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The regulatory uncertainty coupled with the impending Performance Test calculation is a challenging environment to operate a product and we hope for a smoother process in subsequent years. As noted in this article, we caution against undertaking significant action in the short term and instead using the time to plan for when regulatory clarity is provided. JANA has been significantly uplifting our quantitative capabilities to assist and we look forward to discussing in the near future.
The next round of ‘Your Future, Your Super’ Performance Test assessments is fast approaching, with the next calculation period to the 30 June 2022. MySuper products will be tested for the second time whilst Trustee Directed Products (‘TDPs’), defined as multi-asset Choice products where the superfund Trustee controls the strategic asset allocation (SAA), will be assessed for the first time.
Since the policy was first announced by Josh Frydenberg in October 2020, the Performance Test has undergone several changes, most notably the addition of new benchmarks for unlisted asset classes and the change in time horizon for the comparison of a product’s administration fee (formally referred to as the ‘Representative Administration Fee and Expenses’ or RAFE) versus that of the median product from the universe from the full 8 years to the last 12 months.
JANA believes there’s likely significant change still to come that could have a material impact on a product’s Performance Test metric. We outline some of the most significant examples below, what it may mean for Performance Test outcomes, as well as our recommended course of action.
One of the most significant drivers for potential change in fund Performance Test outcomes over the coming years is that from 2023 onwards, years will begin to ‘roll off’ the calculation period for the Performance Test metric (i.e. the Performance Test is conducted on a 8-year p.a. rolling basis). A lot of focus has been placed on the impact of performance from 1 July 2021 to 30 June 2022, most notably that the resurgence in the fortunes of value stocks will have benefitted many products, as will the recent rise in bond yields for products that have held a short duration fixed interest position. However, attention should also be given to years that will roll off the metric as a particularly strong or weak year rolling off could impact the upcoming metrics significantly.
Our analysis indicates that for many funds in the industry, FY2015 was a particularly strong year with the majority of the alpha generated in Q2 2015. There were multiple sources of alpha during this period but an underweight to Australian Equities during a sharp sell off for the asset class is likely the key driver. The implication here is that FY2015 will roll off the metric for the 2023 Performance Test and Funds should be aware that the hurdle may therefore increase. JANA has recently completed the development of a model that can analyse the pass/fail probabilities in future years that incorporates years rolling off and look forward to discussing this with clients over the coming weeks.
We believe that updates to the YFYS regulation will be required because of developments with APRA’s asset allocation reporting forms, which have led to some uncertainty about the methodology that will be used for the Performance Test this year and in future. For the 2021 Performance Test cycle, APRA based the assessment on asset allocation data collected through form SRF533. APRA has since released a new, more detailed asset allocation reporting form, SRF550 and has confirmed that information provided as part of SRF550 will be used to conduct the test for Trustee Directed Products. APRA has not confirmed whether the strategic asset allocation data used for the calculation of the Performance Test for MySuper products for the June 2022 assessment will be drawn from reporting under the SRF533 or SRF550 form.
The challenge is that the information collected as part of the new SRF550 reporting forms is significantly more complex, and the current YFYS regulations do not articulate how the additional information collected will impact the Performance Test calculation. Two key areas where a change to the new reporting form could impact outcomes, and where APRA will need to provide further clarity are outlined below:
There is currently no regulatory clarity on how this information will impact the Performance Test methodology. This will have most importance for funds’ that hedge at the portfolio level, and where foreign currency exposure is higher than the strategic asset allocation to international equities.
It is important to be aware that whilst there are a range of Performance Test methodology uncertainties stemming from SRF550, the quantum of the impacts will likely vary significantly. For example, in sensitivity analysis undertaken by JANA, we estimate the impact of APRA/Treasury’s decision regarding the methodology for currency hedging will be reasonably modest in most cases. However, the decision on whether to use strategic sector or subsector information will be significant and could easily be the difference between a pass or a failure.
JANA considers it unlikely that there will be any key trends in impact on Performance Test metrics that result from a regulator clarifying the methodology for a particular area of uncertainty. For example, APRA confirming that strategic sector level information will be used will likely benefit some products but hamper others.
The methodology uncertainties described above are challenging enough but there are a range of additional Performance Test uncertainties. We discuss some of these below:
Whilst we believe the test could be improved further with new benchmarks (particularly the replacement of the 50% equity/50% bond benchmark for the ‘other’ asset class), retrospectively modifying a benchmark could change a Performance Test metric considerably.The direction of the change will of course depend on the change in benchmark. For example, the introduction of a credit benchmark would almost certainly hamper outcomes for the majority of products given credit exposures are currently benchmarked against fixed interest benchmarks for the purpose of the Performance Test, and typical credit portfolios have outperformed fixed interest over the past eight years. On the other hand, we expect that a change to the ‘other’ benchmark is likely to improve outcomes for most products. Potential alternative benchmarks could include a hedge fund index, such as those produced by HFRI or benchmark that assumes a certain level of return in excess of cash.
A recent APRA Information Paper1 showed the distribution of administration fees for Choice products, but even this is of limited assistance because we don’t know what proportion of these are TDPs, and the value of the account balance used to calculate the RAFE. APRA do plan to release this information in the near term but until this occurs, the distribution of potential median TDP RAFEs is large.
It isn’t an exaggeration to say that the above makes it almost impossible to estimate an exact Performance Test metric with much confidence, particularly for TDPs. This will be of little comfort to fund stakeholders given the implications of failing the test. However, there are still sensible steps that can be undertaken in advance of regulatory clarity:
The regulatory uncertainty coupled with the impending Performance Test calculation is a challenging environment to operate a product and we hope for a smoother process in subsequent years. As noted above, we caution against undertaking significant action in the short term and instead using the time to plan for when regulatory clarity is provided. JANA has been significantly uplifting our quantitative capabilities to assist and we look forward to discussing in the near future.
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