Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
In YFYS, one number ‘doesn’t tell the whole story’
To fix the Your Future, Your Super (YFYS) performance test, Treasury and regulators need to reconsider their fixation on a “bright line” measure.
It’s a testament to the flaws of the YFYS performance test that, several months after it was first applied to MySuper products, the super sector’s intelligentsia are still trying to fix it. Ian Fryer, general manager of Chant West, recently warned about the consequences of imposing the performance test on more conservative choice products, but believes that the wider test is still deeply flawed.
“One number doesn’t tell you the whole story; it tells you something, and it perhaps indicates that you need to look a bit more closely,” Fryer said. “If you have a few different metrics that look at how funds perform from different angles, that you could give you more information, and it could give the regulator more information.”
“The test is simply an implementation test; how well you’ve implemented the asset allocation… (asset allocation) isn’t being measured at all. How do you measure that? It’s hard. But we shouldn’t say “It’s hard to measure this, so we’ll just measure this” – you’re missing the forest for the trees. You’re measuring something that only has a small impact on member outcomes, and you’re ignoring something that has a bigger impact because it’s all too hard.”
Fryer believes that funds are now being driven into “an artificial situation that’s been imposed on them” where managing for the test is now in members’ best interests, by virtue of the fact that being branded an underperformer isn’t – long-term investment consequences be damned.
“Should you be managing towards the test or should you be managing long-term?” Fryer said. “If you’re well ahead of the test, you can sort of keep a bit of an eye on it in the rearview mirror. If you’re right on the line, that’s right next to you in the passenger seat, and you need to be looking at it all the time.”
“The question though is, if you are close to failing the test, is it the right thing to manage partly or significantly towards the test? Is that in members’ best interests? Maybe it is. It’s probably not in members’ best interests that you fail the test and get put on the naughty list and your members get letters from APRA and you go into significant outflow.”
That’ll likely create herding risk (“index everything to the hilt and you’ll be fine”)and YFYS tracking error is now “the main tracking error in town.” All of this is creating a kind of two-speed system, where one group of funds will fret about the benchmark while the other can focus its attention on other projects.
“If you’re AustralianSuper and you’re well ahead of the test, you don’t have to worry about it too much,” Fryer said. “It’s moving into two groups; one that has to focus on the test significantly, and the other group that can do what they like while keeping in mind the potential medium-term impacts of moving away.”
They also haven’t yet had the desired effect of encouraging member movement out of underperforming funds. While APRA’s Margaret Cole has pushed for members to rethink their fund and Treasury has launched an advertising campaign to inform consumers of the consequences of the test, around three million members remain in underperformers. And the member-facing tools that APRA and the government have provided are unlikely to help the situation.
“The problem with the YourSuper comparison tool is you’re comparing high risk MySuper products with really conservative MySuper products, and there’s no disclosure there about very different risks,” Fryer said. “Some of the ways that we’re trying to help people are deeply flawed as well.”
