Already under pressure to reduce fees and boost returns, Australia’s superannuation funds are facing headwinds from a new annual performance test that targets underperformers. Industry players argue the test could put funds’ environmental, social and governance ESG efforts in jeopardy.
The performance test – part of super reforms announced by the Australian government in the 2020-2021 budget – will be introduced in July and superannuation funds will have to meet minimum benchmarks every year.
Funds that fail the test for the first time will be required to inform members about their underperformance and be named on a comparison tool. If they fail a second time, they will be banned from accepting new members.
The test – part of the ‘Your Future, Your Super’ Bill released in October – applies to all default super and trustee-directed products.
On Thursday (April 28), the government released an explanatory statement with updates addressing several concerns from superannuation funds surrounding benchmarks for unlisted property and infrastructure, and the inclusion of fees in measuring performance.
However, concerns over the impact the performance test will have on ESG investing remain.
"It's a real conundrum for the clients. Super funds in Australia have been quite progressive on ESG. And a number of the funds have come out saying that the fund's investments will be net carbon zero by 2050. So they're taking a pretty progressive stance on that," David Carruthers, principal consultant at investment consultancy Frontier Advisers, told AsianInvestor.
"The conundrum that they face is that the government's bringing in this new test, and APRA, has come out with a new guidance note on taking into account ESG in your portfolio," he said, referring to APRA – the Australian Prudential Regulation Authority - releasing on April 22 a draft guidance for financial institutions on managing climate risks.
"So you've got one regulator telling you to do one thing, and then another part of government telling you – well, not telling you not to do ESG, but introducing a big risk," he said.
Super funds have already been under pressure to reduce fees and boost returns, which has resulted in large changes in the industry such as a shift to passive strategies and the creation of mega funds through mergers.
ESG portfolios have the potential to perform as well as, or better than, non-ESG portfolios. For instance, the MSCI World ESG Leaders index performance over the past decade has been comparable to the the MSCI World index. Ten-year gross returns for the former stood at 10.54% as of March 2021, compared with 10.5% for the latter.
In terms of longer-term performance, Morningstar research also found that sustainable funds perform better than non-ESG funds over one, three, five and 10 years.
However, not all ESG funds are created equal. At a webinar last Tuesday (April 20), David Macri, chief investment officer of AustralianEthical, said that their funds generally outperform the market but that it is “difficult to determine which risk factor is actually driving the performance” since ESG is not an asset class.
“It's hard to actually pinpoint where that performance is coming from. Rather than [pointing to ESG] as a blanket reason for it, we look at our own performance and do performance attribution,” he said, in response to a question from AsianInvestor.
“You want to see the performance drivers coming from multiple risk factors, multiple kinds of drivers around that, so that you've got that diversification benefit for the overall portfolio. It really comes down to how you construct a portfolio," Macri said.
In addition, a new white paper by Scientific Beta, a smart beta index provider, suggests that ESG funds that outperform may do so in large part because of an effective emphasis on quality companies, rather than measurements associated with environmental, social or governance strengths.
FOCUS ON PAST RETURNS
The upshot is that not all ESG-integrated funds are likely to outperform the market, and even as funds continue to build up their expertise, pressure to keep from underperforming may hinder efforts to expand ESG integration.
“There are two types of funds, relative to this test. A number of funds are sitting there, they're performing above the test. And those funds, have the luxury to say, okay, we know that ESG is introducing some risk into the portfolio relative to this test. But we're ahead of the benchmark, and we're okay,” Carruthers from Frontier Advisers, told AsianInvestor.
“And then some other funds for whatever reason might be behind the test at the minute. And they say, 'Yep, we believe in ESG. We think it's the right thing to do. But can we continue to take on this risk when it might lead us to fairly catastrophic outcome by failing that test?'”
He said funds were being forced to choose between the right long-term strategy or choosing to minimise their risks in terms of getting through the test.
“[There] is too much focus on the short-term,” he added.
While some argue the government would not fault a fund for investing in ESG, it could make investment decisions more complicated.
“I don't think any regulator or any government would criticise a fund for not investing in a company that uses child labour or labour that discriminated against part of the workforce,” Russell Mason, partner at the superannuation department of Deloitte, told AsianInvestor.
However, he said that while it put another layer of difficulty on investment decision-making, it also improved fund transparency.
“The most important thing is that members of superannuation funds understand exactly what they are investing in (and) that they're not misled; that they're given the correct amount of information to make a considered investment decision, which I think is appropriate,” Mason said.