Practitioners warned on YFYS performance indicators on SMSFs

This was the final step in the government’s response to the Productivity Commission’s 2019 report on superannuation.

In a recent technical update, SuperConcepts executive technical manager Phil La Greca said that the potential implications of grading super fund performance might eventually lead back to the SMSF sector, with practitioners needing to keep an eye out on how it plays out.

This performance test is a comparison of each MySuper fund’s investment performance after administration fees. A benchmark performance calculation is done by APRA using each fund’s actual investment data and a range of uniform asset class and sector indices.

Mr La Greca said the calculations are done as a seven-year rolling average, and each fund is compared with its own asset allocation and investment choices rather than compared with other funds by product label such as balanced, conservative or growth.

“If a fund underperforms against its benchmark, by more than half a percent per annum, the fund is given a fail,” he said.

“If a fund receives a fail, it is obligated to notify all members, in writing, of its underperformance. If a fund underperforms for two consecutive years, then the fund is not permitted to accept new members.

“In this first application of the performance test, there were 13 funds found to receive a fail result. These funds represent $56 billion in assets and 1,000,000 member accounts.”

Whilst the good news is that this test does not currently apply to SMSFs, Mr La Greca noted the regulation is initially drafted for larger funds and then finds its way, in a modified form, down to smaller funds, including SMSFs.

“Nevertheless, these performance tests generate valuable data that essentially states what is regarded as good investment performance for a superannuation fund,” he noted.

“If an SMSF has trouble performing at these known levels, it will become difficult for advisers to justify a recommendation for an SMSF to be established. 

“This could also mean that significant underperformance by an SMSF could require an adviser, operating in accordance with best interest duty, to recommend the winding up of an existing SMSF.”

What SMSFs should consider

As the current test is only applicable to MySuper funds, and these funds are only accumulation funds, this means the test, in its current form, does not have the right parameters for use where funds are providing pensions, according to Mr La Greca. This represents a significant proportion of SMSFs.

“Of course, for those SMSFs in accumulation phase, the first thing to think about is the performance methodology, which does not generally break the earnings calculation into its component parts allowing for proper comparisons,” Mr La Greca explained,

“Additionally, there is no mechanism for the calculation of rolling multi-year averages that would also need to be enhanced. 

“We also need to consider the data used by the regulator to do their benchmark comparisons. The SMSF regulator could certainly use the same benchmarks as APRA; however, the main issue is that the data provided by SMSFs to the ATO is in a significantly different form. 

“This would require a re-designed SMSF annual return, allowing for better classification of the investments and potentially a reviewed reporting cycle. Currently, returns are provided on an annual basis compared to APRA’s quarterly reporting cycle.”

All these measures are also part of the federal government’s positioning of a mutual obligation between itself and all superannuation funds, according to Mr La Greca. 

“This obligation is one where the government provides tax concessions on contributions, earnings and benefits, and the funds deliver the required member outcome of sufficient balances in retirement to reduce or defer government expenditure in retirement,” he observed.

“It is still expected, however, that there will be pressure for SMSFs to quantify their performance in a better manner. Ultimately, the SMSF sector is at least the same size as the MySuper sector. 

“With the move in the next couple of years to expand the performance test to the choice component of APRA fund, it would create an oddity where 75 per cent of the superannuation money has a measurable performance test whilst 25 per cent does not.”