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On YFYS, no quick fix for the ultimate blunt instrument

A new review will address some of the unintended consequences of Your Future Your Super. But while super funds are no doubt holding out for a hero, there’s probably no perfect performance test.

“The fundamental problem with the performance test is that it’s trying to address a very complex, very multi-faceted, very difficult to measure through-time issue,” Craig Roodt, director of investment and wealth advisory at Deloitte, told the Alternative Investment Managers Association (AIMA) forum on Thursday (September 29). “Benchmarks within them have drift. Portfolios have drift. Behaviours change, trustees make decisions and try to respond. And you’re trying to deal with all of that back on a single number.”

It’s mostly for that reason that financial services minister Stephen Jones recently announced a review of the Your Future Your Super (YFYS) reforms, with an eye to making them more sensible but not less consequential. Funds will still be penalised for underperformance, but there is some hope that how underperformance is measured will be more indicative of how they actually invest. But redesigning a test that many within the industry believe to be intentionally punitive is no small feat.

“It’s a really difficult problem. None of us are sitting here saying that we’ve got the magic metric because there’s no magic metric,” David Bell, executive director of the Conexus Institute (photo at top), told the same forum. “And I think, through that lens, hindsight reflects very kindly on what APRA was doing prior to the performance test – a multi-metric, heatmap-based approach with a qualitative overlay. Those elements combined are probably the best you can do – they probably mirror what we all do as an industry when we’re investing.”

It will also be difficult to unwind the impacts YFYS has already on fund behaviour. In the post-YFYS world, there are two types of funds: those that can mostly ignore the performance test, and those that must do everything they can to pass. Much has already been written about so-called “limp mode” funds, which are forced to pull everything back to the benchmark and then find it very hard to get away from it. What’s perhaps more worrying is the behaviour of those funds that have failed and are now trying to avoid failing again.

“If you’re close to failing the test, your horizon shrinks massively and it’s all about trying to reduce active risk in the portfolio,” said Courtney Wilder, head of portfolio design at JANA. “If you’re failing the test we’ve seen, perversely, that it’s the other way round. It’s kind of like ‘all on black’ – within reason, obviously, but it’s definitely taking outsize risk. If you fail the first performance test you’ve got a 70-75 per cent chance of failing the next one because it’s a rolling eight year horizon.”

“The one positive thing about it is that it has reorganised internal teams and funds around finding out where they get the best risk-adjusted return to that alpha. Obviously that’s been diluted by some of the benchmarks not being great.”

Wilder says that tracking error across JANA’s client base is currently roughly two per cent on a total portfolio basis; the probability of a fund failing with two per cent tracking error, according to JANA’s calculations, is around one in four.

“That gives you an idea of how sensitive those funds are to the performance test,” Wilder said.

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