I’ve received some information from a correspondent familiar with both UK and Australian pensions. It touches on a recent blog about the naming and shaming of underperforming Australian Super funds.
Here’s how my correspondent introduced it
I read your recent blog on the Australian pension system and their naming and shaming of “underperforming” funds. Just wondering if you looked under the bonnet at how they defined underperformance? To me, I like the concept but I found it very strange where the Australian regulator ended up. Essentially it is possible to fudge your results so that you can never underperform, but you could have a totally inappropriate default strategy (and therefore never be named and shamed).
What follows are links to two reports from consultants. The first is from Parametric, who seem intent on retaining the status quo in the financial services industry with no thought for member outcomes. (My comments in red)
The Your Future, Your Super performance test could put a number of superannuation funds at risk … This is presumably in the game plan of the Australian Regulator , this is a process of natural selection – the issue is whether those Supers which become extinct, damage those that survive and whether those in them are able to get better value elsewhere.
20 per cent of super funds may fail the test in any given year and there is a probability that around two-thirds will fail it again.
“Our analysis shows that even failing the test once puts a super fund in a precarious situation,” Whitlam Zhang, manager research and strategy at Parametric, said.
“The probability of a second failure is very high because the next performance test will include 87.5 per cent of the same data – that is, seven of the eight years being measured will be the same.” Considering the damage that has been done by year 8 years of underperformance, it is hardly surprising that failing Supers are being put in peril. What is not being discussed here is the loss experienced by savers relative to the benchmark and to the average saver. This could be expressed individually in Aus $ to the embarrassment of the Super and the infuriation of the saver.
Under the performance test, the Australian Prudential Regulation Authority will construct an individual benchmark for every MySuper product based on the product’s asset allocation. Each product will then be compared against its benchmark. This is the Super Industry being asked to be judged on its own terms. The proper benchmark is not the beta return of the asset allocation but the absolute return of the saver relative to all his/her peers.
Products that underperform their net investment return benchmark by 0.5 percentage points per year over an eight-year period will be classified as underperforming. Since the saver did not choose the asset allocation, it seems odd that performance is based on how the assets are distributed. The issue is that rubbish asset allocation can be rewarded if the funds used do well compared to the “industry benchmarks”. So a cash fund that outperformed a cash benchmark could be saved, but a global equity fund that provided 10%pa more absolute return would be canned. This is a flaw born our of industry benchmarking rather than peer-group benchmarking using achieved IRRs of actual savers.
“It will require quite a performance turnaround the next year to bring the fund back to safer ground,” Mr Zhang said. This is tough, 8 years serious underperformance and you are a gonner.
“Any fund whose strategy is to rely on their brand strength and member loyalty to survive the occasional single failure should think twice.” Quite right too; the “occasional single failure” is not how I’d describe 8 or 9 years of consistent underperformance. At that point , underperformance becomes institutional.
Mr Zhang added that funds can avoid failing the test by either decreasing its level of tracking error or increase its expected information ratio. Increasing the information ratio means outperforming the index without taking undue risk – this is easier said than done, if achieved – the fund has earned its right to its money.
“The good news is that tracking error is within the control of a super fund,” he said. ….by simply moving to a low cost tracker to match each of the asset classes selected does the trick. For a Super to have failed to have met a simple target like benchmark (-0.5%) suggests the trustees continued to make unrewarded bets and/or lost control member of charges. By implication, moving the dial on the information ratio is not that simple!
“While it cannot be controlled to a fine degree, it can be dialed up and down.” See above; tracking error , based on matching an allocated asset by a tracker fund or ETF , is super easy to achieve. If Supers want to take bets on active management, they had better be aware of the “high hurdle”,
The analysis comes only weeks after specialist consulting firm Right Lane warned that the legislation could lead to “uncompetitive outcomes” in the superannuation system and result in the domination of mega funds. The general feeling around the world is that DC schemes are sub-scale. Consolidation is considered a “good thing”. Criticism of consolidation has been based on empirical evidence that small schemes create competition that makes big schemes better. Where is that evidence?
“The recent reforms are aimed at addressing structural flaws in the system such as multiple member accounts and fund underperformance. However, the changes will disproportionately affect small and medium-sized funds, challenging their viability and potentially forcing them out of the system,” Right Lane associate principal, Abhishek Chhikara, said. Are members really supposed to support small funds that are underperforming in the interests of competition? Competition drives underperforming funds to the wall.
“This could lead to a system dominated by mega funds, with no room for quality specialist funds.” or expensive consultants
My correspondent has also pointed me to a response from Deloittes to the APRA performance tables. I have the same reservations. This paper too talks about preserving the Australian funds industry , not about improving member outcomes.
The index fees are low and a fund will fail the performance test if it is worse than 0.5% a year behind the index (after fees and tax). That means that active managers (including in-house teams) have a clear hurdle to overcome. A hurdle that may prove too high if active managers can’t demonstrate over 8 years that they can beat indices by up to 0.5%. A Darwinian approach to asset management will prevail- survival of the fittest
Very large superannuation funds are likely to continue to
seek alpha from unlisted assets, especially in areas where size is an advantage in gaining access to private market opportunities. This sounds as if large funds are being given an unfair competitive advantage. Of course , large funds are large funds because they have been competitive on the way. If small funds remain small funds and can’t get a pick-up from private markets – perhaps they should pack it in.
The major criticism of the legislation is that it is retrospective
and measures historic performance prior to its announcement.
Some of the underperforming funds have restructured and
might well give good value in future – but they are bound by theirhistorical execution of their investment strategy. Thankfully, it looks as if APRA are smart enough to stop failing Supers reinventing themselves and excluding their past in exchange for the promise of a rosy future.
All of this is despite it being a requirement for all funds
to warn consumers that past performance is not a guide to future performance. It may not be a guide, but it is certainly better than a promise of good intentions.