Super Funds need to thread the needle between ESG concerns and member returns

Since the passage of the ‘Your Future Your Super’ reforms last year the cardinal rule of the superannuation industry has been thus: You must act in the best financial interest of your members.

In and of itself this maxim presents no problems. Super funds, as the trustees of $3.3 trillion of retirement savings, should be trying to maximise financial returns for their members. It is analogous to the cardinal rule of the corporate world, which until recently, was to maximise shareholder returns.

But the reforms also now mean that funds must be able to argue that their investment and spending choices are in their members’ best financial interests if their strategy is questioned by regulators.

And given the dynamics of modern finance, this is a source of tension. 

This is because shareholder capitalism has fallen out of favour with corporates, investors, and regulators. Taking its place is stakeholder capitalism and the idea that business activity should be made subject to its impact on environmental, social, and corporate governance (ESG) factors.

Australia’s super funds are embracing ESG investing as enthusiastically as their corporate equivalents. The Responsible Investment Association Australasia estimates 42 per cent of super assets are covered by asset owners practicing responsible investing, up from 28% in 2019. But this raises the question: can super funds show this activity is “in the best financial interest of their members”?

To take an obvious example, look at fossil fuels. Super funds are coming under increasing pressure to divest entirely from emissions-intensive oil and gas producers, and many have already begun to decrease exposure.

But at the same time, the ASX 200 Energy Index has risen more than 40 per cent in 2022, while the broader market is in the red. No super fund manager could deny that, in the short term at least, it might be in their members’ best financial interest to retain exposure to these assets.

Another source of tension is the growing trend of direct ownership of assets by super funds. From a members’ financial interest perspective, this makes sense. But many of these assets are significant pieces of emissions-intensive or emissions-adjacent infrastructure like airports, roads, and ports.

How can funds balance the need to produce returns on these significant investments while addressing ESG concerns like emissions intensity, physical climate risks, inclusivity, or accessibility?

These questions are becoming increasingly important as support grows for leveraging the capital of super funds to help finance “nation-building” projects like Victoria’s plan to revive the State Electricity Commission as a green energy wholesaler, or the Federal Government’s plan to build one million new homes by the decade’s end.

These investment opportunities are certainly ESG-aligned. But as the Australian Financial Review's Chanticleer column noted last month, investments that focus on social purpose could mean lower returns.  Will super funds accept that? Given their duty to members, can they accept that?

The answer to these apparent conflicts emerges when you take a broader view of what financial interest means, rather than relying on benchmarks like the new Your Future Your Super performance test that doesn’t incorporate ESG considerations.

Firstly, assessing investment opportunities against robust ESG criteria helps future proof investments against changing customer expectations, new regulatory impositions, or reputation damage. Being aware of an investment target’s exposure to climate-related factors or risk of modern slavery in its supply chain enhances the investment due diligence process.

Secondly, ESG investing is more strategic than just redirecting capital from, for example, emissions intensive industries to green energy generation. The transition to net zero will encompass the entire economy and many sectors will need the help of the super sector’s capital to get there. Investing in industries to make a change can see the goals of better ESG integration and producing returns for members align.

Thirdly, backing “nation-building” projects can provide long-term financial returns to members that are not so easily quantified. The opportunity to own a large portion of new infrastructure is one, and the flow-on effect to the economy of cheaper, greener energy or more affordable housing is another.

Lastly, and importantly, evidence is emerging that ESG-informed investments hold their own against traditional investment choices. In a survey conducted by Deloitte Global and Forbes Insights on the impact of sustainability efforts of 350 executives from the Americas, Asia and Europe, more than half of respondents indicated a positive impact on revenue growth and overall company profitability – benefits that will flow directly through to members.

That isn’t to say that investing for profitable returns and investing for change are free from conflict, particularly when taking a short-term lens.  But funds that are clear eyed about their ESG strategies and understand the relationship between ESG considerations and financial returns should be able to effectively manage this conflict and demonstrate they are indeed acting in their members’ best financial interest.