Financial services minister Stephen Jones has made a sensible decision in requesting that Treasury reviews some of the Your Future, Your Super (YFYS) reforms, particularly the performance test.
On Thursday night, the minister announced it will conduct the review after the second round of performance tests have taken place and will pause the extension beyond MySuper products by 12 months.
In all my research and engagement on the YFYS performance test I have never heard a single fund say that there shouldn’t be a performance benchmark. There is a strong chorus of support from funds for a performance test which protects consumers, particularly those in default options.
But the chorus of concern relating to the design of the performance test is just as loud. Those concerns extend to the effectiveness of the test and its unintended consequences.
Most concerning is that many funds believe they are constrained from maximising member outcomes. The constraints take many forms, from investing in long-dated unlisted assets, to constructing well-diversified portfolios, managing specific portfolio risks such as fixed interest duration and ESG, and reflecting the preferences of members on issues such as climate change. A near universal observation from nearly every fund I’ve talked with is that the performance test has shortened their investment time horizons.
It is in choice products that some of these constraints are most pronounced. So pausing the application of the performance test to these options makes sense. Well done Ian Fryer for leading on this issue.
A review makes sense as it creates the opportunity for a research-based investigation into these issues. Can the constraints be substantiated and are they meaningful?
One frustrating reflection is that nearly every concern raised was predicted by many during the consultation phase. Rather than dwell and point fingers, now is the time to be constructive and focus on identifying a better outcome which preserves (better still, enhances) consumer protections but doesn’t constrain funds from seeking to maximise member outcomes.
The performance test has had a lightning bolt effect. It has already delivered substantial consumer benefits: across the industry administrative fees are lower and investment activity is scrutinised by fund trustees like never before. Industry consolidation will ensure further cost benefits are realised in the future.
However there appears to be negative impacts, mostly in the form of constraints. Our latest research piece, soon to be released, found that even many of the funds with a performance test “buffer” believed that over the long term the test will negatively impact outcomes to members. Identifying the size and extent of these costs will be important. Quality research has an important role to play in this review.
Naturally, attention will soon switch to what an improved performance test would look like. Three reflections:
- One option is to enhance the existing benchmark-based approach. In my view this is akin to applying wallpaper over a cracked wall. A benchmark-based test has fundamental shortcomings which can’t be fixed through benchmark selection;
- Multiple metrics may help to identify the full performance story. In their submission the Actuaries Institute identified a range of inconsistencies between performance test results and member outcomes. Multiple metrics would have reduced the occurrence of such anomalies; and
- With so many considerations, and the need to focus on forward-looking consumer outcomes, a qualitative overlay has merit. The challenge here is how this could work effectively in practice.
Well done Stephen Jones on a sensible decision. Now industry has its chance to provide constructive input into a solution which can maintain consumer protections and enhance their outcomes.