David Bell (left), Ian Fryer and Sara Dix.

Treasury’s review of the design of the Your Future Your Super performance test closed on Friday and submissions from industry stakeholders and lobbyists are expected to fall broadly into two camps for and against the test.

Since then, Vanguard Super has publicly stated that it’s backing the retention of the current performance test in its submission, saying that it’s currently the only “objective, efficient and timely ” option for APRA and super funds to administer.

“While we support the current performance test and principles set out by Treasury, we believe that a further principle should be considered when developing it: simplicity,” said Sara Dix, Vanguard Australia’s head of Australian public policy in a media statement.

“Introducing additional complexity such as risk-adjusted or absolute measures is unlikely to enhance the benchmarking approach.”

Despite initially being blindsided by the test and claiming it was a disaster – with Cbus describing it as “misleading and inconsistent” in a submission to the government – four years on, many funds are expected either not to publicly advocate for a change or even to argue it should remain as is.

In its first iteration the test, which was introduced by the previous Coalition government at the height of the pandemic’s first wave in 2020, benchmarked MySuper funds in each asset class against a basket of 12 indices. Subsequent decisions by both the previous and current governments to amend the test – including increasing the testing period from eight to 10 years and adding some additional indices – assuaged some concerns, especially among those funds who believed the test was ill-suited to portfolios with large allocations to private and illiquid markets.

But perhaps a bigger motivator in funds warming to the test is that they have learned how to “game” it by changing their strategic asset allocation, often by ensuring portfolios more closely mirror the relevant indices, leaning into specific asset classes which are treated favourably by the test (such as credit), and carefully managing the way they report their SAA (strategic asset allocation) to APRA.

David Bell, executive director of The Conexus Institute*, says the compliance risk attached to the test has diminished, earning support for it among regulated entities.

“General consensus is emerging that, under the existing performance test, it is unlikely that any MySuper options will fail in the future,” says Bell ahead of the closure of the submission process on Friday. “This is primarily because the industry is now actively managing for the test.”

Privately, funds have been expressing this view, with one chief investment officer of an industry super fund telling Investment Magazine “you’d have to be an idiot” to fail the test after four years of experience in adapting to the new regime.

While that may keep funds’ compliance and media advisers happy, Bell asks whether the test has now become “redundant” given it is unlikely to result in any penalisation. The answer to that question depends on whether you believe the test is incentivising good or poor behaviour in terms of member outcomes.

A number of asset consultants and academics are expected to argue the latter in their respective submissions to the review, in a growing sign of consensus among independent investment experts, if not among the industry itself.

‘Massive missed opportunity’

Ian Fryer of Chant West is among this emerging cohort, advocating for the replacement of the single-your future metric methodology with a multi-metric approach.

“Everyone knows the current test is flawed and doesn’t really measure what really matters for members,” Fryer says. “It would be a massive missed opportunity to just keep the status quo because funds are comfortable they can pass as they can keep managing to the test.”

He advocates keeping the existing test but adding one or two risk-adjusted metrics. This will avoid the political problem of doing away with a key plank of a reform package that the Grattan Institute has already praised for returning fees to members and is viewed by some in the Liberal Party as a crowning achievement of the Morrison government.

But more importantly, Fryer says, it will “allow funds to focus on producing strong returns for the level of risk taken – which should be the goal of any investment activity.”

At the same time, he acknowledges that the industry is right to be cautious about further change, arguing for a transitionary approach that avoids “yet another retrospective grenade” being lobbed into the super industry.

It is expected that a number of submissions will coalesce around the idea of a multi-metric framework, with metrics such as the Sharpe ratio and net investment returns likely to feature. CPI+ is another option the government has asked for views on, but some experts have privately expressed concern about the merits of this approach.

Bell says a multi-metric test may better align the test with optimal member outcomes, but it may also make it more difficult for funds by “diluting the active management opportunity which exists under the current test”.

Treasury has actively acknowledged the possibility of gaming and the feedback around unnecessary index hugging.

“Many stakeholders during the YFYS Review also suggested that there is a strong incentive to ‘hug’ the benchmarks. This reduces the risk of failing the test by investing in the same assets that make up the benchmarks,” the paper stated.

“Similarly, stakeholders have raised concerns that products which employ an investment strategy that has material sectoral differences relative to the benchmark face additional risk in failing the test due to higher levels of tracking error.

“An example of this is environmentally sustainable investment strategies that do not invest in fossil fuels, or high-emission assets. This is not good for member outcomes.”

Net zero is perhaps the biggest loser of the emerging schools of thought on the performance test. Bell says neither the status quo nor a multi-metric approach would adequately address ESG considerations, with the multi-metric approach representing an improvement.

“Realistically a bespoke solution may be required to address the challenges faced by this part of the super industry, if the government is prepared to take such a step,” he says.

*The Conexus Institute is an independent think tank philanthropically funded by Conexus Financial, publisher of Investment Magazine