Performance Test under Review

Only a year after the YFYS performance test came into effect, the measure has been called into question by the new government.

Barely a year after superannuation funds were first subjected to the Your Future, Your Super (YFYS) performance test, the test has been called into question by the new government.

Stephen Jones was only sworn in to the role of Assistant Treasurer and Minister for Financial Services on 1 June 2022, but he was quick to make clear he doesn’t think much of the Your Future, Your Super legislation.

In early July, Jones asked Treasury to review the operation of the YFYS laws, citing potential ‘perverse and unintended outcomes’.

One of the key concerns seems to centre around the fact that the test penalises tracking error from the benchmarks set by the Australian Prudential Regulation Authority. This is problematic for private market assets, as these investments are lumpy and will not follow any benchmark perfectly. As a result, this will cause tracking errors at certain times.

If super funds reduce their exposure to private markets in an effort to pass the test, then that hits the government directly, since it will mean less appetite for infrastructure investments.

“The Government is aware of concerns that the YFYS laws have the potential to create such outcomes by discouraging certain investment decisions or certain infrastructure investments,” Jones said.

“With two rounds of annual tests completed, the review will consider whether the performance test has had any significant unintended consequences for MySuper products and assess how the test should be applied to other superannuation products,” he said.

The review will also pause the extension of the performance test to Choice products for 12 months to make sure it is fit for purpose. It will also consider whether there have been any unintended consequences from other YFYS reforms, Jones announced.

Performance Test and Faith-based Funds

A separate consultation is underway for the treatment of faith-based super funds and the question whether they should be subjected to the same performance test as other super funds.

This became a key question after Christian Super failed the YFYS performance test last year, but members weren’t leaving the fund, even after having been officially notified.

It is clear that these members chose the fund not just for financial reasons, but also for religious ones.

By the way, the Christian Super MyEthicalSuper option that previously failed the performance test was one out of just three funds that had a positive return this year, making it the third best performing super option in the country.

The proposed legislation now wants to measure religious funds against a supplementary test that considers their faith‑based investment strategy, if they fail the original test.

Faith-based funds often employ negative screens, which avoid investing in certain companies or even whole sectors. This causes tracking error, but it is a compromise many of these members are willing to take.

Of course, faith-based funds are not the only funds that adjust their investment strategy to reflect their member base.

Environmental, social and governance (ESG) or sustainable fund options also limit the universe of investments they are willing to consider on the basis of climate change, modern slavery and other considerations, but there are currently no plans to adjust the benchmarks to better reflect their investment philosophy.

In fact, there are many other funds that have adjusted their investment strategy based on their member demographic.

And this is the key problem with the performance test: it doesn’t consider a fund’s member base.

Previously, we have lamented the fact that the test does not consider risk management and so if a fund has an older member base then the only tool they have is adjusting their weighting to the various asset classes.

It doesn’t allow funds to consider more conservative or more sustainable investments within an asset class without risking failing the test in certain years.

Other than the performance test, the government is also seeking to address issues with YFYS that relate to the perceived regulatory complexity of best financial interests duty requirements.

The review will not unwind ‘stapling’ measures, which reduce the proportion of duplicate accounts, or remove the requirement for trustees to meet high performance and probity standards, Jones said.

Wouter Klijn

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