Stop Press - ATO investment strategy guidelines update

The ATO has recently issued new guidelines in relation to SMSF investment strategy compliance.  The rules or legislation in this regard have not changed but the ATO has stepped up its documentation requirements.

The adoption of a tailor-made investment strategy approach by the ATO will necessitate changes in some industry practices.  A "one size fits all" template is unlikely to deliver the required results. Financial advisers may potentially add value by their facilitation with the clients’ SMSF investment strategy formulation and review under the new guidelines.

Are the guidelines appropriate?

It can be argued that in the self managed context investment guidelines are unnecessary.  It is all very well for the Regulator to say that if the fund loses money then the government will have to pick up the tab through increased social security payments during the member’s retirement.  The fact is that no-one wants to rely purely on the aged pension. 

Members of SMSFs are keen to maximise their returns and have proven year after year that they can do so equally as well as public offer funds. There is no need for an SMSF to have an investment strategy which is effectively the trustee/members telling themselves what to do.  The closely held nature of the investments by the trustee/members ensures that they will do all they can to bolster their fund’s returns so as to provide adequate financial support later in life.

It has to be borne in mind that the ATO is not a prudential regulator and does not review the merits and suitability of the investments in an investment strategy.  The investment strategy covenant in the SIS Act is an operating standard (SIS Regulation 4.09(1)).  The ATO will assess whether the trustee has complied with legislation in the formulation, review and implementation of the strategy.

In addition, a properly formulated investment strategy is also a defence and will provide an appropriate level of protection for the trustees and advisers should the investment fail, against actions that might be taken by any person “who suffers loss or damage” as a result. (Section 55(5) SIS Act).

Backdrop to the new guidelines

Two recent NSW Court decisions (Ryan Wealth Holdings v Baumgarter, Cam & Bear Pty Ltd v McGoldrick) have highlighted the burden on SMSF auditors to obtain evidence of a proper SMSF investment strategy in the audit, to determine whether the fund’s assets align with the strategy and to communicate with the trustees in relation to material risks. 

There is also a concern that less diversified SMSFs may incur a significant loss in value in the event of a fall in the price of an asset, especially where LRBAs are involved.

The ATO ‘best practice’ approach

• The investment strategy must be appropriately tailored to each fund’s specific circumstances.  It is not enough just to set out the investment strategy or “repeat the words in the legislation”.  The trustees have to demonstrate they have considered all the Regulation 4.09(2) factors (objectives, risks, returns, liquidity, ability to discharge liabilities, diversification,  insurance cover) in a fund specific manner, taking into account all the circumstances and the reasons why the investments meet the stated goals.
• It is not a valid approach to merely specify in ranges of 0-100% for each class of investments. This does not reflect proper consideration of the investment strategy. The percentage or dollar allocated to each class of investment should support and reflect the articulated goals and investment approach.  Material assets should be listed if percentages or allocated portions are not used.
• The Fund has to demonstrate additionally it has the mechanism to review the strategy and it adheres to the strategy and the review process.
• The ATO has a warning in relation to using standard investment strategy templates.  “These may not satisfy the super rules” and “they must be appropriately tailored to your fund’s particular circumstances”.  Off the shelf templates will not meet this requirement.  To start tailoring the fund’s circumstances to investment outcomes may involve providing financial advice with the consequential licensing and documentation implications.

Single asset strategy

Diversification and the risk of non-diversification is an important factor to consider in the SMSF investment strategy.  However, investment in one asset or a single asset class is not prohibited.  Funds may have a single real property asset with LRBA, or predominant investments in cash or equities.  Different objectives, risk tolerance levels, fund circumstances (e.g. member working and anticipate making more contributions, members have investments in other asset classes outside super, the lacklustre returns from fixed interest vs high growth investments) may sometimes lead to a single asset strategy.  It is important in the process to consider all the factors and in particular, the concentration risk (risk associated with lack of diversification) which is a risk specific to single asset strategies.  The ATO specified that “it should include how you still think the investment will meet your fund’s investment objectives including return objectives and cash flow requirements.”  It is essential to have good documentation.

Fund auditors

SMSF approved auditors have an important role in contravention reporting to the ATO and in drawing the attention of the trustees to super law contravention.  SIS Regulation 4.09 is a reportable Regulation, meaning that non-compliance with this Regulation may be a reportable event for the SMSF auditor.  The ATO has the following guidelines for SMSFs. 

"The auditor will check that:

• your SMSF had an investment strategy in place for the relevant financial year that considered the factors outlined [Regulation 4.09(2)]
• your fund’s investments during the relevant financial year were in accordance with that strategy
• your strategy had been reviewed at some stage during the relevant financial year."

This prospect of a negative audit report should ensure that trustees meet the investment strategy requirements.