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.
Now Parametric buys into YFYS debate
The Your Future Your Super Bill continues to be roundly criticised by the industry after the deadline for comment has passed and notwithstanding doubts about its passage to legislation.
Proposed regulations, requiring comment by May 26, included two concessions to the barrage of criticism from almost every quarter of the industry – from the profit-to-member and industry fund sector represented by AIST and ISA through to the fund managers and insurance companies represented by the FSC. What could be called ‘the moderates’ in a political sense – ASFA and the Actuaries Institute – had already weighed in.
The two largest asset consulting firms, JANA and Frontier, and numerous fund managers, law firms and other organisations had had their say. The only notable in support of the Bill was Vanguard, the largest index manager operating in Australia and biggest beneficiary in any further shift to passive investing which the YFYS critics say will be inevitable under the proposed regulations’ performance test and penalties.
The concessions announced by the Government on April 28 were that it would allow the inclusion of infrastructure and unlisted property as well as administration fees in the figures for comparisons under its annual performance ‘heat map’ test. They were welcomed. The rump of the proposed regulations remained unwelcome.
Frontier and the Actuaries Institute produced two further submissions on May 25 which included their previous main criticisms. In a ‘regulatory submission’ Frontier said, for instance: “The performance test only assesses a small part of member outcomes:
- The test assesses how well a fund has implemented its chosen strategy, not whether it is a good strategy
- It ignores actual returns and the CPI+ objectives of funds that reflect long term member outcomes
- It does not incorporate most risk adjusted improvements from more diversified exposures, and
- It is not a peer relative assessment of underperformance (unlike the comparison website and some heatmap measures).
“A fund with an investment strategy which will deliver poor long term member outcomes, but is well implemented, will be judged better than a fund with a good long term investment strategy but been lower risk than its benchmark…”
The consulting firm, representing about $400 billion in super fund assets, also provided a separate submission suggesting improvements to the regulation regarding infrastructure.
Last week Parametric, the global implementation manager, reminded the industry that if the Bill passes its political hurdles of Labor and crossbench opposition, the importance of after-tax efficiency by funds and their managers will dramatically increase.
In a statement, Whitlam Zhang, manager research and strategy at Parametric, said last week (June 2) that super funds faced a very difficult choice when selecting fund managers under the APRA performance test,
“Active managers will have to substantially reduce their risk budgets, compared with the way things work now. Taking the passive option carries its own risks,” he said.
“Fund trustees will have to think creatively and make some tough decisions. Tax-managed strategies will have a role to play. In the quest for delivering the best financial results for members, sometimes it helps to focus on the simple things, such as paying less tax and reducing fees.”
The test would lower the appetite and patience of investment teams in strategies that may suffer large drawdowns for long, drawn-out periods of underperformance. Asset managers whose investment universe differs from their benchmark, including alternatives managers and those with niche benchmarks, might appear less attractive.
To work within the constraints of low-risk appetites, trade-offs would have to be made. These might include shifting allocations from private markets to listed markets and significantly reducing the amount of active risk taken within listed asset classes, Zhang said.
“By definition, a super fund investing passively cannot fail the performance test but whether it is the right investment decision for the fund is another matter. Some of the shortcomings of going down the passive route include: not all asset classes can be accessed passively; the fund will have few options for customising and tailoring portfolios to suit members expected outcomes; and the expectation for returns may be lower…
“As the performance test is net of fees and taxes, paying low fees for passive management and reducing taxes paid will increase the chances of outperforming the test.”
