SMSFs give members control and flexibility over the investments that will fund their retirement income, and given these characteristics, some start life based on a single large asset – perhaps a residential property or the commercial premises out of which the family business operates.
Holding one valuable investment as the core of the fund’s portfolio may benefit members over the long term, but it exposes the fund to risk if the asset loses value.
Regulations require SMSFs to have a written investment strategy that considers issues such as diversification of risk, as well as expected returns, and the availability of cash for covering management costs, tax expenses and making lump sum and pension payments when needed.
The investment strategy should be reviewed at least once a year.
Haywood Financial Management and Partners financial adviser Scott Haywood says a fund’s auditor will check the trustees have adhered to the investment strategy and completed all paperwork in line with regulatory requirements.
“The auditor will want to know everything: goals and objectives, what trustees are expecting for investment returns and whether that’s fair and reasonable,” Haywood says.
Funds that don’t adequately consider and explain their plans may be penalised.
The review
One of the first steps in reviewing a fund’s investment strategy is to consider the members’ expectations and appetite for risk.
“It is helpful if all members of the SMSF have aligned risk profiles and aligned goals and objectives,” Haywood says.
“Unless there is alignment, there can be problems.”
Each member needs to understand the investment strategy and have a similar view on what assets the portfolio will hold. And members need to be realistic.
“You can’t have all the investments in bonds and cash but want a return of 7 per cent; that’s not realistic,” Haywood notes.
The assets included must also be capable of meeting the fund’s cash-flow needs. Funds whose members have retired and are drawing a pension will need to hold income-generating assets, such as property, fixed interest and infrastructure, or have assets that can readily be converted to cash. Funds with younger members mainly need to cover running costs.
Flexible but focused
According to Haywood, SMSFs should keep their investment strategies fairly flexible to take full advantage of the options available. Depending on the members’ risk tolerance and preferences, it may be appropriate to allow the fund to invest in assets such as cryptocurrency or to hold between 0 and 100 per cent cash if that would help the trustees to control the portfolio.
However, he points out the strategy must have some focus. The ATO, which regulates SMSFs, will not accept an investment strategy that allows the fund to invest from 0 to 100 per cent of its funds in every asset class. If the strategy does set broad ranges, the fund needs to explain why this is needed to achieve the investment objectives.
Consider diversification
Every investment comes with risk and the SMSF investment strategy needs to consider how risk will be managed.
“When you are a trustee of an SMSF, you need to take the same level of responsibility and diligence with your investments as the trustees of a large industry or retail superannuation fund would do,” Haywood explains.
Diversification is a key tool for protecting portfolios. Spreading investments across several asset classes with different factors affecting performance helps to smooth overall portfolio returns, as gains in one asset class compensate for losses in another.
Buying shares and cash products may help an SMSF that holds direct property to diversify, but to gain better protection and improve overall return potential, trustees could consider adding investments in assets such as infrastructure, energy projects and entrepreneurial ventures.
These types of investments can be difficult and costly for SMSFs to access directly. Investing through managed funds or services such as Hostplus Self-Managed Invest may be a better option, allowing SMSF trustees to retain control over asset allocation decisions, while participating in investments typically reserved for institutional investors.
An investment strategy review does not have to be complicated, but it does have to be done. SMSFs can use the review as an opportunity to tune up their portfolio and safeguard returns to achieve better retirement outcomes for members.
