Eight months after its announcement in the 2020 Federal Budget, the Your Future, Your Super package has now been passed by parliament. The annual performance test will apply to MySuper products from 1 July 2021 and ‘trustee directed’ products from 1 July 2022.
While the performance measure used in the test largely mirrors the performance data used in APRA’s heatmaps, which have now been published for almost two years, we expect its impact on the superannuation industry will be much greater. All funds will weigh up the priority that should be given to meeting the performance test relative to other objectives. Some, perhaps most in the longer term, will change how their investment portfolios are designed and managed.
Some of the key features of the test are:
Unlike a poor heatmap outcome, the result of failing the performance test is highly visible. Funds must send their members a notice (by paper mail, adding another expense) commencing with the words 'Your superannuation product has performed poorly. You should consider moving your money into a different fund'.
That is an unpalatable action for any fund, no matter how much effort is spent on explaining the context or any reasons for the underperformance. Two successive years of failure will see funds barred from accepting new members into the product that failed, which would damage cash flow and destroy the viability of most funds in a reputational sense.
So, it seems, we now have a performance test to be reckoned with. The resultant imperative to minimise the risk of failing may require a rethink of a fund’s objectives. For example, where does the test sit relative to the existing objectives? A MySuper product designed to meet its existing (typically, CPI plus-based) objectives would, based on our initial analysis, have a 10 to 20 per cent chance of failing the performance test over a single eight-year period. Is that acceptable? Or should tracking error be wound back to reduce the risk of failure, even if this is expected to reduce long term returns for members by diminishing the chance of meeting or outperforming existing objectives? It seems a hierarchy of objectives will be needed to ensure the priorities for portfolio design are clear.
Conceivably, we could see a bifurcation of strategies adopted among funds. Those with a strong brand name and market presence, or a well-defined and ‘sticky’ membership base, may consider a failure of the test (at least for one year) to be manageable and hence choose to maintain a higher priority to the existing investment strategy. Those with a weaker franchise might make passing the test the highest priority, dialling down the underperformance risk to an acceptably low level.
With the introduction of administration and advice fees, the test is no longer a pure investment objective for which the task of monitoring and managing performance against the benchmark can be delegated to the investment function. A whole of business approach will be required, with the Board, CEO and other business functions involved in the assessment, monitoring and strategic approach towards the test. Fee pressure relative to peers, already high, will increase.
We have already seen funds make portfolio and product changes, in anticipation of the test becoming law. However, its broader implications will play out over several years. It seems clear though that prioritising and then managing risk of failure will become a top tier issue facing all funds.
The next article in this series will dig deeper into the investment implications of the performance test and explore how funds might manage benchmark risk.