Close to 20% of superannuation funds face a high risk of failure under the ‘Your Future, Your Super’ performance test and around two-thirds of those might fail the test again in the following year, according to modelling by implementation manager Parametric Portfolio Associates.
The firm’s analysis showed that the probability of a second failure was very high due to the fact that the next performance test would include 87.5% of the same data which meant that seven of the eight years measured would be the same.
Under the new performance test, products that underperformed their net investment return benchmark by 0.5 percentage points per year over an eight-year period would be classified as underperforming.
This would mean that trustees whose products failed the test would be required to notify members in writing and products that failed the test two years in a row would not be permitted to accept new members until their net investment performance improved.
Therefore to reduce the probability of failing the performance test, a fund would need to either decrease its level of tracking error or increase its expected information ratio.
“It will require quite a performance turnaround the next year to bring the fund back to safer ground. Any fund whose strategy is to rely on their brand strength and member loyalty to survive the occasional single failure should think twice,” Whitlam Zhang, manager research and strategy at Parametric said.
“The good news is that tracking error is within the control of a super fund. While it cannot be controlled to a fine degree, it can be dialled up and down.”
Those options to dial down risk might include increasing allocations to low tracking error strategies, such as passive or enhanced passive investing; implementation of stricter rebalancing rules to reduce active risk from straying from their strategic allocations; and ensuring that the fund’s risk reporting included total risk and benchmark relative risk.
“It means that investment teams will need even higher conviction in their fund managers in order to compete in this market. Investment strategies that will do well in this regime are solutions that can deliver excess returns in a relatively more predictable manner,” Zhang said.