Review your DIY super investment strategy – here’s what to look for

A worthwhile new financial year resolution is to review your DIY super fund’s investment strategy. And in this current climate, with regulators focusing on the governance of self-managed super funds, following the letter of the law is an excellent risk-ma

In June last year, I reported that the large super funds were starting to shift some of their money away from Australian shares and into assets with lower risk.

I noted that even if the large funds didn’t get their timing exactly right, this shift in asset allocation was more about managing risk than chasing bigger returns. I also warned that, in my view, risk management was a weakness of the retail investor, and that a worthwhile new financial year resolution was to review your DIY super fund’s investment strategy.

In that same column, I disclosed that my super fund’s asset allocation was nearly 100% in Australian shares, and that I would be reviewing my fund’s strategy to ensure it still met my fund’s long-term investment objectives.

Well, I did review my fund’s strategy but my fund continues to hold nearly 100% of its assets in Australian shares. I did not, and have not, changed my fund’s asset allocation, even though it reflects a higher-risk strategy. The consequences of maintaining such an asset allocation for this financial year is that my fund’s capital appreciation will be disappointing. The upside is that, as part of my investment strategy, I reconfigured my fund’s share portfolio in early 2007 to ensure that many of my shareholdings would deliver dividends and distributions when the market turned.

I’m still comfortable with my fund’s overall long-term strategy, although I’m wavering on a couple of my specific shareholdings.

Now that’s my super fund. My investment strategy is very different for my family’s personal shareholdings and other investments.

Different objectives

Last year, I also reviewed (or what I like to call “stress-tested”) our personal investment strategy. We made the decision to divest or reduce shareholdings in several companies during October 2007, restructured property investment loans, sold two properties during 2007, stockpiled some cash, bought another property and held off from too much share buying. We also liaised with our accountant to ensure we managed the tax implications of all of our decisions.

In short, because we use gearing for property investment in our personal portfolio, I wanted to be sure that our portfolio could withstand any increases in interest costs and other expenses, and that if we wanted to sell (or buy) a property, that we could do so at our leisure rather than be worried about market forces. We sold out of shareholdings that we had accumulated over a reasonably long period of time and that we considered were now not consistent with the objectives of our long-term strategy, while holding on to shares that we considered “must-haves”.

I am not sharing these stories of two very different investment strategies to encourage you to do the same – heaven forbid! Each investor has to be able to sleep at night and understand the risks they are taking, and the returns they can expect for taking those risks.

Nor am I telling you these stories to seek approval or criticism for my decisions. The reason I am sharing these stories is to highlight how important it is to have an investment strategy that reflects the needs of the investors involved. My investment strategy for my DIY super fund is very different from that of my family’s investments, for very good reasons.

My super fund’s strategy is designed to deliver me superannuation savings for my eventual retirement in 15 to 20 years’ time (and for my retirement of many more years), and I want my savings to be invested in the asset class that will deliver the best long-term growth, and which permits me to make regular investments in line with my regular super contributions.

For me, direct Australian shares are liquid enough and accessible enough to deliver this objective. My risk profile indicates that I have high tolerance for the ups and downs of the sharemarket (but note that my risk tolerance, and yours, can change over time).

For what it’s worth, here is a list of all the shares that I have interests in today.

My portfolio:

ANZ Banking Group (ANZ). General banking, mortgage and installment lending, investment banking, investment and portfolio management.

Babcock & Brown Infrastructure Group (BBI). Infrastructure investment.

BHP Billiton (BHP). One of Australia’s most recognised and successful companies – minerals exploration, production and processing (particularly coal, iron ore, copper and manganese ore) and hydrocarbon exploration, production and refining.

Castlemaine Goldfields (CGT). Gold mining exploration and development.

Commonwealth Bank of Australia (CBA). Banking, financial and related services.

CSL Limited (CSL). Development, manufacturing and marketing of pharmaceutical and diagnostic products, cell culture and human plasma products.

Envirozel (EVZ). Providers of services and equipment to the infrastructure, environment and construction industries.

IBA Health (IBA). Integrated health solutions providers.

Imugene (IMU). Biopharmaceutical company specialising in the development and commercialisation of animal health products for production and companion (pet) animals.

MYOB (MYO). Developer and publisher of business management solutions targeted at small and medium enterprises around the world.

National Australia Bank (NAB). General banking, mortgage and installment lending, investment banking, investment and portfolio management.

Origin Energy (ORG). Supplier of commercial, industrial and domestic energy.

Pacific Brands (PBG). Manager of consumer brands, such as Dunlop, Bonds, etc.

PaperlinX (PPX). Paper manufacturing and distribution.

Pro Medicus (PME). Development and supply of software and IT solutions to the private medical market.

