The Your Future, Your Super performance test is inhibiting the use of alternative investments and will continue to do so as long as it poses an elevated risk to superannuation funds, but a panel of experts believe the industry is too smart and too creative not to readjust and find a way for the asset class to be included in portfolios.
Hosted by The Conexus Institute executive director David Bell, a group of speakers came together at the Conexus Financial Absolute Returns Conference to discuss how significantly the YFYS performance test would inhibit funds from using alternative investments, and how any deviation from historical portfolio construction would affect member outcomes.
Mercer chief investment officer Kylie Willment said the fact that funds are now subject to a regulatory test with a different focus than the traditional risk and return prospects put investment managers in a “slightly unusual, perhaps unfortunate and slightly uncomfortable position”.
Funds were now focused on passing the test, she explained, rather than “total member outcomes, total expected returns and how they contribute to members balance in retirement”.
There’s no point griping about it, however, the CIO believes.
“The test is here, and I think that we have to believe it’s in the best interests of our members that we stay open and be able to pass the test and be able to continue to grow and accept new members,” she said. “And so obviously, we have to take the test very seriously.”
Courtney Wilder, the head of alternative investment research at JANA who acts as a specialist adviser to funds on the sector, said funds stepping away from alternatives is a “real possibility”.
“I think in reality it will constrain the current use of alternatives,” he said, adding that the extent of that inhibition will depend on what allocation the funds currently have to alternatives and what their tolerance is for tracking error with regards to the performance test.
Continuing to use alternatives in the same way they’ve always been used will be problematic under the performance test, he explained.
Most managers use alternatives as a bond replacement or add-on, Wilder said. Under the performance test rules, that use-type becomes more of a mid-risk, higher-risk approach, “which then gives more procyclicality within that portfolio, and not necessarily as an actual diversified risk portfolio”.
“I think people will use alternatives,” Wilder predicted, “it’s just how they will use it.
“There will be some funds [that] decide it’s too hard and won’t do it. And of course, there are other funds that are probably too big and just don’t do it anyway. So it just depends on the client profile. And I think that will evolve over time as quickly giving more transparency about how APRA want to implement that approach.”
That proclivity to evolve was a point picked up by Bell, who believes the talent of investment managers will find a way to make alternative investments work in the institutional world without taking on the kind of risk many find unpalatable in a YFYS world.
“The world of alternative investment managers, as we’ve seen today, is full of really smart people who are creating the next solutions,” Bell said, adding that “adjustments will be made”.
“There’s too much creativity, too much smarts from the investment management side, not to work out a way for and help superfunds achieve what they need to achieve to maximise outcomes for them.”
Small funds, however, may need more than creativity to maintain their current use of alternatives while satisfying the performance test, Bell reckons. With more limitations on their investment governance structure, subscale funds may have see alternatives as too problematic.
Travis Schoenleber, managing director and head of hedge funds Australia and New Zealand at Cambridge Associates, agreed that smaller funds may find alternatives tricky in the new world.
“What the performance test has done is it has really increased the business risk of a fund, particularly any type of underperformance,” Schoenleber said.
“In order to be taking on some of the risks that you might see in alternatives, you do need a very robust governance structure, you need good expertise within the investment team in that space, you need very good risk management and stress testing as well. So if you do not have that or are not able to outsource that effectively in the new environment at the smaller level, I do think that it’s going to be much more challenging for alternatives.”