Commentary recently by ATO assistant commissioner Dana Fleming that SMSF investment strategy documentation with ranges of 0 – 100% are not acceptable certainly sparked a significant response from within the industry with some arguing that the Regulator over-stepped their mark in respect to decisions being made by trustees. Well, in this article I want to share with you why this view by the ATO is the right one and how trustees should respond.
Let me be clear from the outset, circumstances may exist where asset ranges may have lower and upper ranges between 0 – 100%. However, for the large majority of SMSFs, this is not the case.
Speaking to SMSF Adviser during the recent SMSF Summit events around Australia, Dana Fleming made the following comments:
“The guidance will make it clear that this approach does not in our view address the requirements [in regulation 4.09]. No doubt there will be some feedback on that but I think it’s an important line in the sand to say that this approach is not turning your mind to formulating your investment strategy to achieve your retirement objectives, that’s just saying I might do anything and I’m not sure what it is.”
Why the ATO is right
To understand the requirements that must be satisfied for SIS Regulation 4.09 regarding the formulation of a fund’s investment strategy, you can turn not only turn to information generally provided by the ATO, but also reference guidance provided by APRA, in particular SPG 530, a prudential practice guide on Investment Governance. Whilst the landscape is different for an APRA-regulated fund to that of an SMSF, there are still important lessons that can be naturally applied from this guidance for SMSF trustees.
When looking at portfolio construction, the guidance suggests that in the formulation of an investment strategy that holds more than one asset that the trustee determines asset allocation targets, and ranges appropriate to achieving the investment objectives of the fund. Therefore, is simply having ranges of 0 – 100% across all available asset classes appropriate for the SMSF? In many cases, probably not.
As I suggested earlier, it is not to say that in certain circumstances that particular asset allocation ranges of the fund could reflect (appropriately) 0 – 100%. However, as trustee it will be important to understand the technique and approach to investing within the fund, whether it be:
- strategic asset allocation – arguably most relevant within the SMSF landscape where trustees would take a more long-term asset allocation approach with targets and ranges. It is expected that these will remain relatively static – in this instance 0 – 100% ranges would be seen as inappropriate.
- dynamic asset allocation – this investment approach permits asset allocation targets to be changed during the investment period as a result of changing market factors or views of the trustee (or their investment adviser) on short and medium terms views about market conditions – in this instance it may be appropriate for some asset allocation ranges to be much broader, including 0 – 100%.
- tactical asset allocation – this approach may have the trustee decide to deviate from the target asset allocation for short-term tactical opportunities presented in the market – in this instance, broader asset ranges would be acceptable.
Regardless of the technique to investing taken by the trustee, it is important to establish:
- the investment horizon and investment objectives for the fund;
- the initial target asset allocation for each asset class;
- asset allocation ranges for each asset class;
- consideration of allowable investment types (both allowed by deed and SIS laws); and
- any investment restrictions
Where the fund has a strategic asset allocation approach, the concept of 0 – 100% is not appropriate. What is appropriate are asset allocation ranges that would be set at levels that allow for movement of the actual asset allocation due to normal market fluctuations; that is, the ranges would not be set so wide or narrow that they render the strategy unconstrained or ineffective. It does not prevent the trustees from deviating from these asset ranges, but would adjust the investment strategy asset allocation accordingly at that time.
Consider or risk complaint
When presenting recently at the FPA Congress, an AFCA ombudsman who was in the audience during my session provide some context around investment strategies describing some of the cases the body is currently dealing with, and those that have recently been decided.
“We take everything into account when we look into things – ASIC, ATO, APRA guidance – and some of the things we’re seeing at the moment include cases where there’s no strategy, we see 0-100, we see funds that will cause huge problems if the property devalues and there’s no capacity for contributions to cover shortfall – the list goes on,”
Without adequate consideration to all of the aspects within a fund’s investment strategy, trustees are not only be exposing themselves to regulatory risks, including administrative penalties up to $4,200 (20 penalty units) but also have little or no rudder to help them move towards their retirement objectives. By the ATO putting this type of activity on the radar, it is an opportune time for trustees and the industry more broadly to step up to the plate.