Investment Diversification Requirements for SMSF Strategies

The ATO has notified that at the end of August 2019 they will send letters to approximately 17,000 self-managed super fund (SMSF) trustees and their auditors where the ATO believes the SMSF investment strategies may not meet the diversification requirements under regulation 4.09 of the Superannuation Industry (Supervision) Act (SISA). This is because the ATO's records show these SMSF'S may hold 90% or more of funds in one asset, or a single asset class.

Trustees are reminded to check their investment strategy follows the law, and have their investment strategy ready to show to their SMSF auditor with evidence of how they consider their investment strategy meets the following requirements:

• the diversification of fund investments

• the risks of inadequate diversification with the context of their SMSF investment portfolio (for example, the risks associated with the fund's investments in a diversified portfolio of shares is likely to be lower than that of another asset class, such as (cryptocurrency)

• the making, holding, realising, and the likely return from their fund investments relating to their retirement objectives and expected cash flow requirements

• the liquidity of their investments, allowing the fund to meet costs and pay benefits as members retire

• whether insurance cover should be held for one or more members.

ATO assistant commissioner Dana Fleming said the Tax Office is contacting all SMSF'S that hold 90 per cent of their assets in a single asset class to remind them of their legal obligations in formulating their investment strategy as outlined in the operating standard contained in regulation 4.09 of the Superannuation Industry (Supervision ) Regulations 1994.

"In Particular, this includes having an investment strategy that considers the composition of the fund's investments, including the extent to which they are diverse and the level of risk for the fund and its members where there is inadequate diversification - sometimes referred to as concentration risk, " Ms Fleming said.

"SMSF trustees must also be able to demonstrate they have satisfied the other investment strategy legal requirements which include consideration of the risk involved in making, holding and realising investments; the amount of liquidity needed to pay expenses and benefits; and whether the fund should holds a contract of insurance for one or more of the members."

Ms Fleming said while many of these SMSF's will have a very well-thought strategy and meet all their obligations, it is a reminder to others that when investing in assets, they need to comply with the operating standard and ensure the fund's investment strategy clearly documents the reasons behind the investment decisions.

"Best practice is to document all these decisions and to seek advice when developing their investment strategy," Ms Fleming said.

As part of its focus on this area, the ATO will also be contacting the auditors of these SMSF's to let them know its concerns in relation to concentration risk.

"SMSF's auditors are entitled to ask for evidence of how the trustees have complied with regulation 4.09, and failure to comply can result in the imposition of SMSF administrative penalties equivalent to 20 penalty units, " Ms Fleming said.

Data in the report handed down by the Council of Financial Regulators in February this year

indicated in the 2017 financial year, 41 percent of SMSF's with an LRBA had concentration levels in a single asset class of above 90 percent.

At the time, this represented around 16,700; however further lodgements and changes in statistics, the figure has now climbed to 17,700 based on the ATO's latest reports, Ms Fleming said.