Whitlam Zhang, manager research and strategy at Parametric said, “Our analysis shows that even failing the test once puts a super fund in a precarious situation. The probability of a second failure is very high because the next performance test will include 87.5% of the same data – that is, seven of the eight years being measured will be the same.”

Under the new performance test, each year the Australian Prudential Regulation Authority will construct an individual benchmark for every MySuper product based on the product’s asset allocation. Each product will then be compared against its benchmark.

Products that underperform their net investment return benchmark by 0.5 percentage points per year over an eight-year period will be classified as underperforming.

Trustees whose products fail the test will be required to notify members in writing. Products that fail the test two years in a row will not be permitted to accept new members until their net investment performance improves.

Zhang says, “It will require quite a performance turnaround the next year to bring the fund back to safer ground. Any fund whose strategy is to rely on their brand strength and member loyalty to survive the occasional single failure should think twice.”

Zhang says that to reduce the probability of failing the performance test, a fund needs to either decrease its level of tracking error or increase its expected information ratio.

“The good news is that tracking error is within the control of a super fund. While it cannot be controlled to a fine degree, it can be dialed up and down.”

A fund can dial down risk in order to reduce the probability of failure by taking the following options: increase allocations to low tracking error strategies, such as passive or enhanced passive investing; implement stricter rebalancing rules to reduce active risk from straying from their strategic allocations; and ensure that the fund’s risk reporting includes total risk and benchmark relative risk.

Zhang says increasing the expected information ratio is difficult, “Anyone can tell you that generating excess returns is hard enough, let along delivering it in a risk controlled and predictable manner.”

“It means that investment teams will need even higher conviction in their fund managers in order to compete in this market. Investment strategies that will do well in this regime are solutions that can deliver excess returns in a relatively more predictable manner,” notes Zhang.

The post Super funds could face high risk of failure under ‘Your Future, Your Super’ performance test appeared first on AdviserVoice.

“Active managers will have to substantially reduce their risk budgets, compared with the way things work now. Taking the passive option carries its own risks,” Zhang says.

“Fund trustees will have to think creatively and make some tough decisions. Tax-managed strategies will have a role to play. In the quest for delivering the best financial results for members, sometimes it helps to focus on the simple things, such as paying less tax and reducing fees.”

Under the proposed performance test, each year the Australian Prudential Regulation Authority will construct an individual benchmark for every MySuper product based on the product’s strategic asset allocation, taking into account fees, tax and other relevant assumptions. Each product will then be compared against its custom benchmark.

Products that underperform their net investment return benchmark by 0.5 percentage points per year over an eight-year period will be classified as underperforming.

Trustees whose products fail the test will be required to notify members in writing. Products that fail the test two years in a row will not be permitted to accept new members until their net investment performance improves.

Zhang says: “Clearly this will change the way super funds think about fund manager selection. It will raise the bar for how much conviction is needed before selecting a fund manager.

“It will also lower the appetite and patience of investment teams in strategies that may suffer large drawdowns for long, drawn-out periods of underperformance.”

Asset managers whose investment universe differs from their benchmark may also be less attractive. These might include alternative asset managers that pursue niche strategies.

To work within the constraints of low risk appetites, trade-offs will have to be made. These might include shifting allocations from private markets to listed markets and significantly reducing the amount of active risk taken within listed asset classes.

Those funds that have suffered poor relative performance in recent years will be most under pressure when the new regime takes effect.

A retreat to the “safety” of passive investing comes with its own risks, says Zhang.

“By definition a super fund investing passively cannot fail the performance test but whether it is the right investment decision for the fund is another matter.

“Some of the shortcomings of going down the passive route include: not all asset classes can be accessed passively; the fund will have few options for customising and tailoring portfolios to suit members expected outcomes; and the expectation for returns may be lower.

“Indices can vary greatly within an asset class and selection of an index can potentially introduce as much active risk as an active fund manager. And in the passive investment universe there is no flexibility to incrementally add value through tax management.

“Fund trustee should consider tax-managed passive investing, particularly in listed equities portfolios, which are generally the biggest drivers of risk and return in a super fund portfolio.

“As the performance test is net of fees and taxes, paying low fees for passive management and reducing taxes paid will increase the chances of outperforming the test,” notes Zhang.

The post When it comes to ‘Your Future, Your Super’, focus on the basics: pay less tax and reduce fees appeared first on AdviserVoice.

Mr  Zhang reports to Chris Briant, Head of Australia and New Zealand, Eaton Vance Management (International) Limited and Paul Bouchey, Global Head of Research, Parametric.

As Manager of Research and Strategy, Australia and New Zealand, Mr  Zhang works closely with Parametric and Eaton Vance’s overseas offices to plan and deliver internal and client-facing thought leadership, including pieces relevant to Australian super funds. He focuses on the firm’s after-tax investing, post-retirement and responsible investing capabilities. He oversees Sydney-based analyst Joshua McKenzie and is a member of Parametric’s global thought leadership team in Seattle.

Mr Zhang joined Parametric in 2015 and most recently worked with the firm’s global core platform technology team as Enterprise Data Management Architect.

Before joining Parametric, Mr Zhang was a portfolio manager at a boutique Australian equities asset manager. He previously worked in asset consulting at Russell Investments and as an analyst with the Australian Prudential Regulation Authority (APRA).

“Our Australian business has experienced significant growth in client assets under management and product breadth over the past eight years,” said Mr Briant. “In the next phase of our growth, Whitlam is critical to further developing our Australasian business. He has an intimate knowledge of the funds management industry, having consulted to superannuation funds in Australia, and has deep local subject-matter expertise. All these experiences will prove invaluable in understanding and helping our clients in his new role.”

Mr Zhang replaces Raewyn Williams, who is leaving the firm after seven years to pursue other interests. Mr Briant commented “While we are excited about Whitlam’s promotion, we are sorry to see Raewyn leave and sincerely thank her for her enormous contribution to the business over the past seven years.  We wish her all the very best for her future.”

The post Parametric Appoints New Manager of Research and Strategy, Australia and New Zealand appeared first on AdviserVoice.