Practical how to guide on developing an important 'must have' document for your SMSF

1. SMSF Investment Strategy
Australian Shareholders Association
Presentation Resource Library
May 2013

2. Disclaimer
• The ASA is not licensed to give financial advice.
• The content of these presentations is not designed to
provide any specific investment advice to any person
present.
• The ASA does not accept any responsibility to inform you
of any matter that subsequently comes to our notice that
may affect any of the information discussed.
• Anyone wishing to act on any matter discussed should
seek independent advice from a licensed financial
adviser.

3. Outline
This presentation will cover the following topics:
• What the law says – important legislation
• What the ATO says – key points for SMSF trustees
• What does this mean – interpretations and
practical applications
• Components of an Investment Strategy
• How to prepare a strategy
Through out the presentation there will be examples
provided to help trustees prepare an investment
strategy.

4. What the Law Says
The Superannuation Industry (Supervision) Act 1993 is
the relevant act for SMSF trustees.
All SMSF trustees are bound by this legislation in the
way that they can operate their SMSF.
The legislation is clear that there is a need for an
investment strategy.
Note the four key points in the following slide are the
areas that must be addressed by an SMSF investment
strategy, however trustees are not limited to this and
can include other topics.

5. SIS Act [Superannuation Industry (Supervision) Act 1993]
Section 52 (2)(f) of the SIS Act, requires the Trustees to “formulate and give effect to
an investment strategy that has regard to the whole of the circumstances of the entity,
including, but not limited to the following:
• the risk involved in making, holding and realising, and the likely return from,
the entity's investments having regard to its objectives and its cash flow
requirements;
• the composition of the entity's investments as a whole including the extent to
which the investments are diverse or involve the entity in being exposed to
risks from inadequate diversification;
• the liquidity of the entity's investments having regard to its expected cash flow
requirements; and
• the ability of the entity to discharge its liabilities."

6. What the ATO Says
The ATO has provided further clarification on
some of the key points including stating that
an investment strategy must be prepared and
implemented.
The following slide shows the ATO’s view which
is aligned with the legislation. It is worth
reading as the language is easier to
understand.

7. The ATO’s view
Trustees are required to prepare and implement an investment strategy
that takes into account the whole of the fund’s circumstances which
includes, but is not limited to:
• the risks associated with the fund’s investments;
• the likely return from investments, taking into account the fund’s
objectives and expected cash flow requirements;
• investment diversity and the fund’s exposure to risk due to
inadequate diversification; and
• the liquidity of the fund’s investments having regard to the fund’s
expected cash flow requirements in discharging its existing and
prospective liabilities.

8. What the ATO Says
It is important for SMSF trustees to clearly
understand that they are responsible for
ensuring that their funds Investment Strategy
is prepared and implemented in accordance
with both the SIS legislation and the ATO
requirements.

9. ATO’s View
What this means for SMSF trustees in practical terms is:
• An appropriate investment strategy will set out the investment
objectives of the superannuation fund and detail the investment
methods the superannuation fund will adopt to achieve these
objectives.
• An investment strategy should be unique to the requirements of
the fund and its members and should be reviewed regularly and
updated as required.
• Trustees must ensure that all investment decisions are made in
accordance with the investment strategy and should seek
investment advice or appoint an investment manager in writing if in
any doubt.

10. ATO’s View
Remember also that:
• The SIS Act provides a defence to trustees against an action for loss
or damage suffered as a result of the trustee making an investment.
This defence is available where the trustee can show that the
investment was made in accordance with an investment strategy
formulated under the investment strategy covenant [SISA s55(5)].
• It is therefore recommended that the investment strategy be
documented, such as in minutes, so that trustees can show that
investment decisions are made in line with the investment strategy.

11. What does all this mean?
• Although the law does not actually say that the strategy has to be in writing the
fund’s auditor must sign the audit report stating the fund has adopted its
investment strategy. It might be hard to show this unless it is in writing. Also have
regard to the SIS Act defence provisions.
• Many trust deeds come with an “investment strategy” – these are cut and paste
templates and usually not detailed enough and certainly do not take into
consideration an individual trustees particular circumstances. It is suggested that
trustees need to prepare their own tailored and detailed strategy.
• Trustees need to sit down with the other trustees of the fund and work out what
they want.
• If funds have members of different ages, risk profiles, etc it may be difficult to have
only one strategy. If the fund needs more than one strategy then trustees need to
segregate the assets.
• If a fund has reserves trustees probably need a separate strategy to manage these.

12. Components of a Strategy
A good Investment Strategy should include:
• Purpose of the Fund
• Investment Objectives
• Investment Strategy
• Risk
• Diversification
• Liquidity & Liabilities
• Insurance
• Other

13. Purpose of the Fund
The purpose is usually to provide both lump sum and
pension retirement benefits for the members and in
the event of the members’ death before retirement, to
provide benefits for the dependants of the members.
Note: The law states that the purpose of a fund with
individual trustees can only be to provide pension
benefits.

