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More than one million Australians will shortly receive correspondence from their super fund informing them that it has just failed the regulator’s fund performance test. The question is what, if anything, you should do about it.
The annual fund performance test was triggered by the federal government’s recently passed Your Super Your Future (YSYF) legislation. This requires the industry regulator, the Australian Prudential Regulation Authority (APRA), to assess the performance of all workplace default funds with a MySuper investment product.
APRA has now measured funds’ MySuper investment performance over the past eight years against a benchmark portfolio with a similar asset allocation. To pass the test super funds must achieve returns over the period of no more than 0.5% below the benchmark.
Which funds failed the test?
To enable comparison of traditional ‘balanced’ and ‘lifecycle’ portfolios, in which investments are adjusted as members age, the APRA test calculates returns for a 30-year-old with an account balance of $50,000.
The APRA list of the 13 underperforming super funds provides insight into the number of members affected in each case, equating to a total of over 1.1 million fund members.
Source: APRA. Members figures as at 30 June 2020.
The content of the letter that affected members will receive is largely prescribed by the regulator offering fund trustees little opportunity to argue their case for underperformance. It will direct members to the new Australian Taxation Office (ATO) super fund comparison tool to help them decide whether to move their super to another fund.
The government’s intent, under the minister responsible for superannuation, Jane Hume, was that the performance test would help members avoid the financial impact of long-term exposure to investment underperformance.
The need for this was highlighted in 2019 by the Productivity Commission, whose report on the superannuation system estimated that a typical super fund member could increase their retirement savings by around $660,000 simply by moving from the worst performing to the best performing fund.
Super’s response to the APRA test
Despite the government’s good intentions, the release of APRA’s performance test methodology and results with their blunt and binary ‘pass/fail’ outcome has been widely criticised by the superannuation industry – including industry associations and technical experts.
Amid the inevitable charges of industry self-interest behind this commentary, it is worth noting that the super industry is keen to remove underperforming funds. It would generally prefer to achieve this through merger or the transfer of members to better performing funds. Otherwise, it broadly supports the intent of the performance test.
Speaking at this month’s Australian Institute of Superannuation Trustees (AIST) conference, Australian Super’s Chief Investment Officer, Mark Delaney, said that there was a lot to like about the thinking behind the test and agreed that there are many underperforming funds that have been ‘skating by in the industry for too long’, not getting the results their members deserved.
“The big dirty secret of the super industry is that most funds don’t do much better than a passive [investment] portfolio. If you can’t do better than passive, why should you spend members’ money? If you’re no good, you should quit like anything else in life,” he said.
Super Consumers Australia advocates for Australian consumers with superannuation investments. “The bottom line is these funds have underperformed. Unless there is some specific reason to stay, you should think about moving to another fund to build up your retirement income,” said its director, Xavier O’Halloran, although his organisation cautioned members to do proper research before deciding to switch funds.
Possible flaws in the test
Australian Catholic Superannuation and Retirement Fund (ACSRF) received an APRA ‘fail’ but is critical of the test’s application to its MySuper product (ACRSF is not to be confused with another fund, Catholic Super, which passed). ACRSF reconstructed its MySuper product about three years ago from a traditional balanced option to a lifecycle solution more tailored to individual member outcomes. It gradually transitions members from age 40 to a more risk-averse portfolio.
ACSRF Chief Investment Officer, Michael Block, said the APRA test’s 8-year assessment had melded the historic returns of the new product with those of the previous one, which detrimentally affected the returns calculated over the period. Presumably, this is because the asset allocation for a 30-year-old in its new lifecycle product would be more growth oriented, whereas the typical member would be older and more conservatively invested by design.
Another quirk of the APRA test is the recalculation of net returns to members taking into account fund administration fees. Other published benchmarks only show returns net of investment fees and tax.
AIST’s Chief Executive, Eva Scheerlink has criticised this, not in principle, but in its application. She pointed out that the test bases its calculations on the current fees charged by funds applied to returns over the past seven years.
She argues that this means funds that previously ‘gouged’ members with high administration fees were treated favourably, with the net returns used in the test bearing little resemblance to what their members saw credited to their accounts.
