Nobody questions the need to fix super, although there appears little consensus on what needs to be changed and how.
Treasurer Josh Frydenberg’s October “recovery” Budget delivered an unwelcome surprise to the $3 trillion super industry: a slew of reforms under the title ‘Your Future Your Super’ which could fundamentally alter retirement outcomes.
The changes, launched in the interest of creating better outcomes for members, are projected to save members an estimated $17.9 billion over the next 10 years. But will they actually work? And what will be their real cost?
The new YFYS performance benchmarks – meant to light a fire under dud funds – initially failed to account for allocations to infrastructure and alternative assets, the exclusions of which would cost members almost double what the reforms were supposed to save while styming investment strategies, according to retirement thinktank the Conexus Institute.
But appearing before Senate Estimates in March, Helen Rowell, then APRA deputy chair, said that the regulator was not expecting “any material shifts in investment behaviour” as a result of the new benchmarks.
“We are of the view that a well-developed investment strategy that includes a reasonable allocation to unlisted assets…and infrastructure investments more broadly, should be able to meet the benchmark test, the performance test, if it is, as I said, appropriately developed and effectively implemented,” Rowell said.
A little more than a month later, the Government – and APRA – changed its tune, and new benchmarks were issued that were better adapted to portfolio construction. But David Bell, former Mine Super CIO and current executive director of the Conexus Institute says that while the performance test has been improved, it’s still not clear whether it will be useful for picking the difference between good and poor funds.
“We’ve been pretty consistent in advocating for a second test – a simple risk-adjusted performance calculation based on real-life performance, which you convert into a benchmark base test as well,” Bell told Investor Strategy News. “The obvious critique is that they just want to have one metric – but I think consumers really don’t want to know what the test is. They just want to have a result they can trust. Under the hood you could have a second test, and we’ve done a fair bit of research that confirms there’s no one perfect metric for performance.”
“The quality of the performance test should be proportional to the penalties of the test. If you have a better-quality test, you could have more stringent penalties that would better protect consumers.”
The new benchmarks would be less controversial if the consequences for underperforming them weren’t so catastrophic. After two successive failures of the test, funds would be barred from accepting new members. Bell isn’t sure that that’s the right way of handling underperformance either.
“The outcomes for highly disengaged members are arguably worse. They’re going to remain in funds that have a high potential to become more impaired with the assets left over in those funds, because you typically sell your more liquid assets… You’re probably in outflow rather than inflow. And are you going to be able to attract and retain the best investment staff in that fund structure? All those issues come into play. For this model to work well it will be essential that APRA is engaging strongly with those funds to protect consumers.”
On that front, APRA’s new superannuation czar will have her work cut out for her. Margaret Cole will soon take over from Helen Rowell, who will now be responsible for insurance oversight.
Cole joins from PwC in London and has earned a reputation as an “enforcer” over her 30 years in financial services, including at the British Financial Services Authority during the GFC. APRA chairman Wayne Byers said her experience made her a “natural fit” for the new superannuation paradigm. It seems that APRA is gearing up for war. But should the benchmarks be their weapon of choice?
A poor strategy implemented well
“More transparency is good. We don’t fight against transparency. More visibility of performance and better engagement is a good thing,” according to David Carruthers, head of member solutions at Frontier.
But it’s important that they get the right measures there…We don’t disagree with the aims, just some of the ways they’ve been implemented,” he said.
Frontier believes a “poor strategy implemented well” could boost a fund’s performance – for example, a hypothetical fund with a 100 per cent cash strategy that matches that return would create poor outcomes for members but wouldn’t necessarily fail the test – while the implementation date of July 1, 2021 represents a “terribly, terribly tough timeframe to get all these things done”.
He said: “There’s going to be a heightened risk that it’s not implemented properly. They’ve just announced that the benchmarks have been changed, so for us and the funds that means we have to go back and re-calculate all the numbers that we’ve previously calculated. APRA will be doing the same thing… You wouldn’t want mistakes to be made and things to not be ready.
