David Bell (left), Jo Cornwell and Scott Bennett

The Your Future, Your Super (YFYS) performance test has had significant impact on the investment behaviour of asset owners and portfolio managers. According to research published by The Conexus Institute, super funds were taking a shorter investment time horizon, reducing their portfolio management levers and becoming more constrained in managing risks in order to maintain or build their performance test buffer.

Speaking at Investment Magazine’s Equities Summit in Sydney, Jo Cornwell, Aware Super’s portfolio manager – growth assets, said the performance test warrants the fund’s equities investment team focus on its capital allocation framework and the allocation of its active risk budget.

“We want to have detailed oversight of what the  key contributors are to the active risk we are taking in the portfolios” she said. “But that’s doesn’t necessarily mean jumping straight to passive management to manage risk.”

Scott Bennett, head of quantitative investment solutions – Asia Pacific, Northern Trust Asset Management, has also seen a big push by super funds to de-risk portfolios. “When we think about de risking, it’s not a straight jump to passive. I think a lot of investors are recognizing that they have an active risk budget that they need to be spending and even more so now given where inflation is at.” But he noted super funds were not terminating the mandates of their active managers.

The focus on managing the risk budget is also highlighting the importance of manager capability and selection. “Do we trust our investment managers to deliver on the objectives we have agreed with them and are they being innovative in their fundamental research in order for us to have the greatest confidence that they can deliver alpha in a more uncertain world?” Cornwell said.

The $150 billion super fund has embarked on a strategy to manage about 50 per cent of its assets internally over the next few years to lower costs and give members benefits of scale, in line with similar efforts by other large super funds.

This internal management strategy has given the equities team additional resources to manage tracking error more effectively. “If we identify an area where we need to manage tracking error risk, we have the internal capabilities to enable us to do that. That’s an advantage of our scale and our size,” she said.

Challenges from the test

One of the challenges faced by equities portfolios posed by the performance test is variability or tracking error relative to the benchmark. “It is really how cyclical is my performance pattern and the idea is we want to get that cyclicality very low,” said Bennett.

Another issue is that ESG-focused investments result in high tracking error in the test but this strategy cannot be ignored as every major super fund has a net-zero target he said.

Fund consolidation, not just limited to smaller and poorer performing funds, has caused significant capacity issues. The top 20 super funds in Australia account for over 25 cents of every dollar invested in the Australian equities market, up from around 15 cents 10 years ago.

“From a capacity perspective and specifically, when you think about markets like Australian equities, which make up half the overall equity allocation, it becomes a significant challenge,” said Bennett.

“As we go through this process of funds failing or looking to fail Your Future, Your Super tests and increasing [pressure on] them to merge, that challenge is only going to get bigger and bigger from an implementation point of view.”

The test has also hampered managers’ ability to deliver returns said Bennett. “This is probably the most challenging environment for real returns that we’ve faced in the last two decades. The scope to actually manage [headwinds] effectively and to actually create wealth has left super funds feeling hamstrung,” he said.

Exposure to assets that are highly volatile is becoming increasingly more challenging in the YFYS world. “The biggest challenges for us from a portfolio context are how we allocate to off-benchmark positions,” said Cornwell.

“We’ve been thinking a lot recently about allocations in emerging markets, our allocations in China and our allocations micro caps and small caps and deciding how we want to allocate that active risk budget,” she said.

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