An SMSF Investment Strategy is a legislative requirement for every Self Managed Superannuation Fund.
Upon establishment of a SMSF you will often be provided with a generic template SMSF Investment Strategy. These types of ‘off the shelf’ Investment Strategies are designed to simply ‘tick the box’ of the SMSF being compliant.
However, in many cases it would not serve its purpose if scrutinised under an audit – mainly because they are too vague and people forget to read them to make sure the actual portfolio of the SMSF is consistent with the Investment Strategy.
What is an SMSF Investment Strategy?
Superannuation legislation requires the trustee of a SMSF to formulate, regularly review and give effect to an Investment Strategy for the SMSF and each asset of the SMSF having regard to:
- this risk involved in making, holding and realising (selling) and the likely return from the investments, having regard to its objectives and cash flow requirements
- the composition of the SMSF’s investments and the extent to which they are diverse, or the risks incurred due to inadequate diversification
- the liquidity of the investments having regard to its cash flow requirements
- the ability to adequately value assets
- the ability of the SMSF to discharge (pay) its existing and prospective liabilities (i.e. pension payments, tax, fees, etc.)
- the expected tax consequences in relation to the assets of the SMSF
- the costs that may be incurred by the SMSF in relation to its investments
- Other matters
The information above is basically a regurgitation of the relevant legislation. So, what does it all mean? How does it work on a practical level?
What does a SMSF Investment Strategy template look like?
The information below is not a comprehensive or exhaustive guide to creating an SMSF Investment Strategy. It is merely intended as an outline of what should be included, but may omit other requirements to be included in an Investment Strategy.
There is no set structure for a SMSF Investment Strategy template, provided it covers off on the information above.
Personally, I would have something along the lines of the following:
PAGE 1 -TITLE PAGE
Name of the SMSF, title of the document,date.
- E.g. Investment Strategy for the SuperGuy Superannuation Fund. 1 July 2014.
PAGE 2 – RISKS INVOLVED
Transactional risks, management risks, volatility, gearing/borrowing, liquidity, asset specific risks, etc.
PAGE 3 – COMPOSITION OF THE INVESTMENTS
Include allocation to each type of investment and/or asset class compared to what the ‘ideal’ allocation should look like.
Maybe use a table to show actual allocation vs target allocation as well as any variance
|Actual Allocation||Target Allocation||Variance|
Followed by…. as trustees, we expect the allocation to each investment or class of investment to fluctuate on a regular basis, due to the nature of the portfolio. Therefore, we accept a variance of up to 20% of the Target Allocation as acceptable.
This section should also include discussions on diversification, or lack thereof. For example, having a 60% allocation to one illiquid asset such as a commercial property would be considered a lack of diversification, as it usually cannot be sold within a timely manner and, if it is sold, the whole asset needs to be sold (i.e. part of the property cannot be sold).
PAGE 4 – LIQUIDITY AND CASH FLOW
You want to discuss the ability and time frame for assets to be realised (sold and proceeds received) and what hurdles may be in the way. You should include any situations where investments may need to be sold on short notice and whether you would expect to receive a fair sale price in such a situation.
PAGE 5 – ASSET VALUATIONS
Valuation of the SMSF assets is important on a number of levels. It determines member balances, required pension payments, taxes and many other factors.
You will need to outline how each asset or class of assets will be valued and how often, as well as discussion around the adequacy and reliability of those valuations.
For bank accounts and listed shares owned by the SMSF valuation is simple, because these assets are valued on a market on a day to day basis and valuation is easy to obtain.
But what if the SMSF owns real property or shares in a private company. How will these be valued? Will the method and regularity of valuations be reasonable and acceptable if the SMSF was ever audited?
PAGE 6 – DISCHARGE LIABILITIES
Your SMSF will have certain cash flow commitments that it needs to meet, whether it be now or in the future, such as fees, management costs, expenses relating to assets, taxes, pension payments, loan repayments, etc.
This section of the SMSF Investment Strategy should outline how your SMSF plans on meeting these expenses, specifically relating to the types of assets or investments owned by the SMSF and how easily such investments could be sold if cash was required immediately.
PAGE 7 -TAX CONSEQUENCES OF INVESTMENTS
Each investment has different return characteristics. Some assets produce income or interest only (such as bank account and term deposits), some may be reliant on capital growth (such as private equity) and some (generally most) will have a combination of income and growth, such as Listed Shares (dividends and increase in price) or Real Property (rent and increase in value).
This section of the SMSF Investment Strategy should refer to the taxation consequences of the earnings (including capital gains) from the assets of the SMSF and how these will be paid.
Generally, income is taxed on an annual basis at a rate of 15% and Capital Gains are taxed upon sale of the assets (if a gain is realised) at 15% – reduced by 1/3rd if the asset realised was owned for longer than 12 months. However, this may be able to be reduced by capital losses throughout the year, or carried forward losses from previous years.
All earnings (including capital gains) are received tax free in pension phase or the portion of the SMSF that relates to pension phase.
PAGE 8 – INVESTMENT COSTS
What are the costs associated with the investments of the SMSF? This could include:
- brokerage costs
- stamp duties
- investment management
- financial planner fees
- property management, rates, maintenance, etc.
- sale costs and exit fees
Include discussion on how these costs will be met and impact any returns from investments.
PAGE 9 – OTHER MATTERS
This should include anything else you feel is relevant to the overall SMSF Investment Strategy. Think about these questions:
- How often will the SMSF Investment Strategy be reviewed?
- Are the returns of the SMSF portfolio being compared against a benchmark (e.g. inflation, RBA cash rate, ASX-200 Index)?
- Is there a unique asset of the SMSF that should be justified or explained further?
- Does the SMSF have the ability to invest in derivatives?
- Will the SMSF incorporate gearing/borrowing into it’s Investment Strategy
PAGE 10 – SIGN OFF
The final page should include a sign-off from the trustees of the SMSF/ Investment managers/ Directors of Corporate Trustee or whoever is responsible.
Together with the date and location of where the SMSF Investment Strategy review was held.
How often does a SMSF Investment Strategy need to be reviewed?
There is no set time frame on the review of Investment Strategy. It is simply stated that it needs to be reviewed regularly.
I think this is because the regularity will be determined by the circumstances and investments of the SMSF.
The frequency of SMSF Investment Strategy reviews may be determined by factors such as level of contributions, stage of life of the members (accumulation or draw down or both), types of assets owned by the SMSF and so on.
If you would like anything clarified or have any further questions about SMSF Investment Strategy or any other topics, please do not hesitate to leave a comment.