New research has revealed that super funds may adopt more conservative investment approaches as a result of the Your Future, Your Super (YFYS) performance test, potentially impacting returns over the long term.
Commissioned by J.P. Morgan Asset Management, the research involved interviews with CIOs and heads of investment strategy from 14 super funds representing a third of the total assets under management, as well as two asset consultants.
What J.P. Morgan found is that as a result of the YFYS regulation, strategies in listed assets are set to become more benchmark aware with high-alpha strategies requiring higher degrees of conviction, resulting in smaller allocations.
“Although passive investing is known as an economical way to have market exposure while maintaining reasonable risk diversification, it also limits an investor’s ability to deliver returns beyond the benchmark,” said J.P. Morgan Asset Management Australia and New Zealand CEO Andrew Creber.
“As such, we see combining the benefits of passive investing with high-conviction active management as a more efficient way of building a solid portfolio under the YFYS framework.”
The research also uncovered that CIOs had a greater willingness for risk taking in the alternatives and unlisted space over public assets.
CIOs also suggested that they were now less likely to use tactical asset allocation due to the potential risk of heightened tracking error.
“CIOs have expressed an increased willingness to lock-in profits from asset class decisions over long-term uncertainty, despite accepting that it may hurt longer term returns,” the research said.
“This will result in a lower propensity to bet against a fund’s strategic asset allocation to take advantage of market falls (“buying the dip”), where long-term investors can add significant value.”
Conversely, funds at risk of failing the performance test are currently said to be taking larger bets on credit and considering reducing investments in alternatives and unlisted assets to lower fees.
Moreover, underperforming funds are expected to take smaller but higher conviction portfolio positions to pass the performance test according to the CIOs surveyed, potentially increasing the overall risk within the portfolio.
“Failing funds are also likely to reduce their allocation to high conviction managers where the risk of underperforming is high and increase their allocation to more benchmark-aware investments in public markets. This strategy matches the approach of outperforming funds,” J.P. Morgan said.
The YFYS reforms require an annual performance test for MySuper products and have already prompted changes in the industry. Thirteen funds failed the initial test, with the majority of those now in the process of merging with other funds rather than risk losing members and assets.
