New performance measures for the superannuation industry announced during Josh Frydenberg’s Tuesday night Federal Budget have upped the ante for funds to outperform a benchmark or risk member withdrawals. The measures are also likely to lead to funds skewing their investment decisions further towards listed and passive over unlisted and alternatives strategies, while opportunities to game the benchmarking approach will likely be employed, experts have said.

The measure requiring funds to self-report to members annually if they are underperforming over an eight-year time horizon from October 1 next year will have a significant impact on funds’ investment behaviours, according to Nick Callil, Willis Towers Watson head of retirement solutions, Australia. Callil added this self-reporting requirement is expected to be more meaningful to individual members than existing APRA ‘heatmap’ and the Australian Tax Office’s new fund ranking system underperformance disclosures.

“If you consider funds might have to report directly to their members they are underperforming and then provide them with a comparison website, the implication of which being ‘here is where you can find yourself another fund’, we believe funds will take stronger steps perhaps than they were already to avoid underperforming,” Callil said.

But beyond the cut through it will likely have with super fund members, the performance measurement approach set by the government – whereby a strategic asset allocation benchmark of listed asset indices is tailored for each fund – is expected to result in funds adapting their investment strategies to beat listed market indices, Callil and others have said.

A fund that fails the test two consecutive years will not be permitted to accept new members until its performance improves.

“It’s clearly got a likelihood of pushing funds towards listed asset classes on a passive basis… It reduces the incentive for unlisted asset classes or more expensive active management,” Callil said.

The adaption of strategies within the hedge funds and liquid alternatives sector was already underway to reduce costs in light of APRA’s heatmap system, a panel raised at Investment Magazine’s Absolute Returns Conference in September.

A further tilt in this direction – away from more expensive alternative strategies and asset classes where returns could diverge from a listed benchmark – is likely considering the new yearly performance reporting requirement is more binary with less nuance than the heatmap test, David Bell, the Conexus Institute’s executive director commented.

“While the heatmap methodology has attracted widespread criticism for failing to acknowledge diversification, portfolio protection and risk management strategies, at least by having four metrics a better overall assessment is created. By cherry-picking a single metric the flaws become even more significant,” Bell said.

Flaws in the assessment approach are likely to lead to funds gaming the system, Bell continued.

“As an example, all credit right out to high yield is benchmarked against traditional bond indices creating a free ride opportunity over the long term. This makes for an unfair assessment across funds but also could easily lead to gaming by funds,” he said.

“If I were a new fund you would start with passive and then you would look at what marginal decisions you can take to give you the best chance of beating the benchmark,” Bell noted.

“There is a huge push for funds to employ passive [strategies] in a metric like this because active management can underperform,” he said. The new performance metric uses a rolling 8yr metric so underperforming in any one year is not a disaster for funds.

Funds heavily invested in unlisted assets including infrastructure could struggle as these assets are not naturally benchmarked against liquid indices, Bell noted.

“There will be huge dispersions between listed market and unlisted asset equivalents… industry funds in particular can’t control that risk because they’ve got these assets for the long term so they will wear a lot of variability compared to this benchmark,” he said.

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