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Self Managed Super Fund (SMSF) Article
SMSFs and Investment Strategies

By Tony Negline.

This article may be out of date.

13th March 2008

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There is no doubt that recent market gyrations have given many super investors significant concerns.

Many Self Managed Super Fund trustees have probably taken some time to reexamine if their fund's investment holdings make sense.  It would not be a surprise if some trustees sold out last August when the market had its first real drop, then jumped back in during October when the market began to rise and haven't known what to do since the January falls.

Regardless of the recklessness of acting in haste and repenting in leisure, any trustee who has done this has effectively been doing what the super laws command them to do.

These super laws demand that fund trustees establish, document, implement and, as necessary, review an investment strategy.  When performing this function trustees must take into account the risks involved in making each investment, the likely return from making each investment, the range and diversity of investments, any risks coming from limited diversification, the liquidity of the fund’s investments, the expected cash flow requirements and the ability of the fund to meet its existing and prospective liabilities.

Where did this list come from?  In reality it has been drawn from obligations and duties of trustees of any trust which came about via the evolution of many hundreds of years of judicial decisions in Australia and the UK.  All the Court given trustee duties can be summarized as the expectation that trustees will look after a trust and its assets in such as way that the interests of a trust's beneficiaries were the trustee's own interests.

It is times like the recent past that one sees the benefit of this long developed requirement because it provides a level of formality and seriousness about how trustees are meant to go about their business.  Stock markets which fall heavily, recover, fall again then don't fully recover losses for sometime are the most serious business most SMSF trustees will face.

The tax office has said that they expect a SMSF's Investment Strategy, including any change, to be in writing.  The ATO does not believe that the Investment Strategy requirement demands that a fund invest in a range of liquid investments – that is, investments that can quickly be turned into cash – that are risk free.

If a trustee has written an Investment Strategy but not implemented it very well then at the moment the ATO will encourage a trustee to fix the problem up.  In reality it could impose a penalty.

Over the years we have seen many Investment Strategies.  Quite a few show that trustees tend take their Investment Strategy job very lightly.  For example it is common to see trustees who are allowed to invest their fund's assets into a range of asset classes such as shares, cash, fixed interest and property.  No problem there.  But the trustees have also given themselves authority to invest anywhere between 0% and 100% for all asset classes.

This is done to give a trustee maximum flexibility.  These wide strategic ranges are, in many ways, not an Investment Strategy because they do not show how a trustee has taken all the investment strategy rules into account.  What they do show is what the trustee will do once they have taken these matters into account.  Investment strategic ranges are important but they are not the end of the investment strategy story.

Perhaps the easiest way for a SMSF trustee to deal with this investment strategy requirement is to ask a financial adviser to give them formal advice.  The range of issues which trustees have to consider covers most of the areas that a good financial adviser must work through before recommending particular investments.

However the formal advice process established under the Corporations Act does not cross over well with the super investment strategy requirement.  For example technically an adviser can only recommend certain types of products such as shares and managed funds.  This does not mean that an adviser cannot take other investments into account when framing their investment strategy.  But it does mean that a licensed financial adviser can't recommend residential property unless it is being offered via a particular structure.

How should the financial adviser provide the investment strategy?  A SMSF is a separate legal entity and the super rules demand that trustees deal with their fund's super assets in isolation to everything else going on in their member's lives.  In practise this is very hard to do with SMSFs because the trustees are the members and hardly anyone will not look at their super and not work out how it should be invested without reference to what they own outside the super environment.

When a SMSF trustee asks a financial adviser to draft their investment strategy then the trustee might ask the adviser to, firstly, take all the super fund's investments into account when working out the best strategy and, secondly, to provide the trustees with their own separate advice document for their personal affairs.  This is more expensive but it allows a trustees to clearly demonstrate that they have sought where possible to keep the affairs of their super fund separate from everything else.

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