We never expected the review of the Your Future, Your Super performance test instigated by the Minister for Financial Services Stephen Jones to recommend the significant changes necessary to make the test less costly and more effective. This would require moving the performance test from a legislative to a regulatory framework, and empowering APRA to utilise multiple metrics and a qualitative overlay.
Nonetheless, the changes recommended by the Minister and Treasury will have positive impact. They show a preparedness to listen to industry feedback on a complex problem.
We hope that in the future a more significant review of the performance test structure will be undertaken. There remains significant potential to further improve consumer outcomes through a more effective testing regime which doesn’t constrain funds from creating the best possible long-term portfolios. Our modelling estimates the cost of the constraints created by the existing test to be around $3 billion p.a. Unfortunately the announced changes have little impact on reducing that opportunity cost.
Modest changes, generally beneficial
Two main changes have been made to the performance test design.
The first is the timeframe, which will grow (with time) from eight to ten years. Despite the positive optics this will have little impact. The rolling performance series nature of the test works to significantly shorten time horizons (which incurs the previously mentioned $3 billion p.a. opportunity cost).
The second is the announcement of additional indices. Both domestically and globally, composite benchmarks used for fixed income are now complemented by government and credit indices. Similarly, global equities now distinguishes between developed and emerging markets. The single alternatives bucket (benchmarked 50 per cent bonds and 50 per cent equities) is now complemented by a defensive alternatives (75 per cent bonds, 25 per cent equities) and growth alternatives (25 per cent bonds, 75 per cent equities).
These additions are welcomed. They will result in more accurate benchmarking, improve accountability (less ability to use credit as a way to outperform the test), and reduce constraints on super funds (due to reduced unintended tracking error attributed to inappropriate benchmarks).
The death of sustainability options?
The test will be expanded to trustee directed products. All the benefits (consumer protection, accountability, fee pressure) and detractions (constraints on constructing best possible portfolios) of the test carry over and, in some cases, are magnified.
Sustainability options will be the most problematic area, whereby their portfolios are assessed against traditional benchmarks applying the flawed rolling benchmark methodology. Arguably, these options face an existential crisis. On one hand super funds could make strong commitments which include exclusions, which is what we understand members choosing these options want, and leave themselves exposed to large performance test tracking error and heightened risk of failure and associated brand impact.
Or funds could dial back the scope of sustainability activities, and offer a ‘safer’ product that doesn’t align with the strong activities that members are seeking. On top of all this is ASIC’s current focus on greenwashing activities which, quite rightly, emphasises that products have to be true-to-label.
Hopes for a more significant review in the future
We believe a more significant review in the future should take place. This would allow better consideration of the potential for performance testing to shift from a legislative to a regulatory environment. An appropriately empowered APRA could then use multiple metrics and apply a qualitative overlay. Done well this would improve the efficacy of performance testing and remove the unintended consequences. Consumers would be better off from both perspectives.
In the interim, well done to the Minister and the team at Treasury for recommending sensible improvements to the existing flawed framework.