L-R: David Bell (Conexus Institute), Jessie Pettigrew, Stephen Donaghy, Fahmi Hosain

The inclusion of choice products in the Australian government’s performance test for superannuation funds should not pose a significant challenge for diversified sustainable options, according to Stephen Donaghy, senior manager, investments, at UniSuper.

In a panel discussion about current challenges to sustainable investments, notably Financial Services Minister Stephen Jones signaling that sustainability options will soon be subject to the performance test, Donaghy said diversified products that cannot beat an industry benchmark would demand complex and interesting discussions” with members, and probably should not be offered.

UniSuper has three sustainable and environmental options, which have experienced strong take-up in the last five years, doubling from 6 per cent of funds under management to more than 12 per cent today at around $12 billion, Donaghy said. The fund moved from a closed fund to a public offer fund around two years ago,

Speaking at Conexus Financial’s Fiduciary Investors Symposium in Sydney’s Blue Mountains, Donaghy said most in the industry are comfortable with the objectives of the performance test, despite criticisms of the methodology that is applied. Specific, niche products that target particular views of the market are “not very well served by a benchmark,” he said, with implications for ESG products.

Should perform well against benchmark

However, UniSuper’s Sustainable Balanced and Sustainable High Growth investment options are both diversified portfolios, are actively managed, and should perform well against the performance test benchmark, Donaghy said.

“If you’re running a diversified product, and you don’t think that you can manage to do that in a way which is likely to beat the benchmark, then I think you’ve actually got some real challenges around whether you think that product actually deserves to exist in your menu,” he said.

Also on the panel was Fahmi Hosain, head of government relations and regulatory affairs at Future Super, a direct-to-consumer business that only offers choice products, with stringent exclusions around fossil fuel extraction companies. This exclusion extends to major service providers that enable those businesses to operate – such as Australia’s four major banks. The eight-year-old fund has more than 100,000 members and around $10 billion in funds under management.

Benchmarks are problematic for a fund that excludes “a big chunk” of the ASX300, Hosain said. Additionally, while the performance test looks at performance over a ten-year period, newer funds only need five years of performance history to be captured by the test, he said. Future Super is eight years old, and its biggest option is five years old.

“What that means is, if you have only five years of performance history, every quarter’s performance has an outsized impact relative to a ten-year-old fund,” Hosain said. “And what have we had in the last couple of years? The invasion of Ukraine.”

Significant tracking error

Exclusions of coal, oil and gas also add significant tracking error to the fund’s performance, Hosain said.

However, the fund has a “very, very strong conviction” that its returns will outperform over the long term “due to the transition Australia is going through,” he said. The fund’s membership is mostly young people who will not retire until after 2050 when Australia’s economy will look drastically different, he said.

Jessie Pettigrew, head of responsible investment at Equipsuper said research about member preferences around ESG found members were still concerned about performance.

“They either talk about performance relative to a benchmark, for obvious reasons, or relative to peer funds and to what their mates’ funds are returning,” Pettigrew said. “And that’s a bit of a headwind for, particularly, exclusions-led options and funds.”

The industry has increasingly moved towards measuring success by reductions in actual real-world emissions rather than measuring carbon emissions within a portfolio, she said. However metrics are complicated, particularly when sustainable development goals, biodiversity and other outcomes are factored in.

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