A Guide to Creating a Proper SMSF Strategy.

Trustees of Self-Managed Super Funds (SMSF) are required to meet many legal obligations under Australian regulations, most notably, in relation to the formulation and implementation of a comprehensive and considered investment strategy which is required to be tabled in the minutes of its annual general meetings and be made available to each member of the SMSF on request.

General obligations of trustee(s)

Section 52 of the SIS Act obliges trustees of SMSF’s to include a broad range of legally binding covenants in its governing rules, including such issues as acting ‘honestly in all matters concerning the entity’, performing their duties and exercising their powers ’in the best interests of the beneficiaries’, and, notably, formulating, and implementing a comprehensive and detailed investment strategy which meets all the fund’s investment objectives that has regard for the whole of the SMFS’s circumstances.

The purpose of an investment strategy is to outline a forward looking investment plan that the trustee(s) of the SMSF will formulate, as well as the investment methods by which the investment objectives will be met.

When formulating and documenting this strategy, trustee(s) are obliged to consider the following issues:

• Consider the risk of holding and realising SMSF’S investments and potential returns taking account of trustee objectives and expected cash flow requirements.
• Consider the benefits of diversification of investments of the fund, as well as the risks associated with inadequate diversification
• Ensure the fund has adequate liquidity at any given time to pay member benefits on retirement, upon reaching a prescribed age, or to their dependents in case of death before their retirement
• Ensure the fund has the ability to discharge its existing and prospective liabilities, such as taxes, auditing costs etc.

In addition, if the SMSF has any reserves, the trustee(s) are required to formulate and implement a strategy for their prudential management which is aligned with the SMFS capacity to discharge its actual and contingent obligations, when and if necessary.

New trustee obligations

Moreover, effective 7 August 2012, the former Labor government introduced two additional requirements:

• Trustee(s) are now required to ‘regularly review’ this investment strategy, which according to industry best practice, needs to be at least annually prior to the end of each financial year or when the SMSF’s circumstances change, such as when a new member is admitted or leaves the fund, when a member retires or upon the death of a member, or recommended by the ATO, at any meeting of trustee(s) during the course of the year
• Trustee(s) are now required to consider if it is appropriate to provide insurance cover for one or more of the fund’s members;
  • Factors about each member such as age, health, personal debt, or if they have insurance in industry or retail superannuation funds, should be taken into consideration in the decision making process

Objectives of the investment strategy

When considering the investment objectives of the fund and to comply with the SIS Act which prescribes a ‘sole purpose test’; the SMSF is obliged to invest the assets of the fund to ensure that they increase the benefits to fund members and their dependents on retirement, upon reaching a prescribed age, or to the dependents of members on their death before retirement.

Developing a comprehensive investment strategy to achieve investment objectives

Once the investment objectives of the fund have been established, trustee(s) will need to develop a comprehensive strategy to achieve these objectives.  To this effect, the following should be considered:

• Ensure appropriate mixes of investments held by the fund to ensure the above-mentioned requirements
• Ensure sufficient liquidity to meet all obligations/commitments
• Maximise the tax effectiveness of the fund investments and thereby deliver long term after tax returns for members
• The investment time frame for growth of assets of fund

In developing this strategy, the trustee(s) may specify different asset classes, depending on the investment time frame and risk profiles of members, which may include, but not be limited to all or one of the following asset classes:

• Cash
• Fixed Interest
• Property
• Australian Equities
• International Equities
• Any other investment that the trustees may feel prudent to achieve the objective of the fund

In formulating this investment strategy, the trustee(s) also need to take into consideration relevant features of the various investments in accordance with both the fund’s objectives and appropriate legislation.
Implications of not having a comprehensive investment strategy

Having a comprehensive investment strategy document as detailed above, is crucial as the SIS Act permits SMSF members or their dependents, who have suffered a loss or damage from an investment decision made by trustee(s) to litigate and recover the loss or damage suffered from the trustee(s) actions.

However, having an investment strategy in place provides strong protection against such litigation if the trustee(s) can establish that the investment was made in accordance with an investment strategy formulated under the covenant in Section 52 (2) f of SIS Act.

Moreover, if trustee(s) fail to comply with SIS obligations to have an acceptable investment strategy the trustee(s) run the risk of the fund losing its compliance status resulting in other consequences including loss of concessional tax status, being fined or sued, risk being ‘wound up’ and jeopardising all member benefits in the fund.

In addition, if a trustee intentionally or recklessly fails to comply with their investment strategy, the trustee(s) will be liable for a penalty.