YFYS to push super funds to inferior returns: Thinking Ahead Institute

The Your Future Your Super reforms will make climate change engagement more difficult and push portfolios back towards a strategic asset allocation approach, according to the Thinking Ahead Institute.

In its submission to the government’s proposed legislation, the institute said the industry would either observe or participate in the biggest and “most rapid replumbing of the economic machine history has ever witnessed” if climate change science was correct.

“These risks and opportunities will only enter the index benchmarks after the event, meaning that the reforms raise the risks for a super fund wishing to invest in anticipation of climate change. Or, more simply, the reforms will make engaging with climate change more difficult,” the submission said.

“Similarly, incorporating other ESG [environmental, social, and governance] and sustainability considerations into the portfolio introduces tracking error risk relative to the performance benchmark, which may not be rewarded over the timeframe before the performance test ‘bites’.”

It also said the reforms would push super funds away from a total portfolio approach and back towards a strategic asset allocation approach.

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“We would liken this to going back to an old technology, one that is inferior in return terms by around 0.5% to 1% pa,” it said.

“In effect, the reforms shift a reference portfolio from being usefully operational (a guide to the opportunity set) to being detrimentally behavioural (the management of career risk).”

It noted that other investment changes it expected included:

• The proportion in illiquid assets would drift down through time (no new allocations rather than pressure to sell down), although larger funds would probably be best able to maintain their preferred weight. Managing tracking error against the indices that would be used to benchmark these assets would mean an outflow of infrastructure, real estate and venture/private equity capital from Australia to overseas. If super members did not fund long-term infrastructure projects or innovation, then who would?
• An increased allocation to passive (index-tracking) investments. This would occur in those funds that did not wish to take the risk of underperforming the performance test and where funds believed that they could compete for members on aspects other than just relative returns. Fee considerations would increase the attraction, and therefore proportion, of index-tracking;
• Downside protection may disappear from within products – the constant fee burn always harms against the test, while the payout could come after failing the test;
• Skill in risk reduction would be underaccounted for in test, and we would expect a diminution in a skill that was not recognised; and
• The timing of portfolio changes could be delayed to coincide with announced / reported strategic asset allocation changes (as this flows through to the performance test benchmark), rather than when it was most opportune to do so. This was linked to the move away from a total portfolio approach.