Performance test remains, but with adjustments

The government's intention is clear: the performance test will not be scrapped but refined to better serve its purpose. The recalibrated test is expected to maintain member protection while also easing barriers to long-term, illiquid investments, such as those in housing, infrastructure, and private markets. This adjustment will require boards to operate in a "both/and" environment, balancing benchmark discipline with a more open approach to productive risk.

APRA's recent results underscore the current state of the market, with most MySuper defaults passing comfortably and a subset of trustee-directed products still facing challenges. This division is reshaping fund flows and accelerating product rationalisation. As the super system surpasses A$3.7 trillion in assets, even minor shifts in performance can lead to multi-billion-dollar switches. While early failures in 2021 were high-profile, subsequent waves have seen fewer defaults, though the extension of the test to more complex products has created a new group of underperformers.

"Pass the test, and you protect flows; fail, and you face fee pressure, outflows, and possibly even mergers," one industry insider noted.

Technical insights into the test's impact

The Your Future, Your Super (YFYS) test evaluates net returns against a benchmark derived from each product's strategic asset allocation (SAA), using standard market indices and a tolerance threshold. Failing once requires member notification, while failing twice means closure to new members. While the test has driven fee reductions and enhanced accountability, it also presents unintended consequences.

"Since performance is measured against SAA-based indices, funds are penalised for persistent tracking error," an analyst explained. "This discourages high-conviction tilts and some active strategies, particularly in volatile markets."

Unlisted assets, such as private equity and infrastructure, often face mismatches with liquid benchmarks, leading to elevated tracking errors and timing issues due to valuation lags. Additionally, trustee-directed products with diverse options can struggle to optimise under a single, strict lens.

APRA maintains that the test has improved performance and transparency, a view supported by fewer failures over time and significant member fee savings. However, Treasury is now examining how to preserve these benefits while eliminating distortions, particularly as more institutional capital is needed for housing and energy transitions.

Business implications: capital allocation and competition

The performance test has become a critical factor in capital allocation, influencing which super mandates are granted, which assets are favoured, and which products survive. For super funds, portfolio construction increasingly leans toward listed, benchmark-friendly exposures, while private markets teams face tighter discipline. Asset managers capable of delivering benchmark-aware alpha and offering liquid proxies for infrastructure or property stand to gain an advantage.

"If the review relaxes constraints on illiquids, we can expect larger investments from super funds into projects like build-to-rent and grid upgrades," a fund manager noted. "This could lower the cost of capital for nation-building projects, provided risk/return profiles and governance meet standards."

Platforms, particularly trustee-directed options, face a culling process, leading to fewer, clearer, and lower-fee products with stronger pass probabilities. This menu simplification will compress underperforming niche strategies.

Competitive edge for early movers

Leadership in this new landscape will belong to funds that can both pass the test and invest productively off-benchmark. Emerging strategies include dual-mandate portfolio design, which maintains a benchmark-aligned core while allowing for segregated sleeves focused on illiquid and climate-aligned growth. Additionally, tightening SAA definitions and benchmark choices can better reflect intended exposures, such as using listed infrastructure as partial proxies.

"Strengthening unlisted asset valuation processes and frequency will be crucial," a trustee emphasised. "This reduces timing noise versus liquid benchmarks and is a focal point for both APRA and trustees."

Australia is not alone in this endeavour, with global counterparts like the UK and Netherlands also emphasising long-term accountability and transparency. The likely outcome of Australia's review is a more nuanced test that continues to pressure chronic underperformance while aligning with the nation's retirement and investment goals. As the review progresses, funds that proactively enhance analytics, refresh SAA and governance, and prepare for a more permissive stance on productive illiquids will be well-positioned to capture flows and win mandates.