Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 387

Three reasons why super performance test fails

This year’s Budget included the Your Future, Your Super (YFYS) reform package, which will have a significant impact on superannuation. One reform, a performance test, has proven highly controversial. A performance test sounds like good policy to protect consumers, so why is it proving so controversial?

This article uses some of the findings from a collaborative research effort between The Conexus Institute and five leading industry consultants: Frontier, JANA, Mercer, Rice Warner and Willis Towers Watson. The detailed research (papers and models) can be accessed here.

The performance test explained

The YFYS performance test works as follows:

  • Over a rolling 8-year period the performance of each fund is compared against the performance of a tailored benchmark based off that fund’s strategic (i.e. long-term) asset allocation through time. The benchmarks are all public listed market indices. This could be considered implementation performance, capturing the sum of how well each portfolio position performed against a benchmark as well as the performance of any short-term (tactical) asset allocation calls.
  • Initially if a fund fails the test (underperforms by more than 0.5% pa), it needs to write to its members to advise it has been identified as an underperformer, and provide details of a to-be-developed Government website which will detail performance and fees for the universe of super funds.
  • If the fund fails for a second consecutive year, it is no longer able to accept new members until the fund passes the performance test. The fund can continue to accept contributions from existing members.

This sounds reasonable, so what is the problem?

The concept of a performance test is good policy. Done well, it helps protect disengaged members from sub-standard outcomes from super. Government and Treasury are simply following a recommendation made by the Productivity Commission.

But the devil is in the detail: the performance test has important shortcomings. Additionally, there are concerns that the way the test is applied will likely leave some consumers worse off.

We found three main issues with the test, summarised in the following diagram.

(1), (2), and (3) combine to make for an ineffective performance test.

Here's how to understand (2) better: implementation is an important part of total performance but the asset allocation decisions made by funds are just as, if not more, important. Yet the test ignores the performance of asset allocation decisions. To illustrate, if your fund had made the decision to have 10% more allocated to global shares than to Australian shares over the last 10 years, this would have added more than 0.4% pa to performance. A performance test should capture this component of performance.

The benchmarking challenges noted in (3) impact the assessment of many asset classes including private equity, unlisted property and infrastructure, credit, inflation-linked bonds, and the entire universe of alternative investments.

For example, unlisted property is benchmarked against listed property and there can be huge dispersion in performance between the two sectors which may unduly impact the performance test result at a particular point of time.

In some cases, we calculated that the test would have a very low likelihood of correctly identifying poor performers (likelihood levels akin to a coin toss) while having a reasonable probability of mistakenly identifying good performers as poor.

Finally, none of this acknowledges changes that funds have made to improve themselves, sometimes in response to issues raised by APRA.

Ineffective plus undesirable outcomes

Not only is the test likely to prove ineffective, but we anticipate a range of undesirable outcomes. We summarise these into three categories:

  1. We believe the test will distort the way that funds will manage their investment portfolios. This test will likely be binding compared to other policy and regulatory tools such as APRA’s Heatmaps, the Outcomes Assessment Test and the sole purpose test. The flaws in the test mean it does not align well with the broad investment management principles of focusing on total returns and diversification.
  2. We believe consumers will be confronted with a range of complex and potentially conflicting information. Many will find making a choice difficult and the heavily disengaged may be left in impaired super funds and experience worse performance (because the fund is further impaired).
  3. The focus by industry on the performance test may deter fund mergers. The ‘senior’ fund may not want some of the assets, a membership profile in outflow, nor the distraction that comes with merging with another fund.

Agents, politics, and policy

Unfortunately, superannuation has become highly politicised and some observers view the industry as self-interested agents. Yet strong engagement can contribute to better policy, while poor engagement increases the risk of policy mistakes. Effective engagement requires the trust between policymakers and industry to be strong. Undoubtedly there is room for improvement, but I see both policymakers and industry aligned in their focus on improving member outcomes.

It is good to see that there will be consultation on the performance test and hopefully it is constructive and positive.

Developing an effective performance test is a great opportunity to improve superannuation outcomes for consumers.

 

David Bell is Executive Director of The Conexus Institute, a not-for-profit research institution focused on improving retirement outcomes for Australians. This article does not constitute financial advice.

 

2 Comments
Jeremy Dawson
December 13, 2020

Is this requirement (to not underperform by more than 0.5% pa) before or after accounting for what my fund calls
"Total investment fees and costs and transaction costs"?

