Has COVID-19 volatility undermined APRA’s heatmaps?

The Australian Prudential Regulation Authority’s (APRA’s) heatmap process may have been thrown into disarray by the volatility generated by COVID-19 with new analysis showing things have changed dramatically.

The analysis, carried out by Frontier Investment Consulting, raises real questions about APRA’s initial heatmap process and its future relevance.

The Frontier Advisors analysis of superannuation fund performance through the volatility of March and April found the expected relationship between risk and return largely disappeared following recent market turmoil and said this had implications for the assessment of funds using APRA’s heatmaps with the ranking of funds as either over or under performing shifting significantly since the fund performance assessments were published in December.

“The three year performance to 30 June, 2019, of each MySuper fund showed a strong, positive correlation between funds’ growth/defensive ratios and returns. This formed the basis for APRA’s published heatmaps in December with under-performing funds receiving yellow, and more worryingly red, warnings from the regulator,” it said.

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“However, when three year performance to 31 March, 2020, is reviewed not only has the risk/return correlation largely disappeared, but funds have scattered around the median with several outperformers having lost their preferred status and now finding themselves in yellow and red territory.”

The analysis said Frontier had found that almost one in five funds changed their status as an under or over performer over this brief period and highlighted the difficulty in assessing the merits of a fund based on a single measure of risk.

Commenting on the outcome, Frontier principal consultant, David Carruthers said that attempting to assess performance without a deep understanding of each fund’s approach to risk could lead to the wrong conclusions.

“Being higher or lower risk is neither a sign of a good or bad fund. It may well be an explicit decision taken to suit the demographic profile of the fund’s membership. Of course, there will often be consistent underperformers but it is difficult, and potentially dangerous, to assess funds on single perspectives of risk,” he said.

“Our analysis shows standard deviation was a considerably better predictor of a fund’s outcome in the March quarter than the fund’s growth ratio, which is the metric used in the heatmaps. Superannuation fund members who have been monitoring the heatmap rankings of their fund, especially following the recent volatility, might well be confused to see such a quick change in APRA’s assessment.”