All super funds, including self managed super funds (SMSFs), are required to have an investment strategy to provide fund objectives and direction. This ensures the fund’s investments are directed to the sole purpose of providing benefits upon retirement for members and their dependants when they are due and payable.
Under the Superannuation Industry (Supervision) Act and Regulations (SIS legislation), it is the duty of trustees to formulate, regularly review and implement the fund’s investment strategy otherwise they may be penalised.
All investment strategies must take into consideration a range of requirements including the risks associated with the fund’s investments, returns on those investments, diversification, liquidity and taxation consequences. While the formulation and development of the investment strategy may be relatively easy, as it may be couched in broad terms, maintaining the strategy as part of the regular review may be where the ‘art and science’ of the strategy really occurs.
This is particularly the case in ensuring the asset allocation linked to the strategy is consistent with what actually happens with changes in the fund’s investments. It is for this reason that the asset allocation of funds are usually broad to provide a wide degree of flexibility.
Let’s look at an investment strategy and its asset allocation
as originally formulated for an SMSF. If we consider a typical SMSF, it would have around 25% in direct Australian shares, 35% in cash and term deposits and 15% in direct property. The remaining 25% of the fund would be spread across listed trusts, unlisted trusts and related party investments. Over the past 10 years these asset allocations have remained relatively stable according to the ATO statistics.
If we look at ASIC’s Moneysmart website, they consider an investor with around 30% in shares and property as a conservative investor. This information can be found here:
Therefore, it would seem that an SMSF with a typical asset allocation in its portfolio would be considered to be in the ‘conservative’, moving towards a ‘balanced investor’ category. Based on the ATO information, the typical fund would have at least 40% of its investments in direct
Australian shares and direct property.
The question for a fund is whether the asset allocation
suits the fund’s circumstances and its portfolio construction. The overall investment volatility of a conservative strategy may be relatively stable, however, it needs to be ensured the cashflows generated from the underlying investments or an allocation of cash are able to pay the bills when they become due. This requires making a reasonably accurate estimate of the costs of running the fund such as accounting and audit fees, brokerage and insurance premiums.
In addition to the general running costs of the fund, adjustments may be required to the fund’s investment allocation as the members of the SMSF approach retirement. This may require changes to the fund’s investments so that any lump sum or pension can be paid on time. In some cases it may be the investments within the asset allocation that require changing, for example, moving from growth shares to shares that have a history of paying consistently high dividends. Other situations may require large changes to the asset allocation to enable the cash flow to meet the changed circumstances of the fund.
This could occur where an SMSF has a high proportion of its investments in one property and a lump sum or pension may require the payment of a large amount of cash. In any decisions the trustees make in relation to the fund’s investment strategy and asset allocations, the important things to keep in mind are:
- Try to avoid taking undue risks with your underlying investments, which increases the likelihood of short-term losses. For example, think twice before moving from relatively stable shares to speculative shares even if you think a short-term win will come to the SMSF.
- If the fund is considering payment of an income stream, ensure the cash flow from the asset allocation is sufficient to pay the required amount.
- If there is a relatively long term involved before benefits become payable from the fund, the potential capital growth of the investment is an important consideration.
- Consider the ravages of inflation and protect against the reduction in the real value of the fund’s investments.
All trustees and members of SMSFs have a range of attitudes towards risk and how they see their fund’s investments performing over time. When it comes to the fund’s investment strategy and asset allocation it is important to carefully consider its overall risk profile or tolerance, including the asset allocation’s impact on the overall investment portfolio.