With roughly A$3.7 trillion under management, even small allocation shifts could redirect tens of billions into the real economy. Early movers that master illiquids, liquidity and regulation in tandem will bank a competitive edge.

Case Study: Recalibrating Australia’s superannuation performance test to unlock long-term investment while safeguarding member outcomes

Context: From compliance choke point to capital catalyst

Australia’s Your Future, Your Super (YFYS) performance test, introduced in 2021, has delivered a blunt message: underperform and face consequences. The test compares net returns of MySuper and trustee-directed products to a composite benchmark; fail by more than 50 basis points per annum over the assessment period and penalties bite. The regime has improved transparency and accelerated mergers, but it has also had unintended consequences. Funds and industry bodies argue the test’s mechanics discourage investment in unlisted and long-duration assets—precisely the kinds of investments required for housing and infrastructure.

The Treasurer has confirmed a review aimed at removing unnecessary barriers to these investments, without abolishing the test or diluting its member-first objective. The Financial Services Council (FSC) and the Association of Superannuation Funds of Australia (ASFA) back targeted changes, positioning this as a calibration exercise, not a retreat from accountability. The stakes are material: Australia’s super pool is now around A$3.7 trillion (APRA, 2024). A reweighting of even 2–3% toward domestic long-term projects could mobilise A$75–110 billion in additional capital over time.

Decision: The trade-offs behind targeted reform

Policy makers must balance three goals: protect members from chronic underperformance; remove structural biases against illiquid, long-dated assets; and align super capital with national priorities such as housing and infrastructure. Industry consensus is broad but not uniform. FSC and ASFA advocate more nuanced benchmarks and better treatment of unlisted asset valuation. Larger funds with established private markets teams favour flexibility; some smaller funds prefer the status quo to avoid new costs and complexity. APRA’s prudential stance—discipline, liquidity and genuine diversification—remains the guardrail. The political economy is clear: member outcomes stay paramount, but the opportunity cost of underinvesting in productive assets is now on the table.

Technical deep dive: How the test drives (or deters) asset allocation

The performance test measures each product’s net return against a benchmark portfolio constructed from listed indices mapped to the product’s strategic asset allocation. Two mechanics collide with long-term investing:

- Tracking error penalty: Allocations to unlisted property, infrastructure and private markets inevitably diverge from listed proxies. Persistent tracking error can look like underperformance even when long-run value creation is strong.
- Valuation cadence: Unlisted assets are appraised infrequently and can display “smoothing” relative to daily-priced listed benchmarks. During stress, timing mismatches can widen apparent gaps, elevating failure risk for otherwise sound portfolios.

Other frictions include fee recognition (performance fees in private assets can spike point-in-time net returns) and the “two strikes” rule: a second failure closes a product to new members, a significant commercial penalty. The review is expected to focus on benchmark construction, treatment of unlisted valuations, and the measurement window—targeted tweaks that preserve comparability while reducing bias against productive illiquids.

Implementation reality: Portfolio design, liquidity and governance under a revised regime

Assuming targeted reforms, the operational playbook for funds will still demand precision:

- Benchmark engineering: Revisit strategic asset allocation and index selection to reduce unintended tracking error. Consider custom composite benchmarks that better reflect unlisted exposures where permitted.
- Risk budgeting: Explicitly set tracking error and drawdown budgets at the product level. Align private markets pacing with risk budgets to avoid cliff effects around assessment dates.
- Liquidity ladders: Maintain a robust “sources and uses” model incorporating benefit payments, collateral, and rebalancing needs—stress-tested under severe but plausible scenarios. Many leading funds aim to hold several months of net outflows in liquid assets without forced selling.
- Valuation governance: Increase frequency and independence of unlisted asset valuations, tighten appraisal methods, and document valuation policies for auditability against the test.
- Member communications: Explain the rationale for long-term assets, their expected return and risk, and how the test works. Clear disclosure reduces behavioural risk during market stress.
- Manager architecture: Build or buy capabilities—co-invest rights, secondary market access, and fee structures with high-water marks—to capture the illiquidity premium without overpaying.

Market context and competitive dynamics

The performance test has catalysed consolidation, with the number of APRA-regulated funds shrinking markedly over the past decade. Targeted reform is likely to intensify the “scale-for-skill” race: only larger or highly specialised funds will sustain double-digit allocations to private assets alongside best-in-class liquidity and governance. Expect more mergers, specialist capability hires (infrastructure, private credit, housing), and partnerships with global pension peers.

International precedents support the direction of travel. Canada’s large plans built global reputations on long-dated, direct private market investing within disciplined risk frameworks. The UK’s Mansion House agenda encourages higher allocations to unlisted equities by 2030, seeking growth and diversification while maintaining fiduciary duties. Australia’s review sits within this broader shift to long-term, real-economy investing under tighter accountability.

Results: Scenarios for capital flows, returns and real-economy spillovers

Scenario modelling illustrates the potential impact:

- Capital reallocation: If MySuper products reweight just 3% toward housing, infrastructure and private credit over three years, the system could deploy roughly A$110 billion in additional long-term capital (based on a A$3.7 trillion asset base), staged to manage pacing and liquidity.
- Return profile: A sustained illiquidity premium of 1–3 percentage points over listed equivalents, net of fees, would lift long-run member outcomes if implemented prudently. Assuming a 2% premium on the incremental 3% allocation, portfolio-level uplift could be ~6 basis points per annum—small but persistent, compounding in members’ favour.
- Fee impacts: Private assets carry higher headline fees, but scale, co-investments and performance-aligned structures can compress net costs. The test’s net-of-fee construct incentivises fee discipline.
- Housing and infrastructure: Additional super funding can co-finance social and affordable housing and energy transition assets, provided risk-sharing frameworks (e.g., government guarantees, availability payments, or planning certainty) are in place to meet fiduciary hurdles.

Early adopters with seasoned private markets teams and robust liquidity frameworks should capture relative performance and member retention advantages, particularly as APRA heatmaps and comparison tools keep fee and return scrutiny high.

Lessons: A strategic playbook for trustees, CIOs and policymakers

- Keep the North Star: Member outcomes first. Targeted reform should improve market completeness, not dilute accountability.
- Build for resilience: Treat liquidity as a portfolio product, not a leftover. Codify collateral, redemption and rebalancing rules to avoid performance-test cliff risk.
- Professionalise private markets: Invest in data, valuation governance and manager bargaining power. Scale or partner—standing still is not a strategy.
- Align incentives: Use fee models that reward long-term value creation, with high-water marks and downside protections.
- De-risk public purpose: For housing and nation-building assets, develop bankable structures with predictable cash flows. Public–private partnership discipline remains essential.
- Communicate expectations: Educate members on the role of illiquids, drawdown tolerances, and how reforms work. Trust capital matters as much as financial capital.

Bottom line: The performance test isn’t going away—nor should it. But calibrated correctly, it can evolve from a compliance brake into a capital engine, advancing both member wealth and Australia’s investment capacity. Funds that operationalise this balance fastest will set the benchmark others must chase.