Will the test encourage better outcomes for members?
Another criticism is that some funds will react to the APRA performance test by adjusting investment portfolios to ensure they pass in future. This response will not be confined to just those whose products failed in this first year.
Industry analysts suggest that this could be detrimental to members in the longer term, as it will encourage funds to match market indices and inhibit them from investing in unlisted assets like infrastructure and commercial real estate. Unlisted assets are less frequently valued and are designed to produce consistent income over the long term, rather than short-term profits, which makes them a good fit for super funds. APRA admits these assets are not perfectly captured and assessed in its current test.
Some funds aware of their precarious position had already adjusted their investment portfolios ahead of the APRA assessment, with mixed success.
Mine Super, which did pass the test, said it had started adjusting its portfolio about two years ago, when it studied APRA’s data.
The fund’s Acting CEO, Vasyl Nair said: “We were very fortunate because we started significantly restructuring our investments in order to deliver better member outcomes as prescribed by the [APRA] heatmaps about two years ago so we had a running start coming into the performance test.”
If a fund underperforms slightly over the first seven years of the assessment, hitting the APRA benchmark is achievable over the final 12 months. But underperforming the benchmark by 0.5% over seven years requires outperformance of 3.5% in the final year, with nearly 90% of its performance attributable to the first seven years.
“Turning around a seven-year trailing history in a short period of time in a responsible manner is extraordinarily challenging and I certainly feel for the people at those organisations that weren’t able to turn it around,” said Nair.
This may be true, but seven previous years of underperformance means retaining members is dependent on them taking a great leap of faith that their fund will do better.
Christian Super attributed its ‘fail’ rating to its earlier commitment than most funds to socially responsible or ESG (Environment Social Governance) investment. There has been similar commentary from other parts of the industry about underperformance attributable to ESG investing, although socially responsible funds are closing the gap.
Other funds that passed the test, like Vision Super, have been committed to ESG investing for several years. Those who seek out ESG investments often say they are willing to forgo some return to invest responsibly. The APRA test does not account for this and there is often a gap between what returns members say they will forego in surveys and what their behaviour suggests they will tolerate.
Under or over-performance related to responsible investing is still debated. The Global Chief Investment Officer of BNP Paribas, Edmund Shing, published an article in June 2021 arguing that ESG investing meant buying quality, which meant not sacrificing performance versus non-ESG investments and often reducing losses during market downturns.
The bottom line is, if ESG is important to you then this will influence your investment and fund choices but does not mean you should accept chronic under-performance.
What should I do if my fund has failed the test?
If you receive advice from your fund that its default MySuper investment option has failed the APRA performance test, then there is good cause to be alert but not alarmed. Its performance has not been calamitous, just less than the benchmark set by APRA for that product. You still have time to investigate and make an informed choice.
While Super Consumers Australia suggests you should look at other funds, this is not your only option.
Your fund will offer many investment options that may not only perform better but be better suited to your own expectations, risk tolerance and financial strategy. You can talk to your fund, usually at no cost, about other investment choices within the fund. A ‘balanced’ MySuper option is constructed to achieve the best outcome over the fund’s collective membership, but it may not be the best option for you.
This means that a fund with an older demographic might have set up its default more defensively, with reduced exposure to growth assets. If you are younger or have a relatively high risk tolerance, you and/or your financial adviser may choose a higher growth option.
A lifecycle MySuper option, where the investment portfolio adjusts as you age, should be more tailored to your needs, but is based on a set of assumptions that may not reflect your circumstances or risk tolerance.
Some on the list are already merging
If you belong to one of the four funds already merging or collaborating with other funds, it’s best to consider the performance of the fund your fund is merging into. The four out of 13 funds given a fail in the APRA test and their merger partners are:
- BOC Gases – merging into Equipsuper
- LUCRF – merging into Australian Super
- Maritime – consolidating its investments with HostPlus, but not merging fully
- VISSF – merging into Aware Super
The investment adage ‘past performance is not a reliable indicator of future performance’ ultimately rounds out this conversation.
If your fund is one of the 13 named by APRA, the question is whether you believe past performance is a better and more reliable indicator of future performance than a mere promise from your fund that it can do better.