By Nicholas Ali

In February 2020, the Australian Taxation Office (ATO) issued comprehensive guidelines regarding SMSF investment strategies and stressed the importance of diversification of fund portfolios. The Regulator raised concerns about Trustees using broad asset ranges to comply with the Operating Standards enshrined in legislation. According to the ATO, such an approach, where investment strategies are written to cover almost every fund asset allocation scenario without the need for constant adjustment, didn’t always allow trustees to properly consider and formulate such an important compliance document.

ATO targeted SMSFs over asset allocation

This came hot on the heels of the ATO in August and September 2019 waving a cautionary finger at around 17,700 SMSFs with Limited Recourse Borrowing Arrangements (LRBAs), in which 90 percent or more of the fund’s assets were invested in one asset or asset class, particularly property.

The move caused a variety of reactions in the SMSF industry. Some argued that the Regulator should not tell Trustees how to run their fund (lest we tell them how to spend Our Money). Others in the broader superannuation industry rubbed their hands with glee, believing the ATO was acknowledging SMSF Trustees were incapable of prudently investing the fruits of their labour.

As with most things, the truth was probably somewhere in the middle. The ATO did point out the bulk of LRBAs are for real property, with many secured with personal guarantees, which means if the SMSF is unable to meet the obligations of that LRBA, personal assets are at risk. It also pointed out it was seeing examples of concentration risk; where assets in the SMSF were in one geared property, with the declining property market, particularly in Melbourne and Sydney, being of concern.

ATO issued Investment Strategy Guidelines

This could well have been the genesis of the ATO’s SMSF Investment Strategy Guidelines. The theme in the guidelines is one of Trustees documenting the justification for an investment decision. While there is nothing in the legislation preventing a fund borrowing to invest largely in one asset class, the Trustees must be able to provide the rationale for the decision, considering the sole purpose of superannuation being to provide retirement benefits to the members. Relying on a table of broad investment ranges in the fund’s investment strategy would no longer cut it.

Was the ATO’s decision the right one?

Fast-forward just a few short months, where the government-imposed lockdown in response to COVID-19 has hit the economy hard, and the ATO’s musing seems almost like a premonition.

The robustness of SMSF investments and the investment strategy that underpins them are being tested like never before. For funds with older members or those approaching or in retirement, diversification is a way to preserve capital. Drawing down income streams from cash holdings and not having to liquidate distressed assets, giving them time to recover, is a logical course of action. For those funds that have younger members, such economic turmoil can be an opportunity. With a diversified mix of asset classes and enough cash holdings to take advantage of the market downturn to purchase undervalued investments, there’s a sufficient time horizon to ensure positive returns.

A lack of diversification, on the other hand, with funds largely invested in property via an LRBA, could lead to rent not being received due to the economic impact of the shutdown. Members potentially no longer have a job, which impacts on their ability to make contributions to the fund and have cash to pay back the loan. The fund itself may need to ask for a deferral of loan repayments if it does not have the liquidity to pay back the lender. These issues impact on the nest egg of Australians and make those retirement goals that much harder to achieve.

In February 2020 the ATO was accused by some of providing advice where none was needed. I now suspect many would see such advice as being pearls of wisdom.