Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 415

Super performance test will destroy viability of some funds

The Your Future, Your Super (YFYS) annual performance test will apply to MySuper products from 1 July 2021 and ‘trustee directed’ products from 1 July 2022. Some of its key features are:

  • Product performance is tested against a benchmark comprising prescribed indices weighted in line with a fund’s strategic asset allocation (SAA). This means that the test measures the effectiveness of a fund’s implementation of its strategy relative to its YFYS benchmark, not the suitability or performance of the strategy itself.
  • The performance measurement period is generally eight years (seven years for the first test). While a year of ‘good’ performance helps, each year is the start of a new performance period and so consistency of performance will be rewarded.
  • A product passes the test provided the product return (including allowance for administration and advice fees) does not underperform the benchmark by more than 0.5% pa.

A test with teeth and major consequences

The result of failing the performance test is highly visible. Funds must send their members a notice (by paper mail, adding another expense) commencing with the words:

'Your superannuation product has performed poorly. You should consider moving your money into a different fund'

It's an unpalatable action for any fund. Two successive years of failure will see a product barred from accepting new members, which would damage cash flow and destroy the viability of most funds in a reputational sense.

So, this is most definitely a test with ’teeth’. All funds will weigh up the priority that should be given to meeting the performance test relative to other objectives. Some, perhaps most in the longer term, will change how their investment portfolios are designed and managed.

The risk of underperformance

As an indication of what might be in store, using APRA’s December 2020 MySuper Product Heatmap, 11 single strategies, and a similar number of lifecycle strategies, were more than 0.5% p.a. behind the Listed SAA Benchmark over the six years to 31 December 2020. It’s important to note however that the YFYS performance benchmark differs slightly from the Heatmap benchmark.

Looking forward, a year-by-year approach which blends past performance with forward-looking modelling will be required for products that have experienced underperformance in the past eight years.

Longer term, our analysis of a subset of MySuper options suggests a typical forward-looking probability of failing the performance test over a single eight-year period falls in the range of 10-15%. There is obviously some variability between products, with estimated tracking errors relative to the YFYS benchmark ranging from 2-4% per annum and probabilities of failing the performance test over a single eight-year period ranging from 6-16%.

While the likelihood of failing the test over a single eight-year period is a useful starting point, it doesn’t accurately represent the prospect of the fund failing the performance test over a longer time period that incorporates a number of rolling eight-year time periods.

The chart below demonstrates the cumulative probability of failure over longer periods, assuming a 10% likelihood of failure over a single eight-year period.

Cumulative probability of failing the performance test

If we look at 10 consecutive performance measurement periods, covering a total of 17 years of fund performance (i.e. the first test covers years one to eight, while the 10th test covers years 10-17), the cumulative probability of underperformance reaches 35%. If we extend this to 20 measurement periods, then the cumulative probability of underperformance increases to over 50%.

Over the same period, the likelihood of failing the test in two consecutive years is also around 35%. The longer-term risks of falling foul of the test are clearly material.


Register here to receive the Firstlinks weekly newsletter for free

Implications for super funds

We have already seen funds make portfolio and product changes, in anticipation of the test becoming law. Conceivably, we could see a bifurcation of strategies adopted.

Those with a strong brand name and market presence, or a well-defined and ‘sticky’ membership base, may consider a failure of the test (at least for one year) to be manageable and hence may be comfortable sticking with their existing investment approach and strategy.

Those with a weaker franchise might make passing the test their highest priority, dialling down the underperformance risk to an acceptably low level.

The broader implications of the YFYS package will play out over several years. It seems clear though that prioritising investment objectives, including determining how much emphasis to place on the YFYS performance test, will become a top tier issue for all funds.

 

Nick Callil is the Head of Retirement Solutions and Tim Unger is Senior Investment Consultant at Willis Towers Watson Australia. This article is general information and based on a current understanding of the YFYS legislation.

