The government's new Your Future, Your Super investment performance benchmarking is flawed and will have unintended consequences, according to Rice Warner.
Rice Warner said the proposed package to implement some of the recommendations by the Productivity Commission (PC) poses some issues in effectively cracking down on fund underperformance.
"One of the proposed changes is to monitor the investment performance of superannuation funds relative to benchmarks based on listed assets and to penalise products (and trustees) which under-perform," the company said.
"While the aim of raising overall performance is sound, the implementation is flawed and may lead to unintended consequences unless significant changes are made."
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Rice Warner said that while everyone agrees underperforming funds and products either need to be improved or removed from the system, the proposed new means of measuring are not the ideal way to weed them out.
"The PC report focused on underperformance and made no comment on the extraordinary outperformance of many Australian superannuation funds over extended periods of time, let alone the asset allocation decisions which were integral to achieving this performance," Rice Warner said.
"Some funds have outperformed CPI by 4% to 5% over periods of 30 or more years. Had the PC set a benchmark of (say) CPI + 3.5% over rolling 10-year periods, it would have set a reasonable bar without needing a new metric for funds.
"Further, it would not have interfered in any of the current asset allocation decisions made by successful funds."
Rice Warner said the Your Future, Your Super package accepts the PC's formula and APRA will use that measurement.
Additionally, Rice Warner said based on current performance figures, from October next year, several funds will need to advise members that they have underperformed.
"The funds will have a serious dilemma. The following year, they will need to improve performance to avoid a consecutive year of underperformance," it said.
"Yet, seven of the eight years measured that year will be the same, giving them unavoidable past performance, so they must hope that the new year is much better than the year dropped out."
Rice Warner said it is likely most funds will not be able to turn an eight-year performance around in one year and will be forced to set up different structures to accommodate new members.
"This will be very messy for all concerned. The government appears to hope that these funds will exit the industry," Rice Warner said.
"The over-arching effect of the proposed measures would likely be to pressure funds to forgo opportunities for long-term outperformance to mitigate the risks of underperformance against a nominated benchmark."
Rice Warner predicted many funds will then become passive on Australian shares to an extent that is not optimal.
"Surviving funds will be large and many won't be able to deviate much from the index anyway. They will still want exposure to franking credits, so will keep a sizeable portion of Australian shares," it said.
"One of the outcomes of this is that a much higher percentage of the Australian share market will become passive."
Rice Warner believes investments will be brought in-house as funds seek to reduce costs and the allocation to higher-performing unlisted assets will be reduced.
"Technically, these assets have much higher tracking errors, so they will have different results to the benchmark both better and worse in different periods," Rice Warner said.
"The shift away from higher performing infrastructure would be a poor development for members and the overall economy alike."