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.
Why APRA should have more leeway on YFYS
Deloitte Superannuation – the former Rice Warner crew – are likely some of the only super policy experts that didn’t make a new submission to the YFYS review. According to Deloitte partner Andrew Boal (photo at top) its submission to the previous draft exposure contained everything it wanted to say.
But with a more collaborative Treasury that might actually take the consultation process seriously, the issues put forward in historic submissions bear new examination. One of Deloitte’s recommendations was to allow APRA some discretion in how it deals with underperformance – a recommendation that is getting play in other new submissions. And there is currently no right to appeal in the test, which proponents of the test in its current form believe reduces consumer harm, but which in other cases might amplify it.
“There were some situations where a fund that did fail the performance test the first time around had made substantial changes to its investment team and approach and philosophy about three or four years before,” Boal said. “But the substantial part of why they underperformed was the first four years. And the following four years they were doing okay under their new philosophy. They failed the test – bad luck.”
“Those members on a forward-looking basis were invested in something quite reasonable. But because they failed an eight-year test – most of those years when they didn’t know anything about the test – that might actually be hard on the members.”
Other cases include where a fund takes “a strong view on something” that underperforms for several years before the reasons for that strong view are borne out – just as members have been told to move to a better fund, missing out on a rebound. Boal’s historical funds management example is that of Maple-Brown Abbott, which in the late 90s had a strong conviction that tech stocks were overvalued and underperformed for several years until the Tech Wreck. If the performance test were applied to them, they would have failed – but you don’t have to look far for examples within the 2021 test failures as well.
But critics warn that introducing subjectivity into what is supposed to be a bright line measure will allow funds to justify underperformance, with the Grattan Institute saying in its own submission that “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”.
“It’s really difficult, and that’s part of the rationale of why the government of the day decided to go with a bright line test without discretion. With some form of discretion, there’s always the opportunity – if APRA does or doesn’t exercise that discretion – that you could see a fund go to the legal fraternity and take them to court. So a bright line test got around the problems of getting lawyers involved.”
“That’s the challenge. We’ve got SPS515 and member outcomes, so funds are required to have a business strategy and annually assess their member outcomes. And where they have underperformance or weaknesses they need to have a strategy to fix those. Investment performance is one of those.”
One thing that could be done is to make the consequences of a test failure “a little less draconian”.
APRA might not stop funds from admitting new members, but they might still compel them to send a letter out to all members notifying them of their underperformance, which would be a fairly heavy penalty. But encouraging member movement from an underperforming fund is a Catch-22 of its own; while APRA has in the past been underwhelmed by member movement from failing funds, a mass exodus could endanger any business case a fund has worked up for merging with an underperformer.
“It’s not in members’ best financial interests for them to spend money merging anymore because the other fund is too small,” Boal said. “So in a way, members leaving a fund in that situation can then leave the remaini8ng members stranded and having to be dealt with in some other way.”