If before - then it's not a good criterion for investors. If after - then it makes it difficult for a fund to not underperform stock market indices (my fund says Total investment fees and costs and transaction costs are 0.46%)

Ramani
December 10, 2020

DC Super has relied on robust compliance processes (internal, external audits, prudential reporting, disclosures, conflict management and convergence between good performance and inflows) and many motherhoods (fiduciary interests, outsourced and out-of-mind and enforcement that conflates actions with outcomes). This has not worked on disengaged members who when interested find the rules indecipherable. Hence the move towards performance mesaurement, naming and shaming and effective delicensing.
We moved away from the model that promised performance (called DB). For good reasons. Is this a back-door reentry?
This article highlights how great intentions get stuck. Ignoring risk prferences, changing personal needs and potential for ponzi scams would simply raise expectations without altering the likelihood and impact of type 1 and type 2 errors. Makes the fall more traumatic.
The elephant in the room? Governments and regulators getting too close to fund performance exposes them to compensation claims for policy and prudential malfeasance. The bill will be picked up by the taxpayer who already underwrites super through tax subsidies hoping for the mirage of lower age pension outlays.
Not unlike the state getting too close to citizens' health by getting involved in Body Mass Index control. Great but counter-productive.

 

Leave a Comment:

     

RELATED ARTICLES

Consumers need an effective super performance test

Checking the temperature of the APRA heatmap

10 reasons many fund managers are now blank spaces

banner

Most viewed in recent weeks

400th Edition Special: 45 of the best investment ideas

Over eight years since February 2013, Firstlinks has become a leading financial newsletter, publishing thousands of articles from hundreds of writers. To mark this milestone, 45 experts have joined the celebration for our 400th edition bringing their best investing ideas for the next few years.

Four bubbly market pockets show heightened risk for investors

At the top of every market, there are signs that investors look back on and say the excesses were obvious. While many parts of the market are fairly valued, here are four bubbles which show irrational exuberance.

Turning point: the 2020s baby boom retirement surge

Every week, 2,500 Australians retire, or at least, reach the age of 65, and 2021-2027 will represent the peak years of the baby boom retirement surge. Longevity of life comes with dangers and opportunities.

Hume and Frydenberg reset super with two buzz words

The solutions to retirement problems are obvious. All we need are 'efficiency' and 'flexibility'. Learn what these two words mean and the future of superannuation policy is clear. Just don't tell Paul Keating.

How long will my retirement savings last?

Many self-funded retirees will outlive their savings as most men and women now aged 65 will survive at least another 20 years. Compare your spending with how much you earn to see how long your money will last.

The world in 2030: Six investing tips for the next decade

Six portfolio managers look at how life may change by the end of the decade and how shifting trends are influencing their investment decisions. It's an optimistic view of the world in 2030 as a better place.

Latest Updates

Retirement

How long will my retirement savings last?

Many self-funded retirees will outlive their savings as most men and women now aged 65 will survive at least another 20 years. Compare your spending with how much you earn to see how long your money will last.

Property

Why you can't invest in residential property on the stock exchange

Residential property attracts little interest from institutional investors and the listed market. Here are three reasons why retail investors have an advantage over well-resourced institutional investors.

Investment strategies

Three charts on the surprising rise of Australian retail investors

It may surprise even industry insiders that over 30% of all trading on Chi-X comes from retail brokers. What is the growing influence of retail investors on Australian stock exchanges and who are they using?

Investment strategies

Five reasons why EM equities could power ahead in 2021

A broader rebound beyond tech companies is likely to accelerate. Structural reforms may regain momentum after COVID and a lower risk premium is warranted for emerging markets equities compared with prior crises.

Superannuation

Consumers need an effective super performance test

Fund performance varies over time. A fund may have strong capability and perform well over time, but it may fail the performance test at some point. The YFYS reforms create unwelcome and unintended consequences.

Strategy

Unlimited potential: innovation wrap for March 2021

This month's look at innovations changing the world explores computer chips, cryptocurrencies, renewables, cybersecurity, robotics, mobility, alternative foods, finance ... there is no limit to human ingenuity.

Superannuation

My 'purpose of super' is probably not yours

One problem with defining a single and universal purpose of superannuation is that people have contributed to super for years, even decades, with different ideas and intentions.

Sponsors

Alliances

© 2021 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.