Get your SMSF back on track … or else

PORTFOLIO POINT: The market volatility experienced in recent years can throw SMSF asset allocations out of whack, potentially leaving you in the sights of the Tax Office.

A year ago this week, as Australia’s stock market was hitting its low point, many SMSF trustees had long since abandoned any investment plan they’d previously clung to.

It was, we’re told, a once-in-a-generation investment event. The Australian market had fallen around 55% from its highs, international shares had fared similarly and the commercial property sector had been decimated. While cash was king, the Reserve Bank’s rate cuts had ensured returns there were not flash at the time, but at least the returns were positive.

Fixed interest and bonds? What the heck were they? It had been so long since they’d been an investment class of any note that people had forgotten what they were. But there they were, outperforming and shining like a beacon.

SMSF trustees, as a whole, were cashed up. For some it was a deliberate strategy. For others, fear had gripped them and they couldn’t deal with further losses and had sold out. While SMSF trustees have traditionally always been overweight cash and Australian equities, they were now distinctly overweight cash.

Figures from industry groups, such as SMSF service provider Multiport, show trustees have since continued to plough back into equities, swapping cash for Australian equities in increasing numbers.

For many trustees, the shift back to cash and now back into equities has been dramatic. Many trustees may have seen their allocation to shares fallen from, perhaps, 80% to 20% during the falls from November 2007 through to a year ago. Cash, which might have only made up 20% of their portfolio previously, might now have become as much as 60-80 per cent of the fund, partly through sell-downs, but partly through being the asset class that wasn’t losing money.

The same people may have returned to equities with a vengeance. Share purchases, plus the growth in the value of the shares could have seen the overall allocation to Australian shares increase dramatically, while cash holdings have tumbled.

During the panic, SMSF trustees were probably not considering the overall “investment strategy”. And ignoring the fund’s official investment strategy – or worse, not having one – is something that can get you into serious trouble with the Tax Office.

An investment strategy is actually a requirement of all super funds. It is supposed to take into account the financial goals of the fund, the risks it is allowed to take and how members’ investments are to be spread across investment classes. If the fund has several members with different investment time frames and risk profiles, then the investment strategy is supposed to take those into account.

It’s one of the first things that the Tax Office will ask for if they ever conduct an audit. And it’s asking for trouble if you’re acting outside it at the time they come knocking.

The following is a table off typical investment styles and roughly the asset allocation that classic investment theory would have them invested in.

Risk profile investment allocations:

Investment strategies do not have to be rigid, but they have to exist. Many SMSFs were set up predominantly for the purpose of housing commercial property for the business of a member.

A trustee with a balanced member to invest for might come up with the following sort of scenario.

Typical balanced fund investment allocation strategy:

(However, please not that an investment strategy is far more complex than simply an asset allocation table.)

Leave it too loose and the ATO might consider you’re not taking it seriously. Leave it to tight and you might find that market changes will put you well outside of your limits in any major downturn or upswing.

If your investment decisions have found you inside or outside your investment strategy’s minimum and maximum weightings, you’re in breach. You’ve got two options. The first is to revise your investment strategy so that it fits your current investments. The second is to prepare a trustee minute that allows you to, temporarily, operating outside of the strategy for short-term tactical reasons.

An investment strategy isn’t just there for fun. It’s designed to show that trustees have carefully considered the asset allocation that would be appropropriate for the fund members at the various stages of their lives.

The fluctuations of recent years, including the massive bounces in the last 12 months, will have put many SMSF trustees at least temporarily outside of their official investment strategies. It’s something that requires regular monitoring. Say at least twice a year in fast-moving markets.

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Many SMSF trustees will have recently received an email or regular mail from Macquarie about a proposed shift of their Macquarie Cash Management Trust (CMTs) to a Cash Management Account (CMA) structure.

Until a few years ago, the Macquarie CMT was the largest managed fund in Australia. The CMT at one stage held more than $16 billion. It was/is used by 30-40% of all SMSFs as their base bank account, according to Macquarie. It is important to note that it is not a bank account, but the way that it had been structured meant it had the functionality of most bank accounts.

It was popular because it did not charge fees (apart from for cheque books) and it paid a reasonable interest rate, unlike the accounts offered to SMSFs by major banks.

The advent of the government guarantee has effectively killed off the CMT. Because of the trust structure, Macquarie had to pay the insurance premium for any amount in there above $1 million (not $1 million per client). This meant the interest rate on CMT dropped by around the cost of the guarantee levy. Further, the recent decision by the government to remove the wholesale guarantee further removes the security for CMT investors (essentially it removed the life support that it did have).

Macquarie quickly put into place a CMA structure for clients. Now, about 18 months down the track, CMT is all but dead as a vehicle for new investors to use. And Macquarie has decided to kill it off properly, by proposing to convert all remaining CMTs to CMAs.

The downsides appear to be limited. The functionality of the CMA as compared to the CMT, if they act as your base bank account, will be almost identical. But because the CMA does not have to pay the government levy in the same way the CMT does, the returns will be higher. As at earlier this week, the CMA is paying a 4% return, while the CMT average is 2.64%.

Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.