ATO Alert – Does your SMSF have a diversified investment strategy?

The ATO has advised they have contacted approximately 17,000 SMSF trustees and their auditors at the end of August regarding the diversification of their fund’s investments.

Funds which, according to the ATOs records, hold 90% of more of the funds’ assets in either a single asset or single asset class will be targeted by the campaign and will be asked to review their investment strategy and clearly document the reasons behind their investment decisions.

Why is diversification so important?

Firstly, diversification is a strategy that reduces the risk of investment. Everyone has generally heard the analogy, ‘don’t put all your eggs in the one basket’. By allocating investments among various financial products, industries, categories and fund managers, diversification is designed to protect returns/capital by investing in assets that would react differently to the same event. An event might include a downturn in a particular market segment (i.e. mining OR banking) or a poor financial decision by a company’s board of directors.

There are some risks that are ‘’undiversifiable’’, commonly referred to as systematic risk or market risk. These risks are not specific to a particular company, asset class or industry. Common causes include inflation rates, exchange rates, political instability, interest rates and war.

Secondly, under the Superannuation Industry (Supervision) Regulation 4.09, trustees of a fund are required to formulate, review regularly 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:

(a) the risk involved in making, holding and realising, and the likely return from, the entity’s investments, having regard to its objectives and expected cash flow requirements;

(b) the composition of the entity’s investments as a whole, including the extent to which they are diverse or involve exposure of the entity to risks from inadequate diversification;

(c) the liquidity of the entity’s investments, having regard to its expected cash flow requirements;

(d) the ability of the entity to discharge its existing and prospective liabilities;

(e) whether the trustees of the fund should hold a contract of insurance that provides insurance cover for one or more members of the fund.

If Trustees do not comply with the investment strategy rules, the ATO can impose penalties upon the trustees.

My investment strategy is not diversified – am I in contravention of Regulation 4.09?

The ATO is not saying that a fund that holds assets in a single asset OR single asset class is necessarily in contravention of Regulation 4.09. Trustees are being asked to document the reasons why the Fund has enacted the particular investment strategy and show that any risks of the particular investment strategy have been considered. Trustees also need to be able to demonstrate that the strategy has been regularly reviewed and updated.

The investment strategy is increasingly becoming a focus of the auditor due to recent cases where auditors have been found negligent. The ATO approved 2019 audit report states that the auditors “procedures included testing that the fund has an investment strategy that complies with the SISA and that the trustees make investments in line with that strategy, however, no opinion is made on its appropriateness to the fund members.” To be able to sign off on this audit report, an auditor needs to be able to satisfy themselves that the trustees have considered all the relevant factors and the only way to do this is via a well-considered and documented investment strategy.

If you are concerned about your SMSF investment strategy compliance or have not reviewed your investment strategy in the past twelve months, you should contact a financial planner. A financial planner can assist you to fully understand the risks of your current strategy, identify potential improvements and ensure your documentation is compliant for ATO and audit purposes.

If you do not have a financial planner, Sandy Gosper at Kennedy Barnden can assist you. Please contact the office on (02) 43656789 to book an appointment.