Home / Analysis / APRA’s performance test flaws laid bare… and the unintended consequences

The 88,000 members of Australian Catholic Superannuation and Retirement Fund (ACSRF) are about to be very confused. As are members of some other big super funds. Forty-year-old members in ACSRF’s default MySuper product, LifetimeOne, will be told they just earned an average 20.9 per cent from their super (after fees and taxes for the year to June) and, separately, that the -product underperformed and that they should consider an alternative. And when they are told of this underperformance, it won’t actually be true. The APRA performance test under YFYS is so fundamentally flawed in so many ways that it beggars belief how APRA, Treasury and the Government, allowed this to happen. It’s not as if they didn’t get enough warning. In the case of the ACSRF, APRA has taken a sophisticated fund default product launched in 2018 and transposed the previous MySuper returns to make up seven-year numbers. To date, APRA has not yet informed ACSRF what it calculates its performance to have been, leaving the fund’s executives and directors to only guess. Greg Cantor, the chief executive, said: “You may be a top performing fund by way of investment returns and may still fail the test. It’s all about beating a statutory benchmark.” He was interviewed alongside Michael Block, the fund’s CIO, and David Hartley, a trustee director and the fund’s chair of the investment committee, for a response to the APRA test results published August 30 (see main report this edition).

The three had worked closely with external consultants on the design of the lifecycle LifetimeOne, which seeks to control the very real sequencing risk faced by members of superannuation funds. Hartley said the default product was much better directed towards individual member outcomes than its predecessor product. LifetimeOne takes members turning 40 and offers them a gradual shift from growth to defensive in 31 increments of 1-2 percentage points until aged 70 years and beyond. LifetimeOne is also designed to dovetail into ACSRF’s retirement strategies. “We went from the situation where we were catering for the average member [with the default] to catering for the individual. APRA has spliced together results from two completely different products without making this clear in their announcement,” Hartley said. “Arguably, the ACSRF LifetimeOne product, which has only three years of historic returns and is completely different to its predecessor product, should not have even been included in the test.”  While the products can’t really be compared due to the changes over time, using the YourSuper comparison tool on the ATO website, Michael Block said, ACSRF’s returns compared favorably to a number of funds that passed the performance test.

Putting aside issues relating to specific funds, there are other serious issues with the test. These include the use of cap-weighted public markets indices to represent all investment strategies and associated assumptions which have been roundly ridiculed within the industry. For instance, unable to cope with alternatives, the test gives them an index-style nominal number based on a notional 50:50 split between equities and bonds, even though the strategies are most often designed to avoid as much correlation with those two asset classes as possible. And then there is the fact that the APRA statutory test does not recognise product changes made by trustees during the last seven years to improve future performance, which is what matters most in any proper assessment. Finally, ASIC requires that any publication of past investment returns be accompanied by a statement that past returns should not be taken as a guide to the future.  Not to do so is regarded as being misleading and deceptive and any adviser making a recommendation to switch investments solely on the basis of past performance would likely face the wrath of ASIC. Perhaps ASIC and APRA should compare notes. For a critique of the detail of the test published last week, prompted by the first results, Frontier’s short paper for clients is a good summary. For a longer, more philosophical critique, the papers produced by the Actuaries Institute tend to draw the widest industry acclaim. The Actuaries Institute, whose members belong to a multi-industry profession, from investments and insurance to weather forecasting, produced a paper criticising the draft legislation last December and a further paper in May 2021, referring to remaining “major concerns”. It is said that the second paper is the most critical of any Federal Government legislation that the organisation has ever produced. The main industry bodies have all issued submissions suggesting changes to the test, from the FSC, representing mainly fund managers and insurance companies at one end of the political spectrum, through to Industry Super Australia at the other end, representing mainly industry funds. ASFA, ‘The Voice of Super’, which represents all funds, is probably somewhere in the middle of the political spectrum. Michael Block says that many funds which did not compare as well as others on the APRA test, were those that used defensive alternatives to control risk. For instance, APRA named at least one fund which used a defensive overlay, despite it being beneficial for a cohort of members. The costs associated with the overlay were included and were a drag on performance. This is like being punished for having insurance when it turns out you weren’t burgled in that period. Maritime Super, another fund on the list of 13 to not pass the test, is another example. Maritime, which had a testy time with APRA prior to last week, following the intervention of the union in the performance test debate, had such portfolio insurance provided through an overlay from global consultancy Milliman. The fund went from bottom quartile to top quartile during the correction of March last year, thanks to the insurance. But after the sharpest fall in history, the market rebounded in record time and the excellent short-term relative performance was insufficient for a lasting outperformance. Ironically, Maritime’s members are probably unknowingly moving up the risk spectrum, now having their super managed by Hostplus, whose very young demographic leads to a more aggressive default product. Only about 15 per cent of Maritime’s membership invests through the default product, compared with an average of 80 per cent at most other big funds, including ACSRF. In May this year, Maritime transferred to the Hostplus PST, effectively becoming Host’s biggest single client. But its return from May to June couldn’t make up for previous underperformance so the Maritime members will also be getting a most confusing letter from the fund saying it had underperformed. This is another example of a significant change in a product, which will impact future performance, that is ignored by the APRA test. In fact, if a fund has underperformed only slightly in the first seven years, it is relatively straightforward to improve over the subsequent 12 months. However, if a fund has underperformed the threshold by, say, 0.5 per cent a year over seven years, it will have to outperform by approximately 3.5 per cent in the eighth year, which is next-to impossible to achieve. This is because 87.5 per cent of the data used in the first seven years will remain in the eight-year test. What does a fund do in that situation? Does it take inappropriate risks or make plans to shut up shop, perhaps through a merger, or just allow the members to fend for themselves? And then there are those which passed the test but not by much. APRA allows a margin of underperformance of 0.5 per cent before a fund fails. So, if you were a fund that passed the test but only within the 0.5 per cent leeway granted, what position would you take over the subsequent 12 months? You’d hug the APRA benchmark as closely as possible, wouldn’t you? That means you’d move to index positions across all strategies, quite possibly to the detriment of members.