Your Future, Your Super and its performance test is set to be applied from July 2022 to some multisector choice products. Of course, the test has already been applied to MySuper products. And the letters sent out to members about their “underperforming” products from superannuation funds that did not meet the test received plenty of attention. The Your Future, Your Super reforms will also be extended to the choice sector, and according to Australian Prudential Regulation Authority, the choice sector is a significant component of the superannuation industry, representing 46% (AUD 859 billion) of total member benefits in APRA-regulated superannuation funds as at 30 June 2020. Some of these choice products are available on retail super platforms, and there will almost certainly be a barrage of questions when the next round of “underperforming” letters reaches members. There will also be implications for the advice sector. Advisors need to prepare themselves and work out how to balance best interest duty with the guidance from the regulator.

Test Limitations

Net returns are critical, and it’s important that the industry delivers high-quality outcomes for investors—a mission APRA supports. But the performance test is a fairly narrow measurement of success as applied to multisector options. The test looks back over the last eight years and assesses how a fund has performed relative to its own strategic asset allocation. In effect, it assesses the implementation efficacy of the fund’s own strategy against a number of indexes, from the S&P/ASX 300 Index to the MSCI Australia Quarterly Private Infrastructure Fund Index. It doesn’t consider risk-adjusted outcomes of the fund, it doesn't consider whether the fund has delivered appropriate outcomes for the asset-allocation decisions taken, and it is not forward-looking. APRA¹ recognises that its heatmap does not “provide information on all the relevant factors that should be considered in assessing the outcomes or  appropriateness of a particular choice offering. Accordingly, the Heatmap should not be used in isolation…”. But when it comes to the performance test, members are told in the (pro-forma) letter that their fund has performed poorly and that a well-performing product can be found on the YourSuper comparison tool. The letter does suggest seeking personal advice and explains that seeking the best risk category (namely, asset allocation) is important. However, APRA expects that where there are areas of underperformance, trustees “take prompt action to improve performance or implement exit strategies, such as the orderly transfer of members into another fund.” This makes balancing best interest duties very difficult for advisors. As the industry knows, past performance is not an indicator of future performance and Morningstar’s qualitative assessments of strategies are forward-looking. We also consider that risk-adjusted outcomes over time are very important, and performance should be viewed in the context of risks taken. Advisors will be able to apply these, and other, assessment criteria to determine the appropriateness of the fund for their clients.

Monitoring Choice Funds

But applying one’s own assessment is a risk—going against the regulator’s ‘advice’ should not be underestimated nor should going against the weight of money. By recommending that a client stays in an underperforming fund, there’s not only the obvious risk that the fund continues to underperform the performance test but also a risk that there may be a disorderly exit by members, potentially leaving remaining members exposed to higher levels of illiquid assets. There’s also a risk that the fund is ‘restructured’ (in order to meet the performance test going forward) in a way that is no longer appropriate for the client. At this stage, there’s limited evidence of a run on these funds. For example, the Christian Super’s MyEthical Super Fund’s outflows have been muted. It has lost approximately AUD 5 million out of a AUD 1.2 billion fund in the last 12 months². Hardly time to hit the panic button, but advisors should keep abreast of these trends and also whether funds are in line to fail the test twice. APRA’s initial work indicates that outcomes of choice products have lagged MySuper products. Administration fees are materially higher for choice products, and around 15% of these products underperformed a chosen benchmark by more than 0.75% compared with only 7% of MySuper products³. Advisors should expect a heightened level of enquiries in August once letters are sent. For advisors, it's time to pull out the APRA methodology, understand the performance test, and consider any additional assessments to be applied to the “underperforming” options. And finally, it’s worth keeping an eye on the APRA Heatmap and the list of funds that will be published come August to determine if you want your clients in a fund that may be required to implement an “exit strategy” such as the “orderly transfer of members”. _______________ 1 APRA – Methodology Paper: Choice Heatmap – December 2021 2 Morningstar Direct as at 31 January 2022. 3 APRA – Information Paper: Choice sector performance: improving outcomes for superannuation members – October 2021