Super funds with a responsible, ethical or sustainable focus will soon be subjected to the same performance test as their ‘default’ MySuper peers, as the Government confirms the extension of these superannuation performance test rules.

Currently out for consultation, and closing 2 May, the controversial Your Future, Your Super (YFYS) performance test could be extended to all choice (trustee-directed) superannuation products from 1 July 2023.

The Australian Prudential Regulation Authority’s (APRA) annual YFYS performance test was introduced for MySuper products in 2021, with the aim of protecting Australians’ retirement savings by holding funds to account for investment performance and member fees. Where a product fails the performance test in two consecutive years, the fund will be prohibited from bringing new members into that product.

Email us at policy@responsibleinvestment.org by Monday 24 April. 

What’s the Government proposing?

Many RIAA member products and certified products will be subject to an annual performance test by APRA for the first time by 31 August 2023.

The proposals in the Government’s Exposure Draft Regulations include changes to the timeframe of the test, asset classes and requirements for the notification letter sent to members where a product fails the test before choice products are subjected to the test. Some of the key changes would be:

• A ten-year rather than eight-year ‘lookback’ period: Treasury says this is ‘expected to sharpen the incentive of trustees to focus on long-term decision making and aligns with broader industry disclosures’.
• More granular asset classes within the benchmark: For example, international equities will be disaggregated into hedged/unhedged and emerging/developed markets. Treasury says the purpose of this is ‘to improve the accuracy of the test, reduce the incentive for trustees to avoid certain investments, and reflect the latest index names, while maintaining the integrity of the test.’ 
• Revised member notification letter in case of failure: Treasury says this ‘is intended to improve accessibility and effectiveness by using simpler language, and ensure the notice is fit for purpose of explaining what the result means for beneficiaries.’ 
• Definitions of terms including ‘trustee-directed product’, ‘representative administration fees and expenses’ and ‘Strategic asset allocation’.

What does the test mean for choice products?

We know that many funds’ choice products will meet or exceed the performance test benchmark. There may be others that do not comfortably meet the benchmark.

The Government’s latest proposal of more detailed asset classes could better accommodate the diversity of investment approaches among choice products and improve the accuracy of benchmarking. But the proposals are unlikely to address the core concerns for some ethical choice products. 

What are the challenges?

Recent research from the Conexus Institute has shed light on the complex challenges the test presents to choice products, particularly those with conservative and SRI or ethical options.

Interviews with 10 superannuation fund CIOs found funds were broadly supportive of the test as a consumer protection, as it has reduced fees and consolidated funds, which could flow through to fees. The impacts of the test on funds vary. Some integrate the test into their investment framework, while other funds rely on their existing investment processes.

The Conexus Institute noted that investment approaches like screening and impact investing can result in significant tracking error. In RIAA’s view, this is a key concern in light of the Government’s current push to bring superannuation funds into social projects like affordable housing. As one CIO observed: ‘The ability of the industry to participate in PPP’s and nation building style transactions is hampered if those deals aren’t necessarily part of the benchmarks.

Together with the  Conexus Institute, and FTSE Russell, we undertook further research that modelled three responsible investment approaches against the performance test. This brought some hard data to the debate about whether the test is appropriate for the range of investment approaches that superannuation funds take.

Given the growing consumer demand for superannuation funds to invest responsibly, it’s increasingly important that funds can meet Australians’ expectations about where their retirement funds are – and are not – invested.

Our work with Conexus and FTSE Russell assumed a ‘sustainable’ tracking error of 1%, and found:

• Socially responsible growth option applying RIAA’s ‘avoid significant harm’ requirement for Certification produced a tracking error of 1.5%, meaning SRI options can result in an unsustainable tracking error risk.
• Carbon transition aligned portfolio with a Paris-aligned benchmark and Australian equities low-carbon proxy produced a tracking error of 1.8%, meaning that Paris-aligned portfolios may have untenable tracking error risk.
• Universal ownership of equities plus unlisted ‘green’ assets: Passive equities and unlisted assets in sustainability and energy transition, which produced a tracking error of 0.2%, meaning the risks of expanding the test could be significant for some funds.

What are the alternatives?

Some have said that there should be carve outs for SRI products, that different metrics should underlie the test, or that APRA should have discretion to apply a test with qualitative features and more metrics. There are significant challenges in applying regulator discretion when a numerical result against a blunt ‘benchmark’ is the cornerstone of this consumer protection.

RIAA would welcome a close re-examination of what underlies the performance test, and whether it reflects the direction of responsible investment approaches now and into the future. This is especially important given the Government’s commitment to involving superannuation funds in pursuing Australia’s national and international sustainability goals.

You can read our previous submission to this process from October 2022 here: https://responsibleinvestment.org/wp-content/uploads/2022/10/20221014-RIAA-Submission-Your-Future-Your-Super.pdf

Do you have views on the Government’s proposal? Email us at policy@responsibleinvestment.org by Monday 24 April.