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.
‘They’re going to get smashed’: YFYS chaos looms for choice
A mere 13 funds were dispatched by the first round of the Your Future Your Super (YFYS) performance test. Chant West believes the damage could be worse in the choice sector.
Later this year, APRA’s performance test will be brought to bear against the choice sector after a dry run on the smaller universe of MySuper products. Most MySuper products are growth-oriented variations on a standard 70/30 allocation, but the choice world is more disparate, and contains many more conservative options. It’s those conservative options that could suffer the most.
The problem for some of the funds that have already failed the test arose in the defensive part of the MySuper product. Funds that had taken “appropriate action” to minimise member risk by reducing the duration of their bond holdings or reallocating into defensive alternatives in the face of expected interest rate rises came up short against the performance test.
“When we move to choice investment options, and when we look at choice products where they’re conservative and they’ve got 70-80 per cent in bonds or cash, or where they might have 50 per cent plus in bonds, and the fund has made a choice to go short duration rather than benchmark duration – they’re going to get smashed,” Ian Fryer, Chant West general manager, told media on Tuesday (March 2).
Indeed, Fryer believes that a “very significant proportion” of choice options at the conservative end may fail the test because they went shorter duration. And with funds banned from accepting new money after two successive failures, that could lead to a “really weird arrangement” where older clients won’t be able to put money into the conservative options they want – and likely need.
“That’s a strange place to be in a superannuation world where we try to provide investment options that cover the risk spectrum,” Fryer said.
Preventing the chaos might require the industry to launch the same protests it did when the first iteration of the performance test was set to measure unlisted infrastructure against listed. At that time, industry bodies and individual funds warned on the benchmark risk, and Treasury was forced to add unlisted benchmarks to better match how funds were investing.
Here, Fryer believes APRA or Treasury could split growth alternatives and defensive alternatives – which would require asset allocation information that APRA historically did not collect but which it now is. Funds also have different standards for how they determine growth and defensive, and Fryer believes there needs to be “much clearer guidelines and rules on this growth/defensive piece” – a project which he’s working on alongside David Bell, executive director of the Conexus Institute.
That project is hard, but fixed interest is harder. Data on historical levels of duration going back to the beginning of MySuper – and before – is hard to come by. But even if the benchmarks could be scaled back to match super fund thinking on duration, there is the question of the inclusion of credit and the boost it could give funds if duration was shortened. Fryer thinks that might be “too hard” as well.
And these are all minor fixes for a test that Fryer believes is not so much a bright line as “blunt instrument”. The test comes up with one number that determines whether a fund will pass or fail – but that’s not going to accurately measure “in any way how a fund has gone.”
“A number of the funds that failed the test did so because in their equities they were going more on the defensive side – more low vol,” Fryer said. “The reason they were doing that was because they had older members; it sort of made sense.”
“But it just so happened that the period of measurement for the performance test has been one long bull market… It hasn’t been a cycle; it’s been one long bull market that’s benefited anybody who’s been risk-on and smashed anybody who’s been risk off. Virtually everybody who failed has older members and wanted to invest more defensively on some of these asset classes. A measurement of one number cannot take into account this stuff.”
