Treasurer Jim Chalmers’ recently announced review of the Your Future Your Super (YFYS) performance test will be the fourth in five years, if you count the substantial consultation during the proposal and drafting process. It’s hard to escape the irony of announcing yet another costly review at the Treasurer’s Economic Reform Roundtable focused on productivity.

The performance test has been an area of huge controversy with strong views being expressed, not all being well-informed. It absorbs the resources of Treasury, industry and researchers. All this activity occurs at a cost to super funds, government entities and ultimately consumers. Maximising productivity requires getting as much benefit as possible for the cost.

Every review presents an opportunity to improve systems and outcomes, and this review needs to be productive. We must make it meaningful by being more aspirational than just considering minor tweaks – otherwise the murmurings of discontent will continue and there will be another review in the future.

What is the problem to solve?

The government appears to have two motivations for reviewing the test. First is the concern that it creates incentives for benchmark-hugging and herding while acting as a disincentive to innovate. This is productivity-dampening.

Second is that the test hampers super funds from supplying capital in support of climate and sustainability and nation building activities such as housing and infrastructure. Here, Treasurer Chalmers has been clear that the aim is for the performance test not to act as an impediment, while the objective of super and member best financial interests duty (BFID) both remain pre-eminent.

Our working view is that consumers deserve the protection of a well-designed test, but there are arguably deficiencies in the current test. This review should be broad and have all options on the table.

… and the debate commences

Over the last week, arguments have emerged around maintaining the performance test, removing it entirely or changing it in differing ways. The more binary arguments seem motivated by some combination of self-interest, legacy or ideology. But some changes to the performance test seem both appropriate and likely, so we should be discussing what form any changes might take.

Many of the points raised on different sides of the debate are broadly true. For instance, we agree that the performance test has weeded out some poor funds and led to fee reductions. However, we also see issues with the test, which:

1. Only captures part of the performance story by ignoring the impact of asset allocation decisions;
2. Constrains the ability of funds to optimise their return and risk profiles;
3. Contributes to some of the member service challenges by placing emphasis on administration fees while being agnostic to service standards;
4. Heightens systemic risks by encouraging herding in a huge system that is growing fast;
5. Is becoming increasingly redundant as funds learn how to actively manage (i.e. game) the outcome;
6. Constrains certain investment activities; and,
7. Is accompanied by a lack of rigorous measurement of the costs, largely because estimating these costs involve counterfactuals.

We would like to see the review consider all relevant issues and not just attempt to address the two issues of herding and constraints on certain investments.

Three considerations

There is potential for the YFYS performance test review to deliver something meaningful, in the spirit of improving productivity. We detail three considerations for a more productive review.

Consideration 1: Broad and courageous mandate

The review should have all options for reform on the table, including:

• Abolishing the test
• Maintaining the current test
• Finessing the current test, such as by making changes to the benchmark indices
• Reviewing the broader structure of the test

As far as we can see, there is already an attempt to constrain the breadth of the review to tweaking the indices. This is despite the Treasury review of March 2024 raising broader structural reform as a possibility. More importantly, broadening the test to focus on total portfolio returns might achieve the motivations for the review through reducing the influence of the indices, while also addressing many of the other issues we raise above. Restructuring the test should be placed on the table as an option.

Consideration 2: Assess current settings and future challenges

The review might consider the extent to which the conditions that originally spurred the need for a performance test remain intact.  The test came off the back of a Productivity Commission 2015-2016 review that was scathing of industry performance and assessment practices. It was also critical of APRA’s inability to address underperformance, resulting in the recommendation of a ‘bright lines’ test. The idea was picked up by the Morrison Government.

Do the pre-conditions remain in place today that support the test in its current form? Funds are currently passing the test; there has been significant industry consolidation; and funds’ investment practices have evolved. APRA itself has significantly transformed since a review where the final report was released nearly a decade ago. So perhaps not.

What conditions are likely to apply in the future that might influence the appropriate form for a performance test moving forward? We suggest considering the challenges of managing assets at scale, the systemic impacts of a huge and growing system, the increasingly intense focus on peer grouping and the role of financial advisers in directing member flows.

Consideration 3: Consider the breadth of application and consequences

The performance test is currently applied to trustee-directed accumulation products of APRA-regulated super funds. This leaves many parts of the super system where consumers are not afforded the protection of a performance test. There may be benefit in extending the application of a well-designed test.

The performance test could be applied more broadly to other areas, including retirement options, managed accounts and SMSFs. If broad applicability is a policy aim, then the scope of the review becomes an important consideration.

The consequences for failure should also be reviewed. Failures have generally not resulted in much consumer activity. Rather super funds have tended to merge, while being targeted by media. Can consequences be designed that deliver more effective outcomes for consumers?

A productive review

There can be sizable upside in improving the performance testing framework. Let’s make this review a productive one. Otherwise, using history as a guide, we risk the unproductive outcome of yet another review in the not-too-distant future.

David Bell is executive director of The Conexus Institute.
Geoff Warren is research fellow at The Conexus Institute.

The Conexus Institute is a not-for-profit think-tank philanthropically funded by Conexus Financial, the publisher of Investment Magazine.