Super fund performance tests

The big super funds are the dominant players in local markets, with assets under management that dwarf advice businesses. So the rules that affect them are going to have an impact on the way our markets operate, as well as being an important comparison point for investors.

Funds are now subject to the “Your Future, Your Super performance test”, where funds’ returns are compared to the benchmark returns of indices (the exact compositions of the benchmarks are varied to match the funds’ investment strategies). If the super fund underperforms over eight years it needs to inform its members that they’re in an underperforming fund and could be better off elsewhere. Although early results show that most members don’t switch if that happens, it’s very embarrassing, and of the thirteen funds that failed in the first year of the test, four had merged with other funds by the second year.

The Connexus Institute has done some modelling of what it would take for a fund with some skill (or cost advantage) to be reasonably sure of passing the performance tests and has found that the tracking error from their composite benchmark needs to be kept down around 1%. The funds currently seem to be running at 2-2.5%. Interestingly, the modelling shows that even if the fund has some outperformance “in hand” the fund’s tracking error should converge to the lower limit over the long term. This is because performance is assessed on a rolling eight year basis, so even though now last year’s good performance might give the fund a buffer to take more risk this year, in seven years the good year will have rolled out of the sample but the current year will still be in.

It also means that funds that have a bad year or two are incentivised to dial down the tracking error a lot to reduce the risk that they fail the test in future. There’s some evidence that funds are already doing this.

All this suggests that the big players in the market are going to be a lot more index like, and that insto flows to active managers could reasonably be halved in future. Although the paper doesn’t say this, it’s logical to assume that there will be a lot of funds introducing hidden risk into their portfolios. For example, they would be attracted to a bond manager that’s close enough to the benchmark to be classified as a mainstream fund, but has a small allocation to risker high yield and emerging market debt to boost returns a little.

The other thing that the performance test doesn’t address is what the proper strategic asset allocation is in the first place. Industry funds have famously more aggressive allocations than investors choose for themselves or advice groups would use.

You can read the full paper at YFYS-Sustainable-tracking-error-re-visited-20221012-final.pdf (

Important Information: This document has been prepared by Aequitas Investment Partners ABN 92 644 165 266 (“Aequitas”, “our”, “we”), a Corporate Authorised Representative (no. 1284389) of C2 Financial Services, (Australian Financial Services Licensee no. 502171), and is for distribution within Australia to wholesale clients and financial advisers only.

This document is based on information available at the time of publishing, information which we believe is correct and any opinions, conclusions or forecasts are reasonably held or made as at the time of its compilation, but no warranty is made as to its accuracy, reliability or completeness. To the extent permitted by law, neither Aequitas nor any of its affiliates accept liability to any person for loss or damage arising from the use of the information herein.

Please note that past performance is not a reliable indicator of future performance.

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