DBA Lawyers director Daniel Butler said while the Superannuation Industry (Supervision) Act and the Superannuation Industry (Supervision) Regulations do not prohibit the use of derivatives by SMSFs, they can represent a risky investment.
Mr Butler said that if clients intend to engage in derivatives, the SMSF practitioner should ensure there is a corporate trustee structure in place, ensure the deed and investment strategy allows for investment with derivatives, and ensure the derivative is the kind that can be legally acquired by an SMSF.
In 2010, APRA released a practice guide covering derivatives and while it has since been withdrawn, the guidance stated it is “inappropriate for trustees to use derivatives for speculation” and that the “use of derivatives other than for hedging purposes is likely to give rise to unique risks”.
The use of derivatives for speculation could refer to investment activity that results in the net exposure of the fund to an asset class being outside the limits set out in the fund’s investment strategy, APRA stated.
APRA said this could also refer to investment activity where the risk for the whole portfolio is outside what is considered appropriate in the fund’s investment strategy.
“APRA also doesn’t like uncovered derivatives where you have a position and it’s an open position,” said Mr Butler. “People get blown out of the market with open positions, so you could have an open position where you don’t have a cover of some description [and] where your maximum position is open.
“Unfortunately, over the years, I have seen some clients take $1 million of retirement savings and blow it into the ground within months on derivatives.”
In one case, a client blew $600,000 in three months on options trading, but fortunately, in that case, a corporate trustee structure was in place.
“If he had individual trustees, his negative 300 would have come home to him,” he said.
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The majority of contacts I have from people who trade in derivatives are those who use low cost online administrators with no personalised advice. They haven’t taken advice as “they know everything already about derivatives” and “know they can make money trading”. I politely decline to help with strategy work, even simple stuff like TTR as I know the fund will be in trouble within a few years and these clients will be back looking for someone to blame. I know that sounds harsh but my business case is to only deal with clients with lower risk profiles/tolerances to mine!
Questions for Mr Butler:
while an uncovered call would be speculative (as the stock price good go sky high), an uncovered put would only risk the loss of the exercise price less net premium. Would this be speculative?
re: an individual trustee being liable for the loss – unless negligence was involved, how could a wrong judgement be sheeted back? can the trustee claim any profits?Why the asymmetry?
Any trustee stupid enough to do derivatives trading doesn’t deserve any sympathy. I would be interested to know how many SMSFs follow this madness: a sure way to lose money!! And if any do “uncovered” derivatives they are stupid beyond description.