, return, liquidity, diversification and insurance. If the strategy contains ranges of investments, the auditor should ensure the assets at year-end match up to those ranges. If they don’t then the trustees have not given effect to the adopted strategy, and regulation 4.09 will have been failed. Our audit program is as follows:

Has the trustee formulated and given effect to an investment strategy that has regard to the following:

  • The risk in making, holding and realising assets
  • Likely return from investments
  • Investment objectives
  • Liquidity of investments in comparison to expected cash flow requirements of the fund
  • The composition of investments as a whole including diversification or the risk of inadequate diversification
  • Has the trustee considered whether to have insurance cover for its member(s).
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