Peter: Hello and welcome to Switzer Investing Insights, brought to you by nabtrade. And the big question is, is your SMSF investment strategy up to scratch? The tax office has been sending some notes to a number of SMSF trustees, and the question is around the calibre of your investment strategy. Paul, what do some people need to know?
Paul: Yeah, so the ATO has been concerned about diversification. In other words, this letter went out to a number of trustees who had more than 90% of their assets in one asset class. So, it is a timely reminder about the investment strategy and the importance of it in running a fund and making sure you're acting with it. So let's actually talk about some of the prescriptive things about an investment strategy.
Paul: And also how you put one together and make sure, if you have one, that it really is up to scratch. First of all, it's important to say that you are required to have one as trustees. It's actually set out in the law.
Paul: It should be in writing. The law is not prescriptive about it being in writing, but it's very hard to prove to the tax office or your auditor that you've got one if it's not in writing.
Paul: And the law also requires that it be reviewed regularly, that's at least once a year. But whenever your circumstances change I think is a good reason to actually get the investment strategy out and make sure the fund is, been running in accordance with that. Let's look at some of the things that your strategy should consider. I suppose at the top of the strategy is also just to think about the likely return of the fund's investments and the risks you're going to be taken.
Paul: So in what way is that risk going to return trade off? What return are you after with different investments? What's the risk of investing in that particular asset class? We mentioned diversification. This is the one that the ATO was worried about. So, how exposed will the fund be to an individual asset or potentially an individual asset class? For example, shares. If it was 100% of shares, some people might say that that's not really sufficient diversification.
Peter: Yeah, but Warren Buffet wouldn't, Paul, because he once said that diversification is for wimps.
Paul: Well, diversification is for wimps, Peter, but most of us are wimps, and I think that's-
Peter: Yeah, I'm a wimp, too.
Paul: And I'm a wimp, too. So that's one of the reasons we do diversify.
Paul: The need for liquidity, for the fund to be able to meet its cashflow requirements. And that might be, for example, having to pay out...
Paul: ... for pension and so forth.
Paul: We talked about liabilities. And finally, you are required, this was a change that came in a couple of years ago, you are required to at least consider the insurance needs of the members. And what policies, if any, the fund might wish to take out. You're not required to take insurance for the fund, but you are required to formally review the insurance needs of the members.
Peter: And it's highly relevant when your members are younger and have, say responsible like they're paying off home loans or they've got young kids.
Paul: Yeah, absolutely. So, let's talk about actually putting a strategy together or making sure that yours is appropriate. I always think a really good place to start with any strategy document is to talk about the objectives.
Paul: This is, you're talking about the funds and investments, so they should have an objective. So, properly the objective is going to be, and you might have many objectives, is going to be around return of risk. So, a sample of Victor's might be, for example, return over the medium of say consumed CPI plus 3%. In other words, an inflation plus 3% to top return.
Paul: You might have an objective to generate income of at least $80,000 a year or $100,000 a year. So, in other words, to cover the payment of pensions, whatever it is.
Paul: Or, to grow the fund by 5%, but you can put the objectives in place. You might have both some short term and some medium-term objectives. I think also to detail any particular needs of any of the members. That might be, for example, the payment of a pension.
Paul: So, the fund is going to have to provide for that payment, whatever the draw down is. Or if, for example, the members might be looking to to withdraw a lump sum from the funder in a couple years' time to pay off a mortgage or go on an overseas trip. That would be detailed in your investment objective.
Peter: It's starting to sound like a living kind of strategy, isn't it?
Paul: Yeah, and that's the whole idea about a review and making sure it's appropriate. Most importantly, you should outline the fund's target asset allocation, and that's going to be different depending on particular about what sort of return objectives. But also what risk you want to take, and that's where you might say you have, for example, you're going to have a balanced approach. 30% in Australian equities, 20% in overseas equities, 50% in fixed income, whatever it is. It's going to be sort of a target, and you may not be exactly where the fund is, but it's good to set out what your targets are going to be and maybe what benchmarks you're aiming for. I think you would also detail the eligible security types. In other words, shares.
Paul: What type of shares you might want to purchase. You might, for example, have a requirement that you don't want to share below a market cap of X, or make it the top 100 or whatever it is. Considerations relating to return, risk, diversification, liquidity. Potentially also detail any investment exclusions. So, you might say, for example, the fund might... The trustees might say, "We've all got a lot of property outside super."
Peter: Yeah, good point.
Paul: "We actually don't need the super fund to invest in property." So, you might,, for example, have an exclusion saying, "We're not going to invest in property." You might say, "We don't want to invest in..."
Peter: Coal mines.
Paul: Yeah, coal mines, for other reasons.
Paul: Consider the liquidity issues we talked about so the fund can discharge its liabilities. And finally, this is where you document the insurance needs, if any, of the members.
Peter: Yeah, that's a good point, yeah. So Paul, it seems to me that the ATO is trying to encourage us to run our self managed super funds in a more professional way.
Paul: And that's the important thing to remember, Peter. It is the money we're managing for ours, us and their partners and other other people, and we should be professional in the way we manage it.
Paul: And that's exactly what the tax office is doing, and what the law says that we're required to do. Because we are actually managing this in trust.
Peter: Yeah, exactly.
Paul: And there are obligations that come with that.
Peter: Okay. That’s Switzer Investing Insights brought to you by nabtrade. Thanks for joining us.