“We’ve seen a little bit of detail about this consumer-facing comparative website, but we haven’t seen one [in practice]. You’d think that they’d want to do some consumer testing on this. Certainly, any fund that put up some information without consumer testing, you’d raise eyebrows on that. But it doesn’t look like there’s any time for that to happen.”
The question of whether the reforms will be ready in time for their commencement is a doozy. The Morrison Government seems certain of the answer, with the legislation currently before Parliament mostly unchanged from its exposure draft state. It’s clear that hundreds of submissions to Treasury have fallen on deaf ears, and the reforms have been rolled out with near-zero industry consultation and in the face of stiff opposition from within it. Funds were caught completely unaware by the announcement and have been on the back foot ever since.
An unjustifiable overreach?
Melissa Birks, AIST head of advocacy, says: “There was no consultation with industry about the proposals. When they came out it was a surprise what was in then, and of course mistakes are made if you don’t consult with industry because you don’t get the benefit of the wisdom of the industry…
“I’d suggest if they’d consulted in the first place, the policies they put forward could have been more robust and actually delivered on their intent,” Melissa Birks, AIST head of advocacy.”
The AIST, which represents 48 profit-to-member funds, has “fundamental concerns” about the performance test and opposes the reforms in their entirety, believing they need to be pulled from consideration and reworked to have any hope of succeeding.
“We support the policy intent of the reforms – but the way they’re currently structured, they aren’t going to deliver that. AIST thinks that the Bill needs to be withdrawn and then reworked in consultation with the industry to actually deliver on the policy intent,” Melissa Birks says.
She estimates that $500 billion in superannuation would not be covered by the YFYS reforms due to the fact they only apply to “trustee-directed products”, which would exclude large retail funds. The sequencing of the reforms is also in question, with “no chance” for the performance test to actually do its job before stapling occurs, while the investment veto power is a “huge overreach”.
“We can’t see any reason for it. The regulator already has very good powers to intervene if it thinks a fund is not acting in the best interests of members,” Birks says.
Elsewhere, opinion on YFYS is more positive. Brendan Coates, household finances director of the Grattan Institute, welcomed the inclusion of administration fees under the proposed changes to the reforms – “a sensible move” that will reduce the chances of funds “loading up” their admin fees to compensate for reduced investment fees. He says that while the test wasn’t as effective as it could be, “we shouldn’t let the perfect be the enemy of the good”.
“The whole point of the underperformance test is to weed out those duds. It’s certainly an improvement on the status quo and we can quibble about the details, but it’s still a step towards a more efficient super system,” Coates says.
“The big issue is that it doesn’t go far enough. The underperformance test amounts to taking some of the bad apples out of the barrel, but it does too little to force otherwise average funds to lift their game.”
While stapling might trap some members in bad-egg funds, there are many more members already in them. He expects that APRA will go further than the benchmarks by compelling repeat underperformers to merge or close in order to create better outcomes for their remaining members.
“What the Government has done to date… I wouldn’t expect is the be-all and end-all of the process. The regulators have other tools at their disposal to manage underperforming funds.”
A testament to the uncertainty that the reforms evoke is the unwillingness of many stakeholders – at all levels of the industry – to speak on the record about them. Some anonymous sources noted that APRA’s frontline teams are well-equipped to examine the guts of underperforming funds and force mergers where necessary, and that the ‘bright line’ test reflects more on the Morrison Government’s lack of faith in the regulator than it does on the performance of super funds.
Others warned that the performance benchmarks would heighten sequencing risk, and that the investment veto power represented a worrying trend in the centralisation of government power over private businesses.
APRA, which will have responsibility for enforcing the reforms, declined to comment for this article because the legislation was still before Parliament.
It may not leave there. At deadline, several crossbenchers (including erstwhile NSW Liberal Craig Kelly) have indicated they are unlikely to support the legislation in its current form, while Labor has warned that it will fight YFYS tooth and nail. With the previous Coalition Government’s embarrassing defeat of its industrial relations reform still hanging over its head, we’ll soon see if this is a fight it truly wants to have.