The ATO has recently written to about 18,000 SMSF trustees and their auditors where the fund has at least 90% of their total investments in one asset or a single asset class. They consider trustees may not have considered the lack of investment diversification properly and that high asset concentrations may expose the fund to increased risk. Should you and your auditor be concerned?
The Superannuation Industry (Supervision) Act has a number of covenants or undertakings that SMSF trustees must comply with. These help to ensure the fund is maintained correctly and focussed on providing benefits to members and their dependants. One of the covenants requires that the fund has an investment strategy that considers the investment risks, diversification, likely return and cash flows to be able to pay benefits. There is also a requirement that SMSF trustees consider whether they hold insurance for the fund members.
The requirement to have an investment strategy does not mean SMSF trustees must have a diversified portfolio across all asset types. But as trustee there must be sound and valid reasons for the investment strategy decided on. There is nothing wrong with having a high concentration of assets in just one asset class, such as shares or fixed interest, or just one asset providing the trustees can justify what they have decided. High levels of concentration in the early stages of a fund’s life may form part of a longer-term plan to diversify.
Take for example managed investments, listed trusts or even listed shares. A fund that has all its investments in just on managed fund, listed trust or an ASX listed company or trust is likely to have a high level of risk. This could be compared to a fund that holds a broad selection of managed funds, listed trusts or ASX shares which may be considered to be diversified.
Remember, for a portfolio to be diversified, there is certainly no requirement to own all the shares listed on the ASX. Although this is possible by the SMSF investing in an index managed fund. A selection of about 10 to 15 shares is considered by many commentators and academics to provide an adequate level of diversification.
A portfolio with a lumpy asset such as real estate can bring with it issues, especially if it is mortgaged by the fund having a limited recourse borrowing arrangement. A fund which has a significant proportion invested in residential and commercial real estate may find the property difficult to lease, it may fall into disrepair or rents may not be enough to maintain the property’s day to day operating expenses. Just one of these events may cause cash flow problems depending on whether the fund is in accumulation or retirement phase. If contributions or the rollover of benefits cannot be made to the fund to plug the cash flow gap, then it may end up being technically insolvent.
The latest statistics on SMSF investments is for the 2016/17 financial year as information for the 2017/18 and 2019/18 financial years are still a work in progress. While you would think there are large swings in the proportion of a fund’s asset in a particular asset class within very short periods it is relatively stable. For example, the proportion of all SMSF investments invested in most asset classes has increased or decreased by less than 1% on average between the 2012/13 and 2016/17 financial years.
So, what do you need to do?
For SMSF trustees and their auditors who have received a letter from the ATO, a review of the fund’s investment strategy is recommended to make sure the fund’s current level of investment risk, diversification, returns and cash flow can be justified.
For trustees who have not received the letter it may be a worthwhile time to have a serious review of their SMSF.
Subscribe to SMSF News to receive my latest articles straight to your inboxGraeme Colley, Executive Manager, SMSF Technical and Private Wealth, SuperConcepts
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