APRA’s annual performance test was designed to drive accountability and lift standards. Four years in, it has unquestionably sharpened competition and closed underperforming products. But the latest results have amplified concerns from both industry and policymakers that the framework may be steering capital away from illiquid and transitional assets just as Australia needs more investment in housing, energy and productivity. With the government signalling a review aimed at removing unnecessary barriers to such investments, the regime has entered a pivotal phase.

Context: a powerful test with awkward side‑effects

The test compares a product’s net returns to a composite reference portfolio derived from its disclosed strategic asset allocation. Underperformance beyond a tolerance margin triggers a fail; repeated failure restricts new member inflows. The mechanism has delivered clear consumer wins — fewer persistently weak products and sharper fee discipline — and brought transparency to a market managing more than $3.7 trillion in retirement savings.

Yet fund executives, consultants and industry bodies have highlighted three friction points: tracking‑error risk for active and illiquid strategies; procyclicality in periods of benchmark whipsaw; and valuation lags in unlisted assets that can distort point‑in‑time comparisons. Retail platforms contend the test pressures “index‑hugging”, while industry funds warn it can penalise genuine long‑horizon diversification. The government’s planned review, flagged by the Treasurer as part of an ambition to mobilise super capital in housing and other national priorities, aims to refine rather than abandon the regime.

Decision: how one large fund reframed the problem

This case study synthesises practices adopted by several large funds into an anonymised composite (“Fund Alpha”), representing a top‑10 Australian fund with a multi‑asset MySuper option and a suite of trustee‑directed products. After the 2023–2024 test cycles, Alpha’s board set three non‑negotiables: protect long‑term member value, maintain capacity to invest in illiquids and the energy transition, and achieve a stable performance‑test surplus. The board directed management to redesign portfolio construction, fees and data systems to target a consistent positive margin to the benchmark while preserving strategic differentiation.

Implementation: technical playbook, not spin

Alpha executed a six‑point program over 12 months:

- Benchmark‑aware strategic asset allocation: Re‑mapped the strategic asset allocation (SAA) to the test’s reference indices to quantify structural tracking error. Set a hard limit of 0.8% tracking error to the test benchmark at the total‑portfolio level, with product‑level risk budgets.

- Liquidity and valuation cadence: Lifted the share of liquid proxies within private markets sleeves (e.g., listed infrastructure as a bridge for unlisted pipelines) and tightened valuation frequency in private assets to quarterly with event‑based triggers.

- Illiquid pacing and sequencing: Kept a meaningful illiquid allocation (c. 25%) but sequenced commitments to avoid clustering denominator effects. Introduced “test‑aware” pacing that models rolling eight‑year outcomes through multiple macro scenarios.

- Active risk rationalisation: Concentrated active risk in high‑conviction sleeves (global quality equities, credit dislocation, and climate‑solution private equity), offset by low‑fee core beta elsewhere. This reduced benchmark relative volatility without abandoning alpha.

- Fee compression and procurement: Renegotiated external mandates and internalised selected capabilities, cutting all‑in fees for flagship options by 8–15 basis points, with explicit pass‑through to the test.

- Data, analytics and governance: Built a performance‑test “digital twin” that replicates APRA’s methodology daily. The twin feeds investment committees with live surplus/deficit, attribution by asset class and scenario overlays for policy changes under review.

Results: measurable uplift without abandoning mission

Within a year, Alpha reported the following outcomes (anonymised composite figures):

- Test surplus: Improved from –0.20% p.a. (rolling) to +0.45% p.a. versus the composite benchmark, reducing the probability of a future fail from an estimated ~18% to ~5% across Monte Carlo scenarios.

- Tracking error: Lowered total‑portfolio tracking error to the test benchmark from 1.6% to 0.7%, cutting the risk of adverse point‑in‑time comparisons.

- Fees and member benefit: Reduced headline fees by an average 12 basis points. For a $150 billion flagship option with 1.2 million members, that equates to roughly $180 million in annual fee savings and an estimated $5,400 higher balance at retirement for a typical 30‑year‑old member (assuming 40 years to retirement, 1% real wage growth, and 4.5% real returns).

- Liquidity resilience: Increased the liquid coverage ratio to meet a 1‑in‑20 stress redemption scenario from 1.1x to 1.6x while holding a 24–26% allocation to private assets, including renewables, social infrastructure and build‑to‑rent.

- Communication: Member complaints related to product changes fell by 32% following a targeted disclosure campaign explaining the test and fee reductions.

Market context and competitive dynamics

The performance test has already reshaped the landscape: weak products have exited or merged; surviving funds compete harder on price and scale; and CIOs increasingly frame “regulatory alpha” as a capability — the skill of generating enduring test‑positive outcomes while preserving true diversification. Industry bodies such as ASFA have broadly supported the regime’s consumer intent while calling for technical refinements. Several managers, particularly those with higher active or illiquid tilts, argue that current settings can inhibit investment in emerging sectors central to Australia’s growth agenda.

Lessons: what boards and executives can do now

- Treat the test as a design constraint, not an investment strategy. Codify a minimum surplus target and explicit risk limits to the benchmark across products.

- Build a daily methodology “twin” for governance and decision support. If you can’t measure the margin, you can’t manage it.

- Separate illiquid pacing from market timing. Use rolling cohort analysis to avoid denominator effects around valuation step‑ups and index inflection points.

- Pull the price lever early. Fee compression is the most reliable way to widen the margin without distorting asset allocation.

- Communicate trade‑offs with members. Transparency reduces switching risk and supports long‑term strategies.

Future outlook: what a smarter test could look like

As Canberra reviews the framework, expect debate to coalesce around five adjusters: (1) extending the horizon (e.g., longer look‑back for products with structural illiquidity); (2) refined benchmarks for unlisted and climate‑transition assets to reduce valuation mismatch; (3) explicit tracking‑error corridors rather than a hard cliff; (4) clearer transitional settings for new or materially changed products; and (5) enhanced disclosure so members see risk, cost and long‑run value, not just a single pass/fail flag.

Internationally, regulators are converging on value‑for‑money regimes that balance performance, cost and service — the UK’s approach is one example — suggesting Australia’s next iteration can remain rigorous while being less distortionary. Early movers that internalise these likely settings will bank a durable competitive edge: lower costs, better data, steadier surplus, and continued access to illiquids that underpin long‑term returns and national investment priorities.

Bottom line: the test is here to stay, but smarter design and smarter implementation can align consumer protection with capital formation. Boards that treat this as a strategic redesign — not an annual compliance scramble — will own the next decade.