David Bell, Andrew Howard, Kylie Willment, Greg Barr

The previous government’s annual performance test has forced funds to lower fees and improve some aspects of their governance, industry figures say, while stressing reforms are needed to the way the test is conducted.

Speaking in a panel session titled: ‘YFYS one year on: What’s changed and what challenges lie ahead’ as part of Conexus Financial’s Fiduciary Investors Symposium held in June in the Blue Mountains, panellists said investment decisions were made with “increased focus” since the test was introduced and in some cases administration fees were lowered.

Kylie Willment, chief investment officer of the Pacific region at Mercer, said the performance test has helped drive down administration fees in the industry.

“You’re seeing that at an industry level, I think that those admin fees are coming down,” Willment said, adding this was “part of making the system stronger”.

Robust discussions

Andrew Howard, chief investment officer at Equipsuper, said the new regime had forced funds to have more robust conversations about investment decisions and the trade-offs involved.

“The investment committee was very clear with us in saying, right, we want to understand the proposals that you take to us, help us understand what the tracking risk then looks like relative to Your Future, Your Super, and then help us understand how that’s commensurate with your level of conviction in that,” Howard said.

The potentially devastating fund-wide effect of a performance test failure had also helped eliminate silos, Howard said, where in the past the investment team would have worked closely with the investment committee alone to solve investment challenges. Reporting requirements had also forced improvements in data governance.

“There’s no part of a fund that isn’t impacted by this. So integration is not just in the context of the investment decision-making, it’s also the communication and education across your entire fund.”

But after addressing the question of potential positives of the legislation, speakers had substantial criticisms of the test in its current form.

Member reactions 

While technically a two-strike test, the impact of a first strike was so dire that the test is, in reality, a one-strike test, said Greg Barr, principal consultant and segment head at Frontier Advisors.

“For funds that did fail, generally 10 per cent of members have moved,” Barr said. Shrinking member flows combined with poor markets will make it even harder for first-strike funds to pass this year, he said.

There is also much greater debate around risks in the short term, which can be an awkward fit for long-term investors, said Barr.

“Strategy was always meant to be very long term, but now it’s really, what am I going to look like next year, what intended risks do I want to take next year?”

Funds with exclusions based on socially responsible investment principles are also in “a world of pain at the moment,” said panel chair David Bell, executive director of the Conexus Institute, even though their members had chosen the exclusions that led to poorer performance.

Socially responsible investments hit hardest now

Willment said this was “really an unfortunate outworking of the way that the test is positioned at the moment”. Mercer prefers integration and engagement over exclusions, and this approach is likely to take precedence with socially responsible funds needing to stay aware of their tracking error relative to the YFYS benchmark.

“But I don’t think any of that gets away from the fact that, you know, we’re going to have members out there that still want to invest in options that have reasonably long lists of exclusions,” Willment said. “And I do think that we should have a system that enables them to be able to do that and not find themselves in a failing option.”

Howard noted more bluntly that funds are expected to invest sustainably, but at the same time are potentially punished for it. “Sustainable investing [is] one of the things that funds are being told that you need to do this, it’s really important, you’ve got a role to play. And yet you’ve got a performance test that’s not aligned with net zero in any way, shape or form.”

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