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.
Don’t make the YFYS test ‘toothless’: Grattan
Any moves to fix the unintended consequences of the Your Future Your Super (YFYS) reforms must not undermine the benefits of the reforms, according to the Grattan Institute’s submission to Treasury’s consultation on the reforms. The performance test has resulted in fee savings of more than $100 million for members of underperforming funds, according to Grattan modelling, and the “existence of unintended consequences alone does not justify policy change.”
“The existing test provides a clear and transparent benchmark with defined consequences,” reads the Grattan submission, which was penned by Grattan economic policy program director Brendan Coates (photo at top) and senior associate Joey Moloney. “Funds know how they will be assessed ahead of time, and they understand what happens when they fail. This makes the regime enforceable and enhances the effectiveness of the regulator.”
“Introducing subjectivity into the test – such as allowing APRA greater discretion in applying the test – would compromise its integrity and risk recent gains to super fund members. Funds can always find an excuse for their under-performance or high fees, and regulatory risk-aversion suggests this could lead to the policy being toothless. When the regulator does make adverse judgments, these would be exposed to perpetual legal challenges.”
The Grattan Institute also repeated its calls for a “best in show” system of ranking super funds, previously recommended by the Productivity Commission, into which new members would be defaulted. Grattan’s submission says that “best in show” would improve returns “because funds would compete to make the shortlist and stay there”.
“Market discipline would come from experts who have the time, resources and expertise to decide which funds to shortlist, rather than individuals who don’t,” the submission says. “The government’s focus should be on implementing the remaining Productivity Commission recommendations, not watering down those already implemented.”
Still, there are changes that could be made to the performance test, including extending the test timeframe to 10 years and adding more benchmarks. ESG products should be accommodated “where it doesn’t compromise the integrity of the test”, while any expansion to retirement products needs “careful consideration” lest it compromise the objectives of the retirement income covenant.
But the expansion of the test to choice products should still proceed, the Grattan submission says, given the sector accounts for the highest fees and lowest performance and that product diversity is not a “get out of jail free card.”
“Some argue that there is little justification for expanding the test to choice products given these members have engaged and made active decisions,” the submission says. “However, the outcomes outlined above indicate serious market failure because of the difficulties members have in assessing product quality.”
“It is very easy for members to switch from a MySuper product to a choice one, regardless of their financial literacy. Members should not face a regulatory protection ‘cliff’ after an activity that takes only a few minutes and exposes them to the prospect of even higher fees and worse performance, potentially costing them many thousands of dollars in foregone super savings by the time they retire.”
