CEM white paper authors Mike Heale, Maaike Van Bragt and Alex Beath

Global benchmarking firm CEM Benchmarking applied Australia’s Your Future, Your Super (YFYS) test to the historical results of global pension funds from 1992 to 2020 across more than 1,100 large institutional investors to ascertain the ability of the test to identify poor-performing funds.

While there has been criticism over the test by the Australian superannuation fund industry, CEM’s research found merit in the test.

Overall, the test would have weeded out persistent underperformers among global pension funds according to the findings in the White Paper entitled “What is the value of Your Future, Your Super test”.

The results also show 14 per cent of global investors are expected to fail the test in any one-year over a seven-year time frame, while a marginally smaller 12 per cent of investors are expected to fail the test over an eight-year time frame. The research also showed a further 77 per cent of funds will fail the test in the eight-year time frame if they fail to the clear the bar over the seven-year time frame.

The test can help improve outcomes across the industry. Removing investors that fail consecutive seven- and eight-year tests will improve future net value added across remaining funds from 0.22 per cent to 0.30 per cent over 2011-2020.

Funds that fail the test more frequently tend to be small funds, funds that outsource a greater share of their investment activities and funds that incur high investment costs.

Test still missing some detail

The YFYS test focuses on returns which is key to superannuation members planning for retirement. CEM makes it clear that the investor’s strategic asset allocation is a “far more material prong” and should be incorporated into the test. Additionally, the test excludes risk, which should also be a key component according to Alexander Beath, senior research associate at CEM Benchmarking and the lead author of the White Paper. “Returns are all well and good, but risk should be part of the equation,” he said. “That is the risk-reward proposition of the default asset mix.”

The test is also missing the cost element according to Beath. “Our research ultimately shows that the features of superannuation funds passing the YFYS test tend to be features that are associated with lower costs, so it’s perhaps best to focus some of the test on that, cost. But it’s not just low cost or lowest cost, but rather value for money,” he said.

The CEM testing doesn’t account for any actions undertaken by funds to manage the risk of failing the YFYS performance test. If funds alter their mix of investment activities, it may impact system outcomes. “On the balance of the anecdotal information we have received, we believe the test has unfortunately resulted in portfolio changes that, on a net basis across the system, reduced outcomes for consumers at a particularly bad time for markets,” said David Bell, executive director of the Conexus Institute.

“That said, the reduction in administration fees and the amount of merger activity, which will hopefully lead to further scale benefits, has been a significant positive” he said.

Despite the shortcomings, CEM’s research shows the test improves outcomes across the board by filtering out poor performing investors and increasing the performance standards across the industry.

Industry reform still needed

The Australian Commonwealth government introduced legislation in the 2020/2021 Budget to improve the efficiency, transparency and accountability of the Australian superannuation funds that collectively manage a large proportion of Australia’s $3.5 trillion pool of pension savings. The reforms were aimed at addressing a number of structural issues within the existing system by giving more protection to superannuation account holders.

Under the legislation, the Australian Prudential Regulation Authority conducts an annual performance test for the typical default low-cost, simple products offered by the superannuation funds to their members, called MySuper products.

The test requires funds to have a net value add above -0.5 per cent over a rolling seven-year period, which will be expanded to an eight-year period this year. Funds that fail the test are required to give notice to their members. However persistent underachievers for over two years in a row will not be able to accept new members. A total of 13 funds with $56 billion of assets under management failed the inaugural performance test last August.

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