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.
What comes next for YFYS
The superannuation industry was in something of a state of shock on Thursday afternoon, with late breaking news that the YFYS performance test for Choice products would be paused for 12 months – and that there would be a review into the operation of the laws that created it.
“The (Albanese Government) is aware of concerns that the YFYS laws have the potential to create such outcomes by discouraging certain investment decisions or certain infrastructure investments,” said financial services minister Stephen Jones. “Treasury will be tasked in its review to examine and consider the operation of the new laws in this context.
“With two rounds of annual tests completed, the review will consider whether the performance test has had any significant unintended consequences for MySuper products and assess how the test should be applied to other superannuation products.
The news came just days after ratings house Chant West raised serious concerns about how the test would be applied to Choice products and called for it to be postponed in one of the stronger rebukes of the legislation since it was implemented. Chant West’s recommendations likely provide the strongest way forward for the test to be revised, and general manager Ian Fryer has welcomed the review, while suggesting tweaks could extend beyond the test for Choice.
“The government has made it clear that they’re not wanting to get rid of all that’s been done,” Fryer said. “They see value in the YFYS reforms, but they’re thinking about the implementation so they aren’t creating more problems. They’re good ideas – let’s use those good ideas and implement them well to make sure we achieve the objectives for which these policies were brought in.”
Chant West’s recommendations would see the updated Choice test based on a number of different metrics, including a current performance test applied over five, seven, and eight-year periods; risk-adjusted returns over various periods; and an administration fees metric (among potential others). Fryer expects that scrutiny of Choice products will continue while the test is paused, and that APRA will still use its heatmaps to “put the blowtorch” on underperformers.
One of the areas that could be tweaked for MySuper options is the benchmarking of alternative assets, Fryer says, which could be segmented into growth and defensive now that APRA has more data to draw on.
“At the moment, alternatives are all 50 per cent equities,” Fryer said. “And there’s some funds that have a focus on growth-style alternatives, so they’re laughing… but there’s a bunch of funds which have got much more defensive alternatives, and they’re benchmarked to 50 per cent equities, and that’s cruelled them in terms of the test – maybe not over the past few months, but certainly in the first seven years of the test.”
While the review will not unwind stapling measures, there is ample room for them to be tweaked. Under stapling, if a new employee does not provide the details of their superannuation to their employer, the employer must contact the ATO. But there’s currently no way for that to happen in a timely fashion, and large employers are still resorting to putting new employees into their preferred fund.
“We’re ending up with a similar result to what we used to have. We haven’t got people defaulting into the company fund, but you’ve got employers making that the easiest option – not to get around the laws of stapling, but because following the process of finding a stapled fund is so inefficient,” Fryer said. “… I think it was a big mistake to roll out stapling when they didn’t have the enabling systems.”
The ATO’s YourSuper comparison tool is also problematic, given it’s the “only comparison tool in the country” where investment options can be compared on performance and fees but not risk.
“You can compare a 100 per cent growth portfolio to a 50 per cent growth portfolio and say “Ah, that’s done much better in terms of returns – I’ll choose that one.” But you have no indication that it’s much riskier,” Fryer said. “And people probably have chosen some of those more risky options over the last few months and have got a rude shock because those portfolios have gone down much more.”
“There’s no way any other organization in the country could do a comparison like that and leave off risk. Unfortunately, the ATO comparison did.”
David Bell, executive director of the Conexus Institute, also welcomed the review and supported similar recommendations to those made by Chant West.
“Some of the loudest concerns have been flagged around the ability to manage choice options, particularly options focused on sustainability and options where the trustee may look to manage risk within an asset class itself (e.g. lower duration fixed income in a conservative option),” Bell wrote in response to questions. “Our research suggests these are valid concerns.”
“The key questions regarding the performance test are (1) can a test based on benchmarks be sufficiently improved to address the concerns raised, (2) would it make sense to look at alternative metrics, and (3) is there room for a qualitative oversight (APRA being the primary candidate) to complement the quantitative test?”
