SMSFs warned on rate rise impact as RBA decision looms

Last month, the RBA increased the interest rate by 25 basis points to 35 basis points with economists expecting further increases this year. 

In a recent article, Mr Colley said while the predicted ongoing increases in interest rates “have sent shivers down the spines of many SMSF trustees”, the effect of further rate rises will depend on the fund’s investment strategy and investment mix.

When thinking about the investment strategy for a fund, Mr Colley explained that trustees of superannuation funds, including SMSFs are required to consider factors such as risks and likely returns from investments, cash flows, investment diversification, liquidity and the ability of the fund to discharge existing and prospective liabilities.

“All these requirements are closely linked and can turn out to be a bit of a balancing act when markets are volatile,” said Mr Colley.

“It is up to the trustees to implement and maintain a portfolio of investments consistent with that strategy as it changes over time.”

An increase in interest rates, Mr Colley explained, may see increases in the value of some investments and decreases in the value of others.

“Under these conditions, some investments may provide higher income and capital gains while others may provide less,” he noted.

“This volatility may upset the balance between those investments which have been acquired to produce capital growth while others are for purposes of income.”

This means that the capital and revenue components of the fund’s income may vary, said Mr Colley.

“This may alter the fund’s cash flow and liquidity and may impact on the fund being able to pay its expenses and other liabilities,” he cautioned.

In the case of property for example, Mr Colley explained that interest rate volatility may have an impact on the price of property as borrowers may be restricted in terms of the amount they can borrow.

“Also, the price of new homes may be impacted by the increase in the price of building materials which may be manufactured by companies with high levels of borrowing,” he said.

He also warned that a volatile interest rate environment can impact on equities.

“For example, in an environment where interest rates are increasing, the value of shares in companies that have high levels of gearing may fall as profits may be impacted by the increases in loan repayments,” he noted.

“Companies which sell goods and services which relate to consumer discretionary items may see a fall in share value as consumers tighten their purse strings to pay for essential items such as home loans, fuel and food.”

He noted that rebalancing a portfolio which includes a sizeable or lumpy investment that has increased significantly may prove difficult to sell. 

“Examples include real estate, shares in private companies or unit trusts and specialised investments such as artwork and collectables,” he said.

Where markets move over time or a member leaves a fund, Mr Colley said the fund’s investment strategy may need review or an adjustment.

“However, this is a long-term objective and would be expected to occur at less regular intervals than rebalancing the fund’s portfolio. Any reallocation should aim to align the fund’s investments within its investment strategy and assets allocation ranges,” he said.

Mr Colley also reminded SMSF professionals and their clients that the auditor may look at whether the fund’s investment strategy and allocation are out of alignment. 

“Failing to meet the investment strategy requirements and put that strategy into action is a compliance issue for the fund and can be reported to the ATO by the fund’s auditor in an Audit Contravention Report (ACR),” he warned.