The knock-on YFYS effect for fund managers

Over 65 per cent of flows into the $4.3 trillion funds management industry come from the superannuation sector, according to a report by KPMG and the Financial Services Council (FSC).

The joint report State of the Funds Management Industry found the compulsory super system in Australia was a key reason flows are largely sourced domestically compared to other countries. 

However, the report noted, the volume being managed by external fund managers is declining as more funds move to internalisation.

As of 30 September 2022, 56 per cent of super assets representing $1.1 trillion were managed by external fund managers. 

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“As Australian superannuation funds have grown in size and complexity, a number of super funds have internalised their investment management functions (i.e. developed funds management capabilities in-house).

As such, not all super funds monies are managed by external fund managers as it is has been historically,” the report said.

It also noted the Your Future, Your Super (YFYS) performance test, which was introduced in 2020, and the resulting mergers by funds that have underperformed or are of a smaller size to compete have had knock-on effects for fund managers. 

The report said: “This merger activity has resulted in:

• The number of mandates available in the market decrease[d], but the average fund size increase[d].
• Increased focus on performance against YFYS benchmarks and tracking error which has meant that investment strategies that are not neatly aligned with benchmarks may be under review.
• Additional focus on enhancing product performance is encouraging greater use of passive investment strategies for equities investment (with lower fees than active management) and sharper procurement processes between super funds and fund managers.”

As a result, the report made the recommendation for the YFYS test to be continually monitored for unintended consequences.

“We are supportive of the government reviewing the YFYS performance test (the benchmarks specifically) and of the consultation process on draft regulations regarding the benchmarks used for the performance test assessment,” the report said.

“Given the nascent and importance of the test, we recommend the government continue to assess the YFYS performance test for unintended consequences and to ensure the performance test approach and benchmarks are not inappropriately constraining investment decisions of trustees.”