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.
New problems for choice products in next YFYS test
The Your Future, Your Super (YFYS) performance test has had a positive effect on the superannuation system but it’s still driving funds towards index-like investing rather than focusing them on what’s best for members, according to Chant West general manager Ian Fryer.
“What (the recent iteration of the test) showed is that if a super fund knows what the rules are, what the test is, they can manage towards that and make sure they pass it,” Fryer said. “And that’s sort of a good thing, but it depends on what the test is trying to measure. The test will drive behaviour; if you say you’ve got tom achieve this, everyone is going to achieve that as their first priority.”
Changing some of the benchmarks will “help a bit” by allowing funds to invest in defensive alternatives without fear of failing the test, but at the end of the day it’s still an implementation test – and one that is “driving the wrong sort of behaviour”.
“At all costs, let’s try to track the index,” Fryer said. “That’s not good in the long run. Some funds are a long way ahead of the test and they’ll keep doing what they’re doing. Some funds are close to the mark and their investment strategy will be controlled by this test and they will be investing in such a way that they’re trying to pass the test rather than getting the best return for members. That’s the logical, rational decision.”
Still, the test is probably a net benefit to the superannuation system; it’s in part transferred a members from “bad and okay funds to good funds”. But serious problems remain for its imminent application to multi-asset trustee-directed products (TDPs). Its application to that sector makes sense, Fryer said, because of the significant performance issues uncovered by APRA’s choice product heatmap. But there are some caveats.
“In particular it showed there are significant issues in closed products. There are a lot of closed products that are red on the heatmap. Those closed products will probably fail the test and their members will get a letter saying, ‘Go somewhere else’. They’ll get another letter if they fail again.”
But what then happens is that also you close the product. These products are already closed. That’s the worst consequence they can get. That’s a real issue, and there are so many.”
The other big issue is for TDPs that sit on platforms, where the average member looks different to the average member of a MySuper product.
“The extension to platforms is a problem, because the administration fee is based on a $50,000 balance. If you look at platforms – our numbers show that the average balance on a platform product is $250,000 – comparing on a $50,000 balance is nowhere close to the experience of members in these products,” Fryer said.
“These products tend to have a large dollar-based fee and then quite a low per centage based feed… That fee structure works well for high balances but it’s awful for $50,000. The performance test doesn’t care… It tests you on what you do for members with $50,000. What that could lead to isa many – probably even most – TDPs on those platforms failing the test. They won’t fail the test because their investments haven’t done well. They’ll fail the test because they have a high fee for $50,000 – which is irrelevant.”
Chant West’s solution is to formulate a platform relevant administration fees and expenses (RAF) measurement which will “be a lot fairer”. But other quarters of the superannuation system have also taken exception to changes to the YFYS performance test, including AustralianSuper, which warned that there was no industry agreed definition of growth and defensive alternatives. Fryer said that the distinction isn’t “perfect but it’s something that’s used”.
“Most of the industry is on board and (our proposal) has been with APRA for a while,” Fryer said. “That could be part of the solution, but growth/defensive is still not a perfect science… If you started the system again you might not have growth/defensive, but it is so prominent; it’s in so much stuff with advisers, and our view is that while it’s not perfect it’s something that’s used, and at the moment there are no rules about this stuff.”
AustralianSuper also suggested that the new classification would disincentivise funds from disclosing certain alternative assets as growth assets even if they fit the profile in order to generate outperformance, but Fryer said that gaming the benchmarks would be tough.
“It’s not a barbell, with growth and defensive alternatives at either end; it’s a continuum, so there’s a lot of grey about which one to use,” Fryer said. “Having said that, most funds use alternatives for a particular purpose. They’re either using it to get return or using it to protect return… There’s always the ability to game this stuff, but the way that funds use growth and defensive alternatives they’d have to change the way they invest to get a significant re-classification.”
