Mega funds flag room for improvement in super performance test

Submissions to Treasury on the superannuation performance test reveal varying opinions among funds on how to best enhance the rules to ensure the best retirement outcomes for their members.

Last month, the government announced a review of the design options for the annual superannuation performance test, noting evidence suggesting that “the test may be influencing investment decisions to the detriment of member outcomes.” However, it also acknowledged that the test has improved member returns by increasing scrutiny on underperforming products and holding trustees accountable.

While there is consensus among Australia’s largest funds that the test has been instrumental in delivering better outcomes to members, they put forward varying recommendations for the path forward.

In its submission to Treasury, $82 billion fund HESTA proposed evaluating funds’ performance against an inflation target or industry peers with similar risk profiles across various time frames to pinpoint consistent underperformance.

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“In considering the proposed metrics and principles, HESTA believes a multistage outcomes-focussed test would be more effective and enduring in identifying consistently underperforming funds as well as identifying strong net member benefit,” the fund explained.

It suggested the first stage would compare a fund’s investment option’s net investment returns against an appropriate CPI+ objective.

“Funds with sound investment performance (underpinned by both investment strategy and implementation) are anticipated to pass this first test,” HESTA said.

“This test is designed to ensure that members are delivered appropriate risk-adjusted returns and, by using an absolute measure of success.”

However, it acknowledged there could be market and economic conditions that could result in funds not meeting the CPI+ objective. In that case, it recommended the secondary test that compares net investment performance against competitor funds in similar risk cohorts.

“In this environment, a fund could be deemed as underperforming where it does not meet the primary test and the net return against peers is in the bottom decile over several time horizons,” it explained.

Meanwhile, Australia’s largest super fund, $300 billion AustralianSuper, advocated enhancements that include fewer benchmarks and measurement of the total return received by a member, net of costs, and adjusting for risk.

“The current test design can be simplified. Further calibration, such as different or more detailed benchmarks, will likely reinforce the risks of ‘benchmark hugging’ that come from the current detailed specification of a series of asset class benchmarks,” it wrote in its submission.

“This comes at the expense of considering net returns as the key determinant of a well-designed product.”

The fund held a ‘less is more’ approach to benchmarks, arguing that ideally, relative performance would be assessed against a single metric test such as a simple reference portfolio or a peer comparison of risk-adjusted return.

AustralianSuper explained: “We do not believe that additional benchmarks or more granular benchmarks will improve the effectiveness of the current performance test. We also question the value of adding complexity from a member and comparison perspective.”

Additionally, it did not endorse alterations to the test that would enable different treatment for ESG or climate investments, asserting that the failure threshold should remain unchanged for all products.

“Investors factor ESG/climate risks into their investment decision making as they do with other types of risk, and with the same goal – maximising the risk-adjusted returns delivered to members,” it said.

“We believe that the current test already provides sufficient motivation to innovate and seek out opportunities that support government transition activity. Special treatment of climate risk/opportunity may cause adverse outcomes by impacting how capital allocation occurs in relation to the transition.”

Last year, following an investor roundtable that constituted some of Australia’s largest investors representing more than $2.5 trillion in capital, the Treasurer flagged that a performance test consultation would be in the pipeline to improve the super performance test amid claims it disincentivises sustainable investment from funds.

“The government will consult on options to improve the superannuation performance test so that trustees are held to account for member outcomes without holding back investment in economic priorities such as the net zero transformation and housing,” Jim Chalmers’ statement read.

This was one of the key areas of support in Rest’s submission to Treasury, with the $80 billion fund backing the creation of additional benchmarks within the current test framework, which would cater for emerging areas including the energy transition, decarbonisation, and affordable housing.

It stated that the current test is not sector neutral and investments in emerging asset classes can be disincentivised through their lack of representation in traditional indices, which can have the effect of encouraging short-term decision making.

“Rest supports investing in areas which provide strong risk-adjusted returns, but can also contribute to the quality of the world our members retire into,” it said.

“However, the current structure of the performance test can inhibit such investments, as benchmark and consequent outcomes may not be aligned to the test’s expectation for a full market comparison.

“The existing benchmarks may therefore act as a disincentive to a greater degree of active investment in important sectors of the Australian economy such as the energy transition, affordable housing and agriculture/agribusiness, even where such investments are in the best financial interests of members.”

Speaking to InvestorDaily last month, Australian Retirement Trust’s (ART) Andrew Fisher was of the opinion that the annual performance test did not disincentivise sustainable investments or innovation.

“I think any new and innovative investment that we do, we do have to have a level of discipline around the decision we make, we have to act in members’ best financial interest, and so the performance test serves to apply that discipline with benchmarking tools,” the head of investment strategy said.

“As an industry, we need to learn to work within the construct of the test.

“I don’t think it’s a hurdle to innovative new things – it’s just something you need to think about.”