Are you (or should you be) a sophisticated investor?

When certain criteria are met, you may be eligible to be classed as a 'sophisticated' investor. This opens up more opportunities compared to other retail investors, but it comes with risks.

There’s a specific definition that explains who is considered to be a sophisticated investor for legal purposes.

However, just because an investor is deemed to be sophisticated under The Corporations Act, does not mean he or she should invest on that basis. 

If you choose to become a sophisticated investor, it’s important for trustees to understand any potential additional risks to which a self-managed super fund’s (SMSF’s) investment portfolio may be exposed.

Under corporate law, investors may be a sophisticated investor if they earn, “a gross income of $250,000 or more per annum in each of the previous two years or have net assets of at least $2.5 million.” 

To be classified as a sophisticated investor a person must also hold a current certificate from a qualified accountant verifying he or she has met one of these thresholds.

Once someone has been classified as sophisticated investor, different rules apply to them compared to regular retail investors. This exposes the sophisticated investor to the potential for higher risk – but also the opportunity for higher rewards. 

Typically, an investor will request their accountant provide them with a certificate to verify their status as a sophisticated investor after becoming aware of a wholesale investment opportunity. For instance, their financial adviser may offer them the opportunity to access a corporate bond offer that is unavailable to other retail investors.

Jordan George, head of policy for the SMSF Association, explains some considerations SMSF members should make when thinking about whether they are suitable to be sophisticated investors.

“Being a sophisticated investor opens up more opportunities compared to other retail investors. But that comes with the risk of losing protections afforded to those investors,” he says. 

To offer investments to retail investors, financial product issuers must provide them with a financial services guide and product disclosure statement. 

Statements of advice (SOAs) also protect retail investors. SOAs set out how a financial product aligns with an SMSF’s investment strategy and outline how any financial adviser with whom they are working is remunerated. 

Normal retail investors are also protected because they can pursue dispute resolution systems offered by financial product issuers and also regulators, for instance the new Australian Financial Complaints Authority. 

“So, there are benefits of being a retail investor. You have more protection under the Corporations Act and if something goes wrong with an investment or you receive poor advice, you have more safeguards,” says George.

“You give those up when you become a sophisticated investor because you're taken to be someone with the skills and knowledge to be able to make investments without those protections,” he adds. 

As soon as you become a sophisticated investor you're taking on more risk and the types of investments you can invest in tend to be riskier. 

Typical investments offered to sophisticated or wholesale investors include unlisted investment offers or difficult to access initial public offers, with minimum investment sizes above $50,000.

George notes that just because someone can become a sophisticated investor doesn’t mean they should. 

“You should only do it with the right professional advice and also when you have the right financial knowledge and skills to be able to understand the products that you're investing in under a sophisticated investor arrangement,” he warns.

In assessing the risks around becoming a sophisticated investor, it’s important for SMSF trustees to keep in mind their investment goals and investment strategy. 

“It's really important for trustees to be guided by their investment strategy. That should help them keep in mind the fund members’ risk appetite and investment goals, ensuring they understand any risks they're undertaking in making an investment in a wholesale product,” says George.

The potential for loss of capital, opportunities for the investment to generate income, especially if fund members are in retirement phase, and how easy it is to understand the entities backing the investment are key considerations. 

Once you step out of the standard retail investor world there are far fewer protections in place to ensure an SMSF’s assets continue to grow. 

But being a sophisticated investor can also offer trustees a new world of investment opportunities. 

The idea is to weigh up the risks and rewards and keep in mind the fund’s investment strategy to make the right decisions about whether professional investor status is the way forward for the fund and its members.