The impact of the Your Future, Your Super (YFYS) performance test on super fund investment strategies could be costing members more than $3 billion each year.
Research from the Conexus Institute has suggested that the controversial test is significantly constraining the investment strategies of super funds and restricting them from constructing portfolios which they believe are in the best interest of their members.
“When you dig in and model the detail of the YFYS performance test and consider what is a sustainable long-term investment strategy, the test proves to be quite constraining,” said Conexus Institute executive director, David Bell.
The research estimated a sustainable level of performance test tracking error sits at around 1 per cent. This, Conexus explained, provides super funds with a high degree of certainty that they won’t need to significantly alter their investment strategies in response to short-term performance.
Based on conservative assumptions, linking performance test tracking error to active returns, the opportunity cost due to the constraints imposed by the YFYS performance test is estimated to be $3.1 billion per annum.
Conexus observed that many funds appeared to be running at a higher level of performance test tracking error of 2 to 2.5 per cent.
“It appears that some funds may be relying on their present performance (against the performance test) and focusing on managing the risk of failure rather than the risk of having to significantly alter their investment strategy in response to poor short-term performance,” Dr Bell said.
According to Conexus, the estimated cost due to constraints imposed by the performance test needed to be offset against identified benefits when assessing overall policy effectiveness.
The firm suggested that the government’s review of YFYS laws could result in alterations to reduce the degree of constraint placed on super funds.
But without any significant changes, Conexus said that funds may be forced to wind back their tracking error or risk experiencing a poor year of performance that leaves them needing to sharply alter their investment strategy.
“That’s because some funds were inevitably influenced by having one eye on passing the annual performance test imposed by the Your Future, Your Super regime. The test has interfered with funds’ proper focus as long-term investors,” said Chant West senior investment research manager, Mano Mohankumar.
“It has shortened their time horizon and introduced tracking error risk to the equation, meaning that some funds have had to make compromises so as not to stray too far from the test benchmarks for fear of failing the test (this was especially the case for those funds not far off failing the test).”