 

13 Comments
Guy Metcalfe
July 12, 2021

The cumulative probability of failing the performance test graph is somewhat misleading. There is at least one way to guarantee a fund passes the test every year. Implement the policy portfolio with low-cost index funds and keep total fees and costs well below 0.5%.

Philip Carman
July 11, 2021

In my 40 years in the Money Business, dealing with a range of people from highly paid/sophisticated managers of billions to Mums and Dads, I've found very few who deeply understand risk and reward and fewer still who genuinely dovorce themselves from fear and greed as well as the group-think that pervades markets. Fewer still truly know themselves and their insecurities...
Adding a layer of regulation around managed fund performance based on fear of being caught out on a limb that has not (yet) been recognised as sensible (like being short the capital markets in 2006/07) only serves to ensure that few will ever make calls against the crowd...which ultimately must be done to protect capital - sometimes for two consecutive years.
I well remember BT being "wrong" in late 1985/early 1986 when they were aghast at excessive valuations, only to be proven correct in late 1987, but only after they, too, had been dragged (a little) away from their preferred position (of an even lower exposure) by advisers, other managers and the commercial necessity of not being too "out of kilter" with the mob.
The likes of Kerr Neilsen, who had been an important cog at BT in the 1980s, were deeper thinkers and better than the rest (someone has to!) and went on to lead some genuinely independent thinkers (although still at the mercy of the dumb mob, to whom they had to market theior wares) in setting up some leading investment houses. Thinking differently from the mob gets punished by blunt instruments that measure performance in the short term, but ultimately can deliver better and safer outcomes - sometimes.
Here's the thing: if government (and commentators) believe they know best they should set up their own funds and test themselves. For example: the Future Fund should be available to all Australians who wish to use it and then it should be allowed to compete in the open market. Those two ideas are, of course, intrinsically linked and provide perhaps the only possible solution to the problems of ignorance, envy and fear that pervade human's attempts to both understand and beat markets - of which they comprise the core.

Steve
July 11, 2021

No Philip - Here’s the thing - start performing for clients instead of feeding the funds overinflated fees and salaries. True Client focus would be good rather than just rhetoric. Then the investment industry may just climb itself off the bottom rung of trust they are now on and clients may start believing that they are truely working for the clients and not just for themselves.

Jerome Lander
July 11, 2021

Great article. If super funds weren't already overly "benchmark" focussed instead of being client focussed, they will be now. Any good fund needs to have the opportunity for genuine and meaningful active management, and that is being removed for these institutions as they are effectively forced to comply with government edict. Wealthy investors will continue to invest through SMSFs and allocate their capital elsewhere, where it can be managed in alignment with their interests.

Steve
July 11, 2021

It’s about time those super funds that rip off members with high fees to pay for there overinflated salaries were brought to account.

Steve
July 11, 2021

This is really about reducing the number of super funds for the regulator to monitor, and like Hayne2 is about about culling out the number of advisers to supervise. It has absolutely nothing to do with increasing competition & everything to do with increasing fees to the regulator, while reducing their work load. Not unlike State Govts preferring large residential developments over backyard subdivisions. 

Neil Cox
July 09, 2021

Chris has nailed it. This is nothing to do improving superannuation performance. It's all smoke and mirrors to hide the real alternate agenda.

Greig Meyer
July 09, 2021

It is unbelievable that such a dumb idea has ever made it this far. It is the superannuation equivalent of 80% of drivers believing they are above average. By definition 50% of all funds must fall below benchmark, whatever the benchmark is. The impact of this policy on funds management in Australia is going to be far reaching. It is going to impact on companies and cost of capital, and mean that rational thinking about investing is going to be pointless for the majority of money invested in the Australian share market. For companies the only thing they will need to do to survive will be to make sure that they are big and then all the super funds will have to buy their shares regardless of the quality of management or the merits of the business.

