Research house Chant West has shared its suggestions for improving the Your Future, Your Super performance test as it is concerned how the test is influencing funds’ behaviour.
It said it had seen evidence of funds rejecting appealing investment opportunities, terminating diversifying strategies because they had a high YFYS tracking error and asset allocation that may have resulted in diminished returns.
“While the test has identified and eliminated some funds that were clearly sub-standard and destined to fail, it has caused collateral damage to others that were seeking to do the right thing by their members but were somewhat unlucky in the timing of the first test (i.e. over seven years of strong returns). More ominously, it has driven the behaviour of the surviving funds in ways that, in too many cases, have resulted in diminished returns for their members. Those are the unintended, and unacceptable, consequences of the current test regime.”
It recommended introducing:
- More measurement periods over three and five years to pick up instances where funds had taken steps to address past problems;
- Peer comparison against other investment options with similar risk levels;
- A metric incorporating risk-adjusted returns to indicate if a fund was receiving a reward commensurate with the risk being taken; and
- A simple reference portfolio (SRP) approach, already used in the heatmaps, where the value a fund had added relative to a portfolio with the same growth/defensive mix but comprising nothing more than listed equities, bonds and cash.
Therefore, it recommended a proposed test which included both risk-adjusted returns and the SRP approach which would capture both a fund’s merits and minimise their shortcomings. A fund’s performance would be compared with the performance of an SRP with the same volatility.
This proposed test had a simple benchmark, simpler calculations, simpler volatility measurements and incentivised funds for strong risk-adjusted returns.
“Our preference would be for our proposed test to replace the current test at the earliest possible opportunity. We do recognise, however, that this would be too abrupt a change, in that funds would have to switch their focus from passing one test to passing a different test.
“It may be, therefore, that a compromise can be achieved by running both the current and new tests in parallel for a short time. If that is the case, we would argue that passing at least one of the tests should be sufficient for survival during this period.”
The firm also agreed with the delay to introducing the test for Choice products but were confident they should be included at some stage, as should all diversified choice options. However, retirement income products should not be tested as they were “grossly ill-suited” to the test.
Recognizing of course that Chant West has a massive conflict of interest here. – independent ratings /assessments – laughable. The whole process of comparing absolute returns in isolation – without Sharpe ratio, standard deviation, or value at-risk measures across the industry is a total farce. Might as well be investing in bitcoin – for transparency.