Spark Infrastructure Group (SKI). Portfolio of international utility infrastructure assets.

Telstra (TLS). Telecommunications carrier. Provides home phones, mobile phone, internet, and pay television.

Wesfarmers (WES). Diversified industrial with interests in chemical and fertiliser manufacture; gas processing and distribution; coal mining and production; building materials, hardware, industrial and safety products and services; rail transport and insurance.

I believe property also delivers similar long-term growth but my partner and I use direct property as a wealth accumulator outside super due to the ready availability of gearing (without the need to use complicated gearing structures).

Compulsory requirement

If you run your own fund, the essential and non-negotiable requirement is that your fund must have an investment strategy.

Many DIY super trustees, and even some advisers, may see the requirement to have an investment strategy in place merely as a compliance requirement rather than an essential investment tool. Yes, the super laws require your fund to have an investment strategy in place; and, yes, you will be penalised up to $11,000 if you fail to do so.

And in this current climate, with regulators focusing on the governance of self-managed super funds, following the letter of the law is an excellent risk-management tool in itself.

From the emails that I have received in the past two weeks, it is comforting to read that many Eureka Report readers have carefully considered their funds’ investment strategies, and that they take this requirement seriously.

Flexible strategies

An investment strategy is not a static document, and formulating a strategy is not a one-off process. You can have very different investment strategies within the one super fund, and those strategies can evolve over time.

Individuals who run both accumulation and pension accounts within their DIY super fund may have two or more investment strategies, reflecting the income needs of the pension account and the tax-exempt status of earnings from assets financing income streams.

Some other trustees may develop an investment strategy for a super fund that caters for both short-term trading and core long-term investment holding. Other funds may have individual investment strategies for each fund member.

The question I ask, however, is: When did you last review your fund’s investment strategy? The tax office states on its website and in various publications that a super fund’s investment strategy should be reviewed regularly and updated as required.

If you have not reviewed your fund’s strategy for a while then it’s probably a good time to revisit the strategy for your retirement savings. A lot has happened recently, both in the investment markets and in politics.

Take a look at your fund’s investment strategy, ensure you understand what you can do within your fund, that your investments are consistent with your strategy and that your strategy will still deliver on your objectives.

Mechanics of investment strategies

A recent tax office survey of new DIY super trustees found that about 15% did not yet have an investment strategy in place. Such a high percentage could be partly explained by the possibility that many of those trustees had not yet activated their funds, or not yet started investing.

If you haven’t yet formulated an investment strategy, or you’re not sure whether your current strategy is robust enough, I offer the following suggestions.

Your fund’s strategy must be properly formulated. You will need to draft your DIY super fund’s investment objectives, determine your fund’s asset allocation, and select specific assets.

Section 52 of the Superannuation Industry (Supervision) Act 1993 states that when formulating your strategy you need to take into account:

• Risk and return of any investment.
• Your fund’s investment objectives.
• Diversification.
• The ability to pay your fund’s taxes and other expenses.

The tax office says that the investment strategy should detail the investment methods the trustees will adopt to achieve these objectives. More importantly, it states that the strategy “should be unique to the requirements of a particular fund and its members”. Clearly, you also need to consider the age of the fund members, their income and retirement needs.

The first step in formulating an investment strategy is to decide how well you want your fund to perform. The objective of your fund is usually linked to how much money you need to fund your retirement, the number of years until retirement and the level of contributions you intend to make.

Any objectives you decide on need to be measurable, such as: “To deliver an average annual rate of return exceeding the consumer price index by 4% over five-year periods.” Before you think about copying such an objective into your strategy, understand what such an objective means. The CPI is currently running at about 4%, so a return 4% above inflation means the fund’s objective is to deliver an average return of 8% each year over five-year periods.

You would then need to consider what type of asset allocation would deliver this type of average return, keeping in mind the risk profile of each fund member. Having all of a fund’s money sitting in cash won’t deliver such a return so the trustees must decide how much of the fund’s assets will be in invested in growth assets, and what growth assets they intend to invest in, to generate an 8% long-term return.

The Australian Securities and Investments Commission website provides some general information on choosing an investment strategy that you may find useful, even though the information is targeted towards investors in managed super funds.

Note: As trustees, you should hold a meeting to discuss what your fund’s investment strategy is going to be. Any decisions about your investment strategy (and in my view, the actual investment strategy that you formulate for your fund) should be recorded in the minutes of your trustee meeting. Under superannuation law, trustees of SMSFs are required to prepare minutes of trustee meetings and keep those records for 10 years. Obviously, a copy of your fund’s current investment strategy needs to be kept indefinitely.

Trish Power has written several books on superannuation and investing, most recently Superannuation for Dummies, second edition (Wiley).

This article first appeared in the Eureka Report.