Does your SMSF investment strategy meet diversification requirements?

Lack of diversification or concentration risk, can expose the SMSF and its members to unnecessary risk if a significant investment fails.

ATO warns of SMSF concentration risk

You will have no doubt heard the phrase “don’t put all your eggs in one basket” strategy of investing.

The basic thought process behind diversifying your investments is that if you spread your investments around, you’ll reduce the risk of losing money, because when one of your holdings moves lower, another is likely moving higher. For example, bonds usually move higher when stocks move lower, and vice versa.

At the end of August the ATO will be contacting about 18,000 self-managed super fund (SMSF) trustees and their auditors where their records indicate the SMSF is holding 90% or more of its funds in one asset or a single asset class.

The ATO is concerned that some trustees haven’t given due consideration to diversifying their fund’s investments.

Lack of diversification or concentration risk, can expose the SMSF and its members to unnecessary risk if a significant investment fails.

We are asking the trustees to review their investment strategy and clearly document the reasons behind the investment decisions.

You’ll need to have this documentation ready for the SMSF’s approved auditor for their next audit to help the auditor form an opinion on the fund’s compliance with the investment strategy requirements.

As trustee of the SMSF you must 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.

Its worth noting that in some situations an SMSF may have very little diversification, for example if the majority of funds wereinvested in a single property. In this case, the investment strategy should identify the lack of diversification and explain how the trustees will manage this risk.

You are not precluded from using this strategy, it simply needs to be well documented and managed.

Diversification can be achieved through:

  • investing across a range of asset classes
  • investing in a number of assets within a single asset class
  • investing in Australia and overseas
  • investing in several funds with different management styles

If you need any further assistance please do not hesitate to contact our office.

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