Martin
July 11, 2021

If the benchmark is an independent target - say ASX 200, then it is wrong to say that by definition 50% will fall below that. That statement is correct only if the benchmark is the average of all the funds, which it is not. The portfolio benchmark will be a blending of individual external benchmarks for various asset classes weighted by the asset allocation. The sadder part is that funds will tend to adopt portfolio allocations to mimic the test comparator allocations which will mean that innovation will be stifled. It is however a well overdue improvement to highlight fund managers who take fees yet deliver outcomes worse than the index they seek to beat. As James Bond put it, “three times is enemy action”.

Chris
July 08, 2021

It seems this new legislation has a major "unintended outcome", or perhaps it was fully intended by the ideologues within the LNP ??

JohnPascoe
July 08, 2021

Does this apply to personally self managed super funds with the maximum of 4 members [soon to be 6] ?

Graham Hand
July 08, 2021

Hi John, no, the test does not apply to SMSFs. You're on your own with that one.

George
July 10, 2021

Nothing to do with SMSFs. SMSFs and SMSF trustees are not regulated by APRA.

 

Leave a Comment:

     

RELATED ARTICLES

Three retirement checks for when you have enough

Retirement adequacy: COVID means we need to work longer

Large super funds struggle to match index in Aussie equities

banner

Most viewed in recent weeks

10 little-known pension traps prove the value of advice

Most people entering retirement do not see a financial adviser, mainly due to cost. It's a major problem because there are small mistakes a retiree can make which are expensive and avoidable if a few tips were known.

Check eligibility for the Commonwealth Seniors Health Card

Eligibility for the Commonwealth Seniors Health Card has no asset test and a relatively high income test. It's worth checking eligibility and the benefits of qualifying to save on the cost of medications.

Hamish Douglass on why the movie hasn’t ended yet

The focus is on Magellan for its investment performance and departure of the CEO, but Douglass says the pandemic, inflation, rising rates and Middle East tensions have not played out. Vindication is always long term.

Start the year right with the 2022 Retiree Checklist

This is our annual checklist of what retirees need to be aware of in 2022. It is a long list of 25 items and not everything will apply to your situation. Run your eye over the benefits and entitlements.

At 98-years-old, Charlie Munger still delivers the one-liners

The Warren Buffett/Charlie Munger partnership is the stuff of legends, but even Charlie admits it is coming to an end ("I'm nearly dead"). He is one of the few people in investing prepared to say what he thinks.

Should I pay off the mortgage or top up my superannuation?

Depending on personal circumstances, it may be time to rethink the bias to paying down housing debt over wealth accumulation in super. Do the sums and ask these four questions to plan for your future.

Latest Updates

Investment strategies

Three ways index investing masks extra risk

There are thousands of different indexes, and they are not all diversified and broadly-based. Watch for concentration risk in sectors and companies, and know the underlying assets in case liquidity is needed.

Investment strategies

Will 2022 be the year for quality companies?

It is easy to feel like an investing genius over the last 10 years, with most asset classes making wonderful gains. But if there's a setback, companies like Reece, ARB, Cochlear, REA Group and CSL will recover best.

Shares

2022 outlook: buy a raincoat but don't put it on yet

In the 11th year of a bull market, near the end of the cycle, some type of correction is likely. Underneath is solid, healthy and underpinned by strong earnings growth, but there's less room for mistakes.

Gold

Time to give up on gold?

In 2021, the gold price failed to sustain its strong rise since 2018, although it recovered after early losses. But where does gold sit in a world of inflation, rising rates and a competitor like Bitcoin?

Investment strategies

Global leaders reveal surprises of 2021, challenges for 2022

In a sentence or two, global experts across many fields are asked to summarise the biggest surprise of 2021, and enduring challenges into 2022. It's a short and sweet view of the changes we are all facing.

Shares

2021 was a standout year for stockmarket listings

In 2021, sharemarket gains supported record levels of capital raisings and IPOs in Australia. The range of deals listed here shows the maturity of the local market in providing equity capital.

Economy

Let 'er rip: how high can debt-to-GDP ratios soar?

Governments and investors have been complacent about the build up of debt, but at some level, a ceiling exists. Are we near yet? Trouble is brewing, especially in the eurozone and emerging countries.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.