It is easy to bemoan the loss of portfolio flexibility created by the poorly designed Your Future, Your Super (YFYS) performance test.
But, viewed through a positive lens, there is now a fascinating challenge to integrate the impact of YFYS into a fund’s updated investment model.
Some funds will do this better than others leaving these funds better placed to maximise outcomes for their members.
One exciting outcome of new Conexus Institute research is that for many funds there will exist a surprising degree of portfolio flexibility. We see a clear opportunity for funds to utilise active management, both traditionally implemented (directly or through external managers) and through alternative investment products.
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Adjustment period for super funds
Funds are at the start of addressing their go-forward strategy in a YFYS world. The major adjustments, with an emphasis on the investment model, are detailed in the diagram below.
It has been nearly a year since the YFYS reforms were announced in the federal budget. The length of the adjustment period is unknown, but the dust should have settled within another year for most funds.
Reassessing the business model
Funds will need to consider their scale and what business model and service offering best complements this. In this context size and organic growth profile are both important: size informs scale benefits while net inflows should be used to inform the possible allocation to illiquid assets as part of the investment strategy.
It is a difficult challenge.
Funds need to account for the impact on net inflows because of stapling and performance test outcomes, both areas where the impacts are presently unknown. Further, funds aren’t developing their business strategies in a closed environment: they will need to account for the dynamics of actions taken by other funds, notably consolidation activities and the development of B2C strategies.
Of course, trustees don’t need to simply convince themselves that their business model is sound. APRA will be reviewing the business plan of each fund. The Member Outcomes Assessment looms as a tool which can be evolved further.
Investment governance excellence
Best practice super funds will have a common distinguishing feature: excellent investment governance. Underpinning this will be a high-quality investment committee with practical and technical experience.
There will be a strong working relationship between the CIO and the chair of the investment committee, who performs the important role of being a communication channel within the broader board.
Excellent investment governance will be represented through an agreed tolerance for the likelihood of failing the performance test and an agreed framework for trading-off the maximisation of member outcomes against the likelihood of failing the performance test.
Other features of best practice super funds in a YFYS performance test world:
- A strong understanding of where the performance test aligns with managing for best member outcomes and where it conflicts with this objective.
- Implemented modelling of the trade-offs between maximising member outcomes and the risk of failing the performance test. This will be integrated into tools (metrics and dashboards) used to support portfolio decision-making. The diagram below is a simple illustrative example.
- Processes to ensure that the components of investment management not captured by the YFYS performance test continue to be appropriately assessed and reviewed. This includes the performance of asset allocation decisions (including the overall risk decision) and the performance of risk management activities.
A resolved investment model will enable substantial investment opportunities
The changes to investment model, SAA reporting and ESG integration combine with investment governance excellence to create a resolved go-forward investment model. Our research suggests that this may result in a surprisingly large amount of investment management flexibility.
Active management is far from dead.
The remaining components of a reviewed investment model and the resulting positive opportunities will be explored in a subsequent article. The full research is scheduled to be released at the upcoming Absolute Returns Conference on September 15.