The focus on superannuation fund performance has ramped up over the last few years.
Following a recommendation from the Productivity Commission, the Treasury Laws Amendment (Your Future, Your Super) Bill 2021 introduced the performance test regime. This was initially applied to MySuper products from July 2021, but it was expanded to a subset of Choice products (known as trustee-directed products) in 2023.
The consequences for funds who fail to meet the performance test are strict, with a letter being sent to members to advise them about it; consecutive test failures result in the fund being closed to new members.
Most MySuper funds that failed in 2021 have since been wound into another fund. The test will be expanded to all Choice funds in the future, with broader implications. APRA also issued their first Choice Heatmap in December 2021, highlighting those products that were failing to meet the benchmark.
ASIC has also been taking a close interest in fund performance and issued Report 779 – Superannuation choice products: What focus is there on performance? on February 21st. This report was focused on underperforming funds and the responsibilities and actions of super fund trustees, advice licensees and advisers.
Underperformance was assessed against targets defined in PDSs and over a period of at least five years. Seemingly the level of underperformance ranged between 0.2% and 6.7% per annum.
Key findings
There are important messages in this report for all three key stakeholders in the Choice marketplace – trustees, licensees and advisers. ASIC suggested that there was a tendency for each of them to rely on the others; trustees were relying upon advisers to address underperformance, licensees were relying upon the fact that the trustee had put the underperforming options on the menu and advisers were relying upon licensees to monitor and assess performance issues.
ASIC also concluded that there was a tendency for over-reliance on research houses, with trustees and licensees accepting a minimum neutral rating for product approval. The implication was that this should no longer be sufficient.
Some of the key messages for trustees concerned the due diligence process in selecting investment options for their menus and the review of ongoing performance and communication of performance to members. ASIC highlighted the lack of reporting of performance against targets as defined in PDSs.
Evidently, ASIC believes that many trustees can do better, particularly regarding messaging members about fund performance. The clear suggestion was that there should be targeted messaging for impacted members. We might also argue that the trustees should be providing more information to advisers.
In terms of licensees, the focus was on the APL approval process, performance review activity and the processes they have in place to ensure that their advisers are actively and appropriately reviewing clients where under-performance is an issue. There was some focus on how products were added to APLs as well as the non-APL approval process.
ASIC noted that APLs are not a mandated obligation. This is correct – there is no reference to them in the legislation – but licensees are expected to have strong risk management practices, and it’s difficult to see how this can be achieved without an APL of some form.
Licensees are expected to undertake due diligence on the products they enable their advisers to recommend, and they need to be regularly monitoring fund/investment option performance. It’s clear ASIC does not think this can be facilitated solely by relying on research houses, especially if the product in question only has a neutral rating.
Larger licensees are likely to have teams devoted to this activity and a formal committee to approve changes and oversee performance. For smaller licensees, though, these obligations will require careful consideration of the processes they have in place to comply with ASIC’s expectations as stated in this report.
The implications of under-performing funds
It’s important to note, though, that having clients in an under-performing fund or option does not automatically suggest that they should be moved to another fund/option. ASIC acknowledged a range of reasons why this may not be in the client’s best interest.
One obvious reason with Wrap products is the tax consequences. Given the CGT implications for changing funds, particularly if they are approaching retirement, this may be best avoided.
If the level of underperformance is minor relative to the cost of moving them to another fund/option, this may also be a good reason not to move them. It could also be the case that performance is poor over a longer period but good over a shorter period; this should not necessitate moving the client, particularly if they haven’t been in the product long term.
Whatever the reason, the key message is that the underperformance must be understood and the rationale for staying must be explained to the client if the adviser concludes this is the best option for them. This should all be recorded on the file.
A specific message for advisers
This might seem like a prickly situation to some advisers, given that they position their service and value proposition on the basis of advice strategies rather than stock picking. Others will argue that some of this is contrary to the old adage that past performance is no predictor of future performance.
Nonetheless, we all need to be aware that performance is critical to long-term outcomes for members/clients – and both licensees and advisers should maintain a close focus on it.
As part of the review, ASIC inspected 88 advice files and found the advice to be inappropriate in 11 cases. In those 11 cases, clients held a high percentage of assets (100% for seven of them) in under-performing funds.
ASIC summarised their key concerns with the files, suggesting that they had failed to:
- demonstrate that the adviser conducted a reasonable investigation and assessment of the underperforming option
- identify the underperformance
- explain why it was appropriate for the client to retain the option despite the underperformance.
In aggregate, then, ASIC Report 779 delivers a message to trustees, licensees and advisers: they need to increase their focus on underperformance and build processes to ensure that underperformance is understood and that clients are being informed and advised (including the reasons) whether to retain or move to another fund or investment option.
Many advisers will already be doing all of this – but if not, it will be necessary to reassess business processes and data sources.
Advisely Partner