A group of asset consultants and researchers have asked Treasury and policy makers to consider the possibility that “zombie funds” could be created as one by-product of the government’s new performance test.

Further, the group has said that future consolidation among superannuation funds could be stalled if the performance test is implemented as planned in 2021 in its current form.

“If there are some poor performing assets within their funds this [performance test] approach might leave them stranded… these zombie funds will find it difficult to find a partner to merge with or take on their portfolio,” Andrew Boal, researcher Rice Warner’s chief executive (pictured, middle) described during a discussion at Investment Magazine’s November Fiduciary Investor’s Symposium. Watch the full session on playback here.

Boal joined Mercer senior consultant Emily Barlow, Willis Towers Watson Nick Callil and the Conexus Institute’s David Bell to discuss the proposed Your Future, Your Super reforms in light of a detailed review into the proposed reforms the group released in late November along with Frontier and Jana.

Based on a statistical analysis of the proposed Your Future, Your Super performance test, the review found that for the case studies considered the measurement has between a 42 per cent – 65 per cent chance of misidentifying a bad performer as a good performer, and a 35 per cent chance of mistakenly identifying a good fund as poor. The group is expected to make its detailed findings public and has already shared its report with Treasury and government.

The lack of consideration of risk taken at the portfolio level and performance attributable to asset allocation decisions are among the main criticisms identified by the detailed review. The paper also highlighted potential unintended consequences stemming from funds changing how their manage tracking error to meet the listed performance benchmark, particularly as it related to owning unlisted assets.

The group supported the government’s plan for a performance test to remove underperformers but it highlighted a new test incorporating multiple metrics rather than the one single metric was needed.

Zombie funds

Among the most significant industry wide consequences raised by the group was the emergence of so called zombie funds – those funds that underperform or are at risk of posting multiple years of underperformance during the eight year performance window.

“Funds might be able to wear being labelled an underperformer, but being unable to take on new members, that will be a significant impact on those funds,” Willis Towers Watson Callil (pictured below) said.

The proposed Your Future, Your Super performance test requires funds to inform members if they fail the asset allocation benchmark by more than 50 basis points over an eight-year performance window from July and then and prohibit those funds from enrolling new members if they fail the test the following year.

The performance test might work against the government’s stated aim of reducing the number of funds in the market, Callil and the group agreed.

“There are already barriers to consolidation among smaller funds or larger funds acquiring smaller funds,” Callil said.

“There is no easy exit for some of these smaller funds, they’re not necessarily attractive merger targets for some of the bigger funds because they just don’t move the dial on some on the metrics that these funds are looking at,” he said, before adding that the performance test was unlikely to provide a catalyst for consolidation of smaller funds.

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