Last week saw the release of the APRA performance test for default super funds. The reporting requirement covered the 80 or so funds that are classified as MySuper accounts. These are superfunds permitted to accept Super Guarantee contributions where the employee doesn’t make an active choice. By the very nature of that scenario, governments and regulators feel it is appropriate that ‘someone’ is checking on the performance, because the members are often quite oblivious to how their superannuation is performing.
The test will measure performance over the last seven years, (moving to eight years in 2022) and if a fund misses the benchmark by more than 0.5% per annum, it will be deemed to have ‘under-performed’. The penalty is to write to all members, telling them of the underperformance. If in the second year, the underperformance has continued, then the fund can no longer accept members, and must write to all members recommending they move to a ‘better performing’ fund.
While that sounds good at face value, my sense is that over time it will end up creating some unintended consequences.
Where is the disclaimer?
What is the first thing we learn in investing? What disclaimer is required whenever a fund or investment published historical investment returns? PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RETURNS. In fact, it is mandated in ASIC Regulatory Guide 53, that references to performance when advertising a product must also contain warnings such as the one above.
Apparently ASIC didn’t pass that memo over to APRA. The focus solely on returns implies that all we need to do to be successful is to switch to a ‘top performer’. If switching to a top performer for the last year, or even seven years was all that was needed for success, it would mean we as investment professionals, need nothing but a spreadsheet to make our recommendations.
Seven years seems like a fair time period to measure things, but prudent investment strategies can underperform for relatively long periods of time. I have written recently about the growth vs value divergence in the sharemarket which I think is about to reverse. A little history lesson is helpful to see how chasing what has worked for the last seven years can be a disaster in the next seven years.
The Wiltshire 5000 index is a US based index of the top 5000 US stocks. The Wiltshire ‘Growth’ index is the top half of that stock universe sorted by highest P/E and price/cashflow. The Value index is the bottom half of the universe of stocks by P/E and price/cashflow.
In the seven years from February 1993 to February 2000 the Wiltshire Growth index outperformed the Value index by 72%, or around 8.1% p.a. compounded. Seems like a long enough time frame, and a no-brainer investment.
Chart 1: Wiltshire 5000 Growth/Value performance differential (www.longtermtrends.net) Feb 1993 to Feb 2000
However, during the following seven years to February 2007, the Wiltshire Growth index gave back all that outperformance. It underperformed by 11.5% per annum over that period.
Chart 2: Wiltshire 5000 Growth/Value performance differential (www.longtermtrends.net) Feb 2000 to Feb 2007
Australian superfunds are not immune to chasing past performance. I recall in 2000, when the US market was trading at a nosebleed 40x P/E multiple, the PSS/CSS Superfund, (the fund of the Public Servant Sector) increased their exposure to overseas equities dramatically, up to about 44% of total assets. Disastrous underperformance followed. Yes, even large super boards can get caught up in the madness of markets, and abandon prudence and age old wisdom that past performance does not guarantee future returns.
My concern is also that this existential threat to superfunds may lead to imprudent risk taking. I was at a conference in June at a rather prestigious table that included investment committee members from two prominent industry superfunds (un-named on account of Chatham House rules). The summary from one of them was that those near the bottom of the current underperformance band will simply ‘swing for the fences’ as they have nothing to lose. This excessive risk taking may come at precisely the time when their previously prudent investing style is about to be rewarded.
REST super, the default fund for the retail and hospitality industry, was very close to a fail report. So close, according to the AFR, that they had to get the super consultant JANA to review the information they were submitting to APRA for any potential errors. A cynic might say JANA job was to rehash the figures so that they scrape through for another year. Rest has around 1.8 million members.
The seven year return for the REST MySuper product was 7.29% per annum. While I don’t have intimate knowledge of the REST investment strategy underpinning the fund, it seems rather harsh to think they may next year be forced to tell their members that they need to consider moving to another fund. More so if the other ‘top performing’ fund got there by taking bigger risks.
The other consequence of bulk moves could be forced asset sales, that further disadvantage the members as the fund becomes a forced seller.
One of the big concerns that I have when people move superfunds without getting advice is the risk of insurance gaps. This can occur because the default insurance that comes with a new superfund will generally exclude any pre-existing conditions. For example, if a member has had a treatment for a melanoma, then moves funds, and then dies later on from that condition, then it is most likely the insurance in the new superfund would deny a payout and the insurance in the old fund is likely cancelled when he moves.
Another frustration for me is the ‘guilty by association’ factor when people read only the headline. Two large masterfund offerings that are held by a few of our clients are Colonial First State and also BT Retirement Wrap. While we use the customised portfolio versions, those two funds also have MySuper products. They both appeared on the ‘Underperforming’ list. Naturally this causes concern for our clients. When contacted we are able to carefully review the actual performances which alleviates concerns, but it does create un-certainty in people’s minds.
Colonial First State for example offers the excellent First Sentier Geared Share Fund. The Super version of this fund has a 10 year return of 17.58% per annum over the last 10 years. This is an excellent option for members under 40 with at least 20 years to retirement. Yet, the underperformance of their MySuper option puts an unwarranted stain on the brand.
A further complication which makes the comparisons difficult is that many funds, rather than taking a one-size-fits-all approach, have created age based default funds. These are designed so that even dis-engaged members get a gradual reduction in risk as they approach retirement. That would seem to make sense. But as those funds have lower exposure to growth vs defensive investments in recent times, it has proven a performance disadvantage.
It will be interesting to see if these new APRA reports published on the ATO website have the intended effects over the next few years, and whether some of the un-intended consequences outlined become evident. The core message is to get advice before rashly making any changes.
With an ongoing review process, investment performance and relative risk taken is monitored and discussed regularly. Risk acceptance and identification of asset bubbles and mean reversion probabilities should also come into your decision making process.
