SMSF investment strategies: Dealing with increased scrutiny
With the 2020–21 financial year entering the last quarter, it is timely for SMSF trustees to consider the currency of the fund investment strategy, in light of the increased scrutiny being applied to the validity and effectiveness of existing documentation.
In this article, we consider the scrutiny applied to SMSF investment strategies, not only by the ATO but also by the fund auditor, partially triggered by recent case law and other factors.
Do we really need one?
Although some SMSF trustees may consider an investment strategy to be more nuisance than provide any value, the reality is that their opinion is overridden by the relevant superannuation legislation¹, and oversight by the regulator.
Importance of an SMSF investment strategy
The Superannuation Industry Supervision Act 1993 (SIS Act) and Superannuation Industry Supervision Regulations 1994 (SIS Regs)¹ require SMSF trustees to “… formulate, review regularly and give effect to an investment strategy that has regard to the whole of the circumstances of the entity including…” with a detailed list of considerations provided.
An indication of the importance of an investment strategy in the eyes of the ATO is found in the ATO Tax Ruling TR 2008/9², which covers the meaning of an Australian super fund.
In that ruling, the ATO looks at what it considers to be certain “strategic and high-level decision-making processes and activities, which include (among others):
- formulating the investment strategy for the fund; and
- reviewing and updating or varying the fund’s investment strategy….”
While it may have been considered as little more than a “compliance document”, recent ATO guidance has elevated the formerly humble investment strategy to a higher status and requires ongoing scrutiny.
The ATO’s requirements
The guidance and requirements from the ATO have effectively been provided in two parts.
Extent of diversification
Initially, in August 2019, the ATO wrote to about 17,700 SMSF trustees, as well as the auditors of those funds, regarding the limited diversification of investments of those SMSFs.
The intent of the ATO correspondence was to remind trustees and auditors that the lack of diversification should be formally considered as part of the review of an investment strategy for their SMSF.
In particular, the ATO was reminding trustees that, in reviewing the investment strategy, as well as considering the overall circumstances of the fund, they must also drill down to specific issues, one being to consider the extent to which the fund investments are diverse and the risks which could apply from a lack of diversification.
Although SMSFs do not need to have a diversified range of investments, the SMSF trustee needs to have considered the various risks that may arise from that lack of diversification.
Tailored and specific
From the second part of the ATO guidance³, released in February 2020, it became clear that an investment strategy permitting a range of investments, for all investment categories, of 0 per cent to 100 per cent would generally not be acceptable, as it would indicate a lack of proper consideration by the trustee.
In fact, the ATO release noted the investment strategy needed to be tailored and specific to the fund circumstances, not merely repeat words in the legislation.
Further, it should, according to the ATO, take into account the personal circumstances of the fund members, including their:
- employment status, and
- retirement needs
and explain how the investment strategy meets the retirement objectives of each member.
The ATO expects, in the instance of the trustee nominating 0 per cent to 100 per cent for some or all investment categories, that the trustee should articulate, in the investment strategy, why a broad range is required.
In doing so, the trustee will be seen to have given consideration to formulating the investment strategy.
In attending to the audit of the SMSF, there are currently three main areas impacting auditors:
- recent case law, which has placed significant emphasis on the role of the auditor in regard to the fund’s investment strategy;
- the expectations from the ATO that the auditor will have reviewed the investment strategy and ensured that it met the requirements of the superannuation legislation; and
- for new audit appointments, a greater vetting of the investment strategy can be assumed, as expectations of the new auditor, with “fresh eyes”, may significantly differ from those of the previous auditor.
While in most years new auditor appointments would not warrant a mention in the context of an article on this topic, the end of this financial year is likely to see a significant change of auditors, as a result of the new auditor independence guidelines for audits conducted after 1 July 2021⁴.
ATO figures indicate more than one-third of SMSF audits have been conducted “in-house”, so there is reasonable expectation that a significant number of those audits will be conducted by a new auditor after 1 July 2021.
Recent case law was also mentioned above, and the relevance of that is because of the findings that a significant percentage of blame rested with the auditor in two cases, namely:
- Cam & Bear Pty Ltd v McGoldrick  NSWCA 110, and
- Ryan Wealth Holdings Pty Ltd v Baumgartner  NSWSC 1502,
in which apportionment of the blame against the auditor in each instance amounted to 90 per cent and 80 per cent, respectively.
A thorough review of the investment strategy by the auditor makes sense, for a number of reasons.
The main steps in making sure an SMSF investment strategy remains complying are:
- ensure it is current,
- review or replace it regularly (at least annually), and
- check the review or the replacement considers:
- investment risk/return,
- liquidity and cash flow requirements,
- ability to discharge liabilities,
- extent of diversification, and
- insurance for members,
as well as the specifics of the members outlined earlier.
Although SMSF trustees may consider the investment strategy to be a compliance document, the ATO and courts place significantly greater emphasis on it, and increasing scrutiny can be expected from the ATO, and auditors, in years ahead.
Michael Harkin, national manager for training and advice, Topdocs
1. SIS Act s 52B(2)(f) & SIS Reg. 4.09(2).
2. ATO Taxation Ruling TR 2008/9 – Income tax: meaning of “Australian superannuation fund” in subsection 295-95(2) of the Income Tax Assessment Act 1997, paragraph 20.
3. Titled “Your self-managed superannuation fund (SMSF) investment strategy” – https://www.ato.gov.au/super/self-managed-super-funds/investing/your-investment-strategy/.
4. More detail is provided in the ATO guidance paper, reference QC 65081, which can be located at https://www.ato.gov.au/Super/Sup/ATO-guidance-on-independence-standards-now-available-for-SMSF-auditors/.
Tony Zhang is a journalist at Accountants Daily, which is the leading source of news, strategy and educational content for professionals working in the accounting sector.
Since joining the Momentum Media team in 2020, Tony has written for a range of its publications including Lawyers Weekly, Adviser Innovation, ifa and SMSF Adviser. He has been full-time on Accountants Daily since September 2021.