Kim Bowater and Ian Fryer

A major shortcoming of APRA’s Your Future, Your Super (YFYS) performance test is that it can push a number of funds, especially those who came close to failing the first assessment, to focus on passing the test at the possible expense of long-term outcomes for members according to Ian Fryer, general manager at Chant West.

Speaking on Conexus Financial’s ‘Future of Super’ podcast in a discussion regarding the results of the second YFYSperformance test, released in August by APRA, Fryer said the results looked good on the surface but ultimately failed to address the repercussions of the test for Australia’s superannuation industry as a whole.

“The Treasury is trying to recognise funds that aren’t doing all that well, and move members from those funds to others, so that seems to have worked well indeed,” Fryer said. “There are some other funds that may well have failed a second time as well but had already exited. So on the surface that looks like a success.

While the industry may have succeeded in learning how to pass the test, however, regulators need to focus on assessing funds based on long-term performance, warned Fryer.

“We’re looking at a test which looks at one number over one period,” he said. “We shouldn’t think that that one number is going to tell us everything we need to know about the quality of investment outcomes.”

Unintended consequences

Also speaking on the podcast was Kim Bowater, director of consulting at Frontier Advisors, a leading asset consultant for Australian institutional investors for more than 25 years.

Bowater said the timeframe of the test had so far failed to take cyclical market factors into account, in a way that put undue existential pressure on underperforming funds and instead favoured a short-term focus on investment.

“What was really interesting was… in the second year of the test, we have such a different environment that funds were investing through,” Bowater said. “It was a really difficult period, equity and bond markets were down, things that had performed poorly for the seven years [such as] liquid alternatives; value bias; being more conservative within asset classes; paid off last year.”

“And we saw funds that had failed the test go to the top of the peer performance charts and be top performers,” she continued.

Bowater also pointed out the interaction between the performance test and different market environments and cautioned that the test had failed to recognise different strategies across the cycle.

“The test isn’t really investing across a cycle,” Bowater said. “Funds will always invest differently and there’ll be times when different approaches come out on top, and when different approaches struggle.”

“You want to… have a test that picks up those different environments in full, and not just assess that on one particular sort of environment. And it suggests that what the test can do is pick up funds and fail funds that aren’t actually, over the long-term, bad funds.”

Bowater and Fryer also pointed out the risk posed by the performance test to ESG and social impact investing efforts in the industry. Not only must funds now navigate short-term performance benchmarks in addition to long-term climate risk mitigation goals, for example, but also limitations about the level of risk allowed by the test for various asset classes.

“I think it’s also another consideration for… new investments that you might take to do with social, [like] affordable housing, social infrastructure, even things like wind farms. Things that can have a really good investment proposition, can be good return for the risk being taken… but don’t really kind of align to any of the benchmarks where you might think they belong as an asset class,” Bowater said..

The need for nuance 

Both Bowater and Fryer raised the need for an industry performance test that relied on a “multi-metric approach,” taking in multiple perspectives over multiple periods. They also called for the introduction of a review mechanism whereby APRA can assess funds on a case-by-case basis rather than deciding the fate of funds wholly on the basis of imperfect metrics.

A review mechanism would make APRA’s job more complicated, but would ultimately “lead to much better results and will lead to funds making better decisions and choosing better investments,” said Fryer.

This year’s performance test results saw 64 MySuper products pass the assessment and five products failed, four of which failed for the second time.

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