Four candidates for YFYS expansion – and why we’re not convinced

Of the options floated in the current Treasury consultation on strengthening the APRA performance test, otherwise known as the Your Future Your Super performance test, one would have major ramifications for the advice sector: extending the test beyond MySuper and trustee-directed products into new territory.

We looked closely at the four candidate areas mentioned in the consultation paper – externally-directed products (EDPs), separately managed accounts (SMAs), single sector products and account-based pensions (ABPs) – and came away largely unconvinced.

Our reticence was not because of a lack of reasons to consider extending the test to these areas. For each there is a reasonable argument that the same problems the test was designed to fix when announced in 2020 are present today. Rather, it was that what seems a reasonable initial case does not translate through to a strong final case. After we worked through the detail, our enthusiasm had cooled significantly.

The Conexus Institute’s submission can be accessed here.

Why even consider expanding the YFYS test?

Our starting point was the Productivity Commission’s (2018) original reasoning for introducing a bright line test. Four conditions supported the case back then:

1. Performance dispersion across funds: There was a tail of poor performers to “clean up”.
2. Fee dispersion across funds: Fees on some products seemed unreasonably high.
3. An absence of comparative data: This limited the ability to make informed decisions which could aid effective competition.
4. Limited regulatory capability to act on poor outcomes: A product-level test could fill a hole in regulatory oversight.

When we applied the checklist, the case for expanding the test looked strong in each candidate area. Performance and fees in the SMA sector are difficult to assess and compare. EDPs show similar dispersion, particularly multi-asset offerings managed to a total-return objective. Single sector products are highly disperse by nature, even if comparative data is somewhat more available via platforms and research houses. ABPs appear to demonstrate greater performance and fee dispersion than accumulation products, not all of which is explained by legitimate differences in retirement-phase strategy.

So, there seems a reasonable case for testing all four areas based on the original four pre-conditions.

What changed our minds

Considering the pre-conditions was just the beginning. After digging into how each sector operates, we concluded that the YFYS test is likely to be either unsuitable or ineffective if applied in each expansion area. Four additional considerations did most of the work in shifting our position.

1. Whether other approaches could do a better job: Treasury’s parallel consultation on member protections – particularly proposed governance requirements for platform super funds – looks likely to lift standards regardless of whether the YFYS test is extended to these areas.
2. Nature of the investors: Members in MySuper are largely disengaged and relying on their fund as a fiduciary by default. Members choosing SMAs, single sector options or EDPs have made an active choice, often under financial advice. It seems reasonable that investors who move further along the choice spectrum take on more responsibility for the outcome, albeit recognising that advisers acting in clients’ best interests is a critical requirement.
3. Operating model flex: Performance testing only works if it can’t be easily dodged. In the SMA sector in particular, testing could simply accelerate a shift towards single-sector versions of the same accounts, managed discretionary accounts or investing via a SMSF through non-super SMAs or managed investment schemes. All sit outside the test’s reach. A test that pushes activity into untested channels provides little consumer protection.
4. Other practical problems: We also identified a grab bag of specific aspects applying to each area. For instance:
5. The five-year track record requirement excludes newly-launched products from testing (and notably would not have caught Shield or First Guardian).
6. An awkward fit between a strategic-asset-allocation-based test and products built around a real-return or risk-managed objective.
7. Single sector products are often part of a portfolio where the total portfolio outcome is what matters.
8. ABPs can form one component of an overall retirement solution where the outcome is an income stream; and may be managed for limited drawdown risk, inflation protection or tax efficiency which the test does not treat appropriately.

Where we landed

Running all four candidate areas through these additional lenses left us with four different conclusions.

EDPs: There is a genuine case for testing but it is not compelling enough for us to advocate for this extension. The combination of existing research-house scrutiny, anticipated governance reforms for platforms, and the poor fit between current test design and many products leaves us equivocal rather than opposed.

SMAs: We don’t support extension. The sector deserves more scrutiny and accountability – we are not arguing otherwise – but the YFYS test is the wrong tool. It’s also the sector most exposed to the test simply pushing activity into channels that are un-tested and less transparent.

Single sector products: We don’t support extension. These products are deliberately chosen and typically one component in a broader portfolio. Testing an intentionally selected component in isolation doesn’t apply well.

ABPs: We’re more open, but only at the margin. Retirees deserve some form of performance assessment. The case for testing an ABP strengthens where it is a clone of an already-tested accumulation option and not embedded within a broader retirement income solution. Where an ABP has been genuinely redesigned for retirement, applying the existing YFYS test would be unfair, uninformative and unhelpful. We’d rather see retirement products assessed later as part of a holistic retirement income strategy framework, with any narrow ‘clone-testing’ being an interim measure.

The broader point

We are not arguing against scrutiny in these areas. Quite the opposite, particularly for SMAs. Rather, we are arguing that the YFYS test, which was conceptualised and calibrated to do a specific job in 2018, is the wrong instrument for improving outcomes in the candidate areas.

Stretching the YFYS test into sectors where members have exercised genuine choice, where providers can route around it, or where the underlying product does not resemble what the test was built to assess, risks adding cost and complexity without a sizable uplift in consumer protections to show for it.

If Government and Treasury want better outcomes in these sectors, the more direct path is likely to be the governance and transparency reforms already on the table rather than widening the net of a test that was never designed to catch everything.