14. Investment Objectives
First consider and document:
• The number, age and risk profile of the members.
• The retirement plans of each member: pensions or
lump sum.
• Current and future liabilities of the fund including
tax, expenses and pensions.
• Future member contributions.

15. Investment Objectives
Then take into account:
• Fund’s current investments.
• Members other assets.
• The need to segregate assets in the fund - eg members with
different risk profiles.
(If trustees segregate the assets, then they can just have
separate classes of members eg Class A and Class B and
prepare an objective and strategy for each.)
The Trustee should document through relevant minutes that
they have taken the circumstances of the fund into
consideration when formulating the investment strategy.

16. Investment Objectives
Formulate a General and/or Specific Objectives
For example:
• To achieve a long term rate of return approximately
equal to CPI. It is expected that year-on-year returns will
vary little with a small probability of a negative return in
any one year.
• To achieve cash related returns ensuring that the capital
value of the fund is preserved at all times, so that a
negative return is avoided.

17. Investment Strategy
Identify the types of assets the fund will invest in and
document this.
For example:
Investments shall be made in accordance with the Trust Deed and any
overriding superannuation legislation. The fund’s investments may
include any investment considered prudent at the discretion of the
Trustee and may include but not be limited to all or one of the
following:
• direct equities, stocks, instalment and other investment-style
warrants and derivatives and including participation in dividend
reinvestment programs, rights issues, share participation and buy-
back programs and the like; [Continue for other assets types.]

18. Investment Strategy
• Identify both a long-term (3-5 year) and short-term
(usually 2 years or less) strategy.
• Outline the fund's target ranges (as a percentage) for
each asset class it intends to invest in, based on the
current or future asset allocation.
• A separate strategy needs to be set out for each class
of members.
• Identify ranges for each asset class – these can be
indicative.

19. Investment Strategy
This is an example of possible Asset Class Range table :

20. Risk
Investment risk is borne by the members, as fluctuation in investment returns
will affect the level of the members’ benefits on withdrawal.
Detail each member’s risk profile or one for the whole fund.
For example:
• Class A members have a relatively long time horizon. These members are
prepared to endure a reasonable level of volatility of returns in
expectation of long term growth.
• The composition of the members is diverse and the collective risk
tolerance indicates that there should be a balance of reasonable risk and
volatility to achieve long term capital and income growth.

21. Risk
The relationship between long term risk and return in the different
classes also needs to be addressed.
For example:
Cash
Cash will generally be held in a cash management account (CMA)
which is rated AAA and the trustee considers this to be reasonably risk-
free. The CMA provides ready access to funds at a higher interest rate
than an at-call savings account. The trust expects to achieve a return
of approximately the 90 day bank bill rate less 1%.
This needs to be done for each asset class in the previous table.

22. Diversification
• Diversification is a general investment principal that states
that spreading funds across a range of different
investments helps to reduce risk and smooth investment
returns.
• If the fund is not diversified, then the strategy needs to be
explained in detail.
• The Trustee needs to outline various ways that
diversification can be achieved, such as investing in
different asset classes as opposed to one single type of
asset.

23. Diversification
Some examples:
• Diversification is achieved through a mix of investments across a range of
asset classes. The Trustee recognises that diversification can result in
significant reduction to return volatility while maintaining the level of
anticipated return.
• Funds are primarily invested in equities and the Trustee recognises the
higher risk and volatility of this strategy. Volatility will be compensated by
the higher return and growth in the longer term. The shares are invested
in different industries and sectors, which will spread risk to a satisfactory
level.
• Funds are primarily invested in fixed interest and cash. This is suitable for
the fund’s policy of maximising capital preservation and avoiding a
negative return.

24. Liquidity & Liabilities
Issues to Consider and Document
• Cash for pension, taxation and other operational expenses.
• Reference should be made to short, medium and long-term needs.
Trustees should consider and document the following where members’ assets
are not individually segregated.
• Members ages and time horizon in the fund.
• Any anticipated benefit payment amounts over the next 1-5 years.
• If the fund’s assets are not diversified eg one property, how that will be
handled if a member wishes to exit the fund or dies and the remaining
member(s) are not beneficiaries.

25. Insurance
Trustees are also required to consider insurance
for members as part of the fund’s investment
strategy.
This does not mean that insurance must be
taken in an SMSF but only that the trustees need
to consider it.

26. Other
Reserves Management Strategy
• A separate strategy (or strategies) needs to be detailed for
reserves.
On-Going Monitoring of the Investment Process
• The ATO rules state that the Investment Strategy is to be
reviewed ‘regularly’. It is recommended anecdotally by the
ATO that this should occur at least 3 times per annum.
• It should also be reviewed if a major change in strategy is
contemplated e.g. purchase of property.

27. Acknowledgement
The Australian Shareholders Association would
like to thank member Jenni Eason for providing
the material for this presentation