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Self Managed Super Fund (SMSF) Article
SMSF valuation issues for Westpoint investors

By Tony Negline.

This article may be out of date.

22nd March 2006

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The collapse of the Westpoint group of entities and the loss of investors money is, to be frank, depressing.  Many investors will see their hard earned savings either severely depleted or completely gone.

For a variety of reasons we may never know why the monies are all gone.  If we are to believe media reports, the financial structure behind the Westpoint businesses were unsustainable.  There were simply too many outgoings compared to the promises made to investors.

Financial planners who could receive very handsome commissions for recommending these products to their clients are being blamed for encouraging their clients to invest.  It remains to be seen if any planners are guilty of negligence and because of impending legal action it is inappropriate for us to offer an opinion.

Quite a number of Self Managed Super Funds  invested quite a lot of money into various Westpoint products.  It is never good when super funds loose a considerable amount of their member's retirement savings.

Recently the Australian Prudential Regulation Authority released a revised version of their Superannuation Circular “Managing Investments and Investment Choice”.  As APRA point out its super circulars are designed to “provide general guidance on how [it] interprets and administers relevant legislation”.

Now it is true that APRA do not regulate SMSFs (the Australian Taxation Office look after that job).  However the APRA circular gives us a very good guide on some of the issues that need to be considered when a super fund trustee is considering how to invest their fund's money.

This APRA Circular deals with a trustees duty to invest their super funds investments prudently and in accordance with legislative requirements.

Super trustees must create and implement an investment strategy.  But any strategy cannot exist without objectives and you can’t set objectives unless you have some idea of where you are currently at and what you want to achieve.  Before drafting an investment strategy, trustees should consider solving two important issues, understanding the fund and developing some fund investment objectives.

The following questions may help a trustee to know their fund a little better.  Why does the fund exist?  Can the fund take risks?  If so, who will ultimately bear those risks?  What is the time horizon of the fund?  What is the expected growth (members, contributions, acquisition or disposal of assets) in the fund?  What are the fund’s cash flow requirements over the short, medium and long-term including catering for likely cash flow requirements and unforeseen events?

Once a trustee has a better understanding of a fund it’s easier to work on establishing the fund’s investment objectives.  The finished objectives might deal with a SMSF’s purpose, expectations, risk profile and time horizons.

Once you know what the fund is set up to achieve, you can turn your attention to developing the investment strategy.  The superannuation legislation requires a trustee to take into account risk and return, diversification, liquidity requirements and ability to discharge existing and prospective liabilities of the whole fund.  Some trustees build a spreadsheet model of their fund and then they change the assumptions to see how robust their strategy is.

Trustees might also find it helpful to decide at what point corrective action may be required with their investment strategy and asset holdings if the fund’s investment objectives are not being met.

For example, economists believe that three consecutive quarters of negative growth means an economy is in recession. Five negative quarters normally signifies a depression has hit an economy. What corrective action might be taken in these circumstances?

An investment strategy must also comply with the fund’s trust deed and all other investment restrictions and obligations contained in the super laws.

Developing, implementing and reviewing an investment strategy are not difficult.  Initially they will require time and effort.  A trustee might want to involve a fund’s professional advisers such as accountants and financial planners to act as a valuable sounding board on the practical and legal aspects of establishing and reviewing investment strategies.

You will notice that we haven't even talked about the actual investments a trustee decides to make.  The APRA Circular warns trustees that “awell-formulated investment strategy would not ordinarily provide that all, or a large proportion, of the fund’s assets be invested in one asset (such as a single property) or a single asset class ... if, on a reasonable evaluation, investments of a particular fund do not display adequate diversification given the nature of the fund, the onus will be on the trustee to provide a justification ... for these investments, including an outline of how they are viewed as consistent with the investment strategy”.

APRA said that if a trustee decides that “some [asset] concentration is permitted within the fund, the trustee should conduct due diligence that includes an independent market evaluation based on an arms-length transaction before acquiring the asset, or assets”.

Asset concentration is a major issue for many super funds.  A recent Federal Court case dealt with an employer super fund that had a large exposure to direct property investments.  The fund had to pay out most of its assets to departing employees however the heavy concentration of property caused the fund's trustees to sell the properties in a fire sale.  The members suffered a loss as a result.

The Court described the fund's investment strategy as inadequate and that there was a “failure to make proper provision for the chance of payouts to the members”.

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