A tale of two tests: why Britain’s VFM needs Australia’s playbook
The upcoming Pensions Bill in the UK proposes a value for money (VFM) framework for DC schemes. A similar experience in Australia – the performance test – had unintended consequences for climate solutions investing. Will the VFM repeat the performance test’s errors? or will this time be different?
A sweeping set of reforms for the UK defined contribution pension schemes is making its way through the House of Commons. Some of these will have implications for DC climate solutions investing.
The most notable, in that regard, is the value for money (VFM) framework - that compares the performance of different schemes, assigns a rating based on performance and sets out consequences for laggards.
It is in effect, a first-of-its-kind public test of DC value generating prowess, intended to hold the industry to account. The idea, a legitimate prudential tactic, is one with precedent.
The Australians have been at it for five years. Back in 2020, they introduced the Your Future Your Super performance test – which the VFM ethos bears striking resemblance to. Australia’s performance test had the unintended consequence of inhibiting climate solutions investing. If the UK’s VFM regime is to avoid these errors, lessons from down under are worth noting.
Benchmarks
The reason Australia’s performance test risked disincentivising climate solutions investing wasn’t the comparison itself. Rather, it was the basis on which it was done.
Australia’s method focused on benchmarking investment performance based on indices, split by asset classes. Climateworks Centre, an Australian research organisation notes that the way things stand, the benchmarks ‘offer little flexibility for superannuation funds to consider climate when investing’.
The issue here is which way the benchmarks face – incorporating climate into performance is by its very nature a forward-looking exercise.
“Benchmarks are by nature backwards looking”, says Max Messervy, founder and principal of Oakledge Advisors. Messervy says most benchmarks tend to inadequately price externalities – including GHG emissions – into current asset valuations.
“Using backwards looking and structurally mispriced benchmarks to measure the performance of assets whose value is mostly realized in a more climate-aware future, creates a potential fundamental mismatch in terms of time horizon and asset valuation”, Messervy told Net Zero Investor.
The call for benchmark reform is rather global in scope. In the US, a collaborative effort involving Paul O’Brien - a trustee of Wyoming’s retirement system - and the Responsible Asset Allocator Initiative is aimed at reforming benchmarking practices.
In a bid to get the Australians to look ahead, Climateworks Centre recommended including climate indices in the performance test – noting a list of asset owners that already invest in these. That list includes CalSTRS and CalPERS in the US, the Church of England Pensions Board, LGPS Central and Brunel Pensions Partnership in the UK.
Whilst the VFM was in the works, the FCA consulted the industry on the use of forward-looking metrics. In its response, the Pensions and Lifetime Savings Association – an industry collective – welcomed the idea but noted that finding consistency in projections will be easier said than done.
The PLSA recommended a compromise – let schemes select metrics for their strategy, then put guardrails around that choice.
Short-term returns vs long-term opportunities
In addition to the way it measured performance, Australia’s performance test sparked criticisms over the period of measurement. The Australian test, sceptics warned, prioritised short-term returns. In effect deterring long-term investment thinking – the kind that lends itself to climate solutions allocation.
“It remains the case that the short-term, benchmark-hugging nature of the test in its current form risks deterring funds from pursuing long-term sustainable investment”, Nayanisha Samarakoon, head of policy and advocacy at the Responsible Investment Association of Australasia told Net Zero Investor earlier this year.
Getting the period of performance comparison right, is then a central tenet of a test’s ability to accommodate climate investing. The FCA’s consultations in the UK included a question on duration of performance measurement.
The consultations were based on measuring performance over 1,3 and 5-year periods.
“There is a danger that these relatively short periods will mean different providers’ investments herd around the currently more accessible listed market”, the PLSA said in its response. The response goes on to outline that this approach risks disincentivising illiquid asset allocation for instance into private equity or infrastructure which have holding periods of 7 – 10 years.
To the Australians, the PLSA’s concern will feel familiar and particularly applicable to climate solutions investments.
Oakledge Advisors’ Messervy says the VFM’s choice of duration could certainty affect a DC scheme’s climate strategy.
“The question will be what form the ‘penalties’ or requirements related to addressing underperformance will ultimately be, and whether there's any allowance for assets (such as some climate solutions) that may take longer or may require regulatory or policy shifts before their full value is realized”, he notes.
Together we stand
Perhaps the greatest lesson from Canberra is that a test in need of reform is a test in need of consensus.
The Australians agreed that the test’s effect on climate investing needed redressal. After all, they succeeded in convincing Australian Treasurer Jim Chalmers to ‘have another look’ at the performance test. What they struggled to arrive at was common ground on a way forward.
To be fair, there are key differences between the two contexts. For instance, in Australia, employees can shift schemes, if the test results aren’t convincing. In the UK, the power rests with employers. Even though both tests were aimed at the same prudential concerns, their context differs. The UK’s is part of a broader policy package aimed at incentivising DC schemes to invest, among other things, in private markets at home. Neither operate in isolation.
Their performance test taught the Australians a lesson they'd want their UK counterparts to hear - beware the law of unintended consequences. A performance test, as well intentioned at it may be, carries material implications for climate solutions investing. Avoiding unintentional consequences then, calls for intentional testing.
Our DC Investment Survey 2026, in collaboration with Schroders, investigates the investment implications of VFM and other DC regulotory changes leading into 2026.
