Equity portfolios impacted by the YFYS performance test

David Bell (left), Jo Cornwell and Scott Bennett

The Your Future, Your Super (YFYS) performance test has had a significant impact on the investment behavior of asset owners and portfolio managers. According to research published by The Conexus Institute, super funds took on a shorter investment time horizon, reduced their portfolio management leverages and became more constrained in risk management in order to maintain or strengthen their performance test buffer.

speaking to Investment magazineit is Action Summit in Sydney, Jo Cornwell, portfolio manager of Aware Super – growth assets, said the performance test warrants the fund’s equity investment team to focus on its capital allocation framework and the allocation of its active risk budget.

“We want to have detailed monitoring of what are the main contributors to the active risk that we take in the portfolios,” she said. “But that doesn’t necessarily mean going straight to passive management to manage risk.”

Scott Bennett, Head of Quantitative Investment Solutions – Asia Pacific, Northern Trust Asset Management, also saw a strong push for super funds to reduce portfolio risk. “When you think about risking it’s not a straight leap into liabilities. I think a lot of investors recognize that they have an active risk budget that they have to spend and even more so now given the inflation But he noted that super funds do not end the tenures of their active managers.

The focus on risk budget management also highlights the importance of manager capacity and selection. “Do we trust our investment managers to achieve the objectives we have agreed with them and are they innovative in their fundamental research so that we have the utmost confidence in their ability to generate alpha in a more uncertain world? said Cornwell.

The $150 billion super fund has embarked on a strategy to manage approximately 50% of its assets in-house over the next few years to reduce costs and provide members with benefits of scale, in line with similar efforts by other large super funds.

This internal management strategy gave the equities team additional resources to manage tracking error more effectively. “If we identify an area where we need to manage the risk of tracking error, we have the internal capabilities to enable us to do so. It’s an advantage of our scale and size,” she said.

Test challenges

One of the challenges faced by performance testing equity portfolios is variability or tracking error relative to the benchmark. “It’s really how cyclical my performance model is and the idea is that we want that cyclicality to be very low,” Bennett said.

Another issue is that ESG-focused investments lead to high tracking error in the test, but this strategy cannot be ignored as every major super fund has a net zero target, he said.

Fund consolidation, which is not just limited to smaller, less successful funds, has caused significant capacity issues. Australia’s top 20 super funds account for more than 25 cents of every dollar invested in the Australian equity market, up from around 15 cents 10 years ago.

“From a capacity perspective and specifically when you think about markets like Australian equities, which are half of the overall equity allocation, that becomes a significant challenge,” Bennett said.

“As we go through this process of funds that fail or seek to fail, Your Future, Your Super is testing and increasing [pressure on] as they merge, this challenge will only become greater and greater from an implementation perspective. »

The test also hampered managers’ ability to generate returns, Bennett said. “This is probably the most challenging environment for real returns we have faced in the past two decades. The scope to actually manage [headwinds] effectively and actually creating wealth has left super funds feeling paralyzed,” he said.

Exposure to highly volatile assets is becoming increasingly difficult in the YFYS world. “The biggest challenges for us in a portfolio context are how we allocate off-benchmark positions,” Cornwell said.

“We’ve been thinking a lot recently about emerging market allocations, our China allocations and our micro and small cap allocations and deciding how we want to allocate this active risk budget,” she said.

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