Majority of super funds face great likelihood of failing the YFYS test

By Cameron Micallef

July 08 2021
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Superannuation funds have a greater than 50 per cent chance of failing the Your Future, Your Super test over the lifetime of its members, a recent study has revealed.

Super funds more than likely will fail the YFYS test

As part of the government’s new reforms in the superannuation sector labelled Your Future, Your Super (YFYS), funds will have to adhere to an annual performance test comparing the rolling eight-year net returns of each MySuper product with what it could have attained based on its stated investment strategy.

Funds that underperform their designated benchmark by 0.5 per cent or more, in two consecutive years will have to inform all members in writing, and will be barred from accepting new members while their performance remains substandard.

However, Willis Towers Watson director of investment Tim Unger said that over a 20-year period, over half of all funds will fail the YFYS test.

Going through various scenarios, Mr Unger has found that regardless of how strong the performance of a fund, due to timings and risks, the odds of failing the test are high.

Mr Unger said a superannuation product with a 10 per cent probability of underperformance in any eight-year period has a cumulative probability of 35 per cent to underperform over a 17-year period.

Under a hypothetical situation, the fund manager explained that even funds that, broadly speaking, have similar performance to their objectives, take different paths to achieving their outcomes.

For example, if Fund A outperformed in 2015 and 2016 but had poor performance in more recent years, come 2023 and 2024 it will have a heightened risk of failure as those strong returns drop out of the rolling eight-year period.

Likewise, if Fund B did well in 2016 and 2018 but poorly in 2017 and 2019, its risk of failure spikes in 2024 and 2026 when the positive impact of those earlier years is lost.

“If we look at 10 consecutive performance tests, which cover a total of 17 years of fund performance (i.e. the first test covers years 1-8, the second covers years 2-9, while the 10th test covers years 10-17), a product with a 10 per cent probability of underperformance in any given eight-year period has a cumulative probability of underperformance over the 17 years of around 35 per cent,” he said.

“If we extend this to 20 measurement periods, then the cumulative probability increases to a little over 50 per cent.”

With the laws based on two years’ worth of underperformance, Mr Unger shows these same funds have a 7 per cent chance of failing over the two consecutive periods.

“However, once again if we extend the assessment period to include 25 measurement periods, the likelihood of failing the test in two consecutive years is over 40 per cent, which is clearly a very significant risk for a fund,” he explained to members.

He goes on to explain that even a fund with a 5 per cent chance of failure over eight years has a 40 per cent chance of underperformance over 25 periods, and around a one in four chance of consecutive failures.

“All of this suggests that funds will need to pay a lot of attention to how much risk they are taking relative to the YFYS benchmark,” Mr Unger concluded.

About the author

Cameron Micallef

Cameron is a journalist for Momentum Media's nestegg and Smart Property Investment. He enjoys giving Aussies practical financial tips and tricks to help grow their wealth and achieve financial independence. As a self-confessed finance nerd, Cameron enjoys chatting with industry experts and commentators to leverage their insights to grow your portfolio.

About the author

Cameron Micallef

Cameron is a journalist for Momentum Media's nestegg and Smart Property Investment. He enjoys giving Aussies practical financial tips and tricks to help grow their wealth and achieve financial independence. As a self-confessed finance nerd, Cameron enjoys chatting with industry experts and commentators to leverage their insights to grow your portfolio.

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