How to choose an ethical super fund

More super fund members are choosing funds that follow ESG investment principles. But what is ESG investing, does it outperform and how do you choose an ESG super fund?

• ESG investment principles are a framework for super funds to invest in such a way they promote environmental, sustainability and governance economic and investment outcomes.
• Super funds that practise ESG principles are very open about how they operate, make their investment decisions and what they invest in.
• Super funds that invest this way earn investment returns as high as the overall market. Most of Australia's top-performing superannuation funds are those most committed to following ESG investment principles.

Millions of super fund members throughout Australia have become aware of the influence their fund's investments can have on fighting climate change and promoting sustainability and positive social impact.

For example, by using the fund's investments to help combat pollution, boost the generation of renewable energy, reduce deforestation, discourage the consumption of tobacco products, reduce inequality and discrimination, limit the sale of armaments, and fight modern slavery.

When super fund members choose funds that do this, they are choosing to invest their superannuation according to a set of philosophies and principles that may be known variously as ethical, responsible, sustainable, socially aware or impact investing. An umbrella term that combines all these elements is ESG investing, meaning to invest in such a way that promotes positive environmental, sustainability and governance (ESG) outcomes. At its simplest, ESG investing seeks to avoid investments that do harm, instead favoring investments that do good.

There are two main ways in which super fund members can choose a super fund that follows ESG investment principles:
1. Choose an ESG super fund investment option that is explicitly labelled 'ethical', 'sustainable', 'responsible' or 'socially aware'.
2. Choose a superannuation fund that, while it might not offer a specific ESG investment option, as a whole follows ESG investment principles.

How do ESG investments perform?

Choosing ESG superannuation funds might make members feel better about their investments, but how does it impact their account balances?

To investigate this, Rainmaker Information regularly analyses the returns of thousands of super fund investment options and has found there is little difference between the average returns of those offered through super funds that follow ESG investment principles compared to the overall corresponding sector averages.

As shown in the chart, there is almost no difference, and where there is a difference in the sector averages it's ever so slight. These results mean that not only do ESG super fund investment options perform just as well as regular investments, they can sometimes do better. Reinforcing this, most of Australia's top-performing funds are also those most committed to ESG investment principles.

But you should not invest into a super fund just because it is an ESG super fund. You should invest into it because it's proven itself to be a good superannuation fund, meaning that if it invests according to ESG principles, you can be confident it will do so to a high standard. Rainmaker does not believe you should invest into a super fund simply because it claims to be ESG, it should first have a proven track record of investment success.

Markers of a good ESG super fund

Because investing into super funds that follow ESG investment principles has become very popular, there is a risk that some funds might try to talk up their ESG credentials. To help you spot if your superannuation fund really is committed to ESG investment principles, Rainmaker Information is developing an enhanced framework that describes what to look for in an ESG super fund. This framework includes disclosure and explanation of the following elements:

• Proxy voting, that is, how super funds vote at the shareholder meetings for the companies into which they invest.
• Portfolio holdings, that is, funds should fully disclose all the underlying investments they hold.
• Stewardship commitments and affiliations with ESG protocol and advocacy groups.
• Investment strategy, investment screens and thresholds that trigger them.
• Modern Slavery Statements, that is, how they manage and mitigate risks they might be investing into companies that exploit workers, particularly those in emerging economies.
• Their greenhouse gas emissions (GHG) and consequent abatement disclosures.
• Net-zero commitments and the strategy through which the fund intends it will achieve its aims; and
• How the fund manages and monitors its ESG commitments, including associated Key Performance Measures.

These markers of a good ESG superannuation best practice follow on from the ESG Leadership fund ratings Rainmaker introduced in 2022.

But never forget that although fighting climate change and promoting ESG practices are important, the number one job of your super fund is to maximise your investment returns.

This means that following ESG principles should never come at the price of fund members being expected to suffer lower returns, or conversely, expecting them to pay higher fees.

Portfolio holdings disclosure

Portfolio holding disclosure is when your super fund openly tells you all the investments it holds in each of its investment options. This doesn't just mean it tells you it holds shares, properties and bonds, but which company shares, which properties and which bonds.

While it is now compulsory for superannuation funds to do this, not all funds publish this information clearly.

This portfolio holdings information should be easy to find on your super fund's website, it should be clear and reasonably easy to decipher noting that this information can by its nature be complex and highly detailed. This information is important if you want to specifically check what your superannuation fund is and isn't investing into.

For example, if you don't want to be a member of superannuation fund that invests into fossil fuels or gambling companies, there's no better way to check this than to look at your fund's portfolio holdings disclosure lists.

Net zero

Australia's climate action commitments centre on the Paris Agreement that came into force in November 2016. It is a legally binding international treaty on climate change action signed by 196 nations. The goal of the Paris Agreement is to limit global warming to below two degrees compared to pre-industrial levels, though the agreement states that 1.5 degrees is the preferred aspirational target.

The Paris Agreement is based on international commitments that nations made as part of the United Nations Framework Convention on Climate Change (UNFCCC) and the Kyoto Protocol, which was itself based on the 1992 UN Climate Change Convention.

The core way that nations are expected to help reduce climate change is by reducing their GHG emissions. The major plank of this is the push for as many nations as possible to adopt net zero by 2050, which means that by this time nations will be expected to be producing zero overall GHG emissions, that is, net zero after taking account of any abatement, crediting or offsetting arrangements.

Other measures that make up the Paris Agreement are that developed nations will provide financial assistance to developing nations to reduce their own GHG emissions, that all nations will try to develop technology solutions to support climate action and developed nations will support developing nations to build their capacity to reduce GHG emissions.

It is up to each nation to decide how will it achieve its own climate action target. However, under the Paris Agreement, they must publicly commit to emissions-reduction targets known as Nationally Determined Contributions (NDCs). These plans must be lodged with the UNFCCC which administers the global agreement. Before the November 2021 COP26 Climate Change Conference in Glasgow, only about half the nations that signed the Paris Agreement had submitted NDCs. But more did this at the conference.

This heavy focus on the Paris Agreement and net zero is why so many superannuation funds are incorporating their own net-zero commitments into their investment strategies. They implement these by either investing in companies that themselves have made net-zero commitments, they divest away from companies that don't support net zero, or they have made a commitment to try to encourage companies in which they are investing to commit to net zero.

The Safeguard Mechanism

The Safeguard Mechanism is a set of laws and policy framework passed by the Australian Parliament in 2023 to promote sustainable development and address climate change concerns.

The way these work is that certain facilities and companies in Australia that emit significant amounts of GHGs are required to monitor, manage and reduce their emissions.

The mechanism primarily targets facilities and companies in sectors such as electricity generation, mining, manufacturing, and oil and gas production. There are 219 facilities and companies that fall under the Safeguard Mechanism and they have been assigned baseline emission levels, which represent their historical average emissions.

They are required by law to ensure that their emissions do not exceed these baselines - either by mitigating (reducing) their GHG emissions or by purchasing abatements such as Australian Carbon Credit Units (ACCU). But the kicker is that under the Safeguard Mechanism laws they are required to progressively reduce their GHG emissions by 43% by 2030 and by 2050 to be net zero.

The Australian government has said it will also periodically review the Safeguard Mechanism to ensure it remains effective in achieving emission reduction targets. The policy aims to contribute to Australia's international commitments under the Paris Agreement and align with the country's broader efforts to transition to a low-carbon economy.

While the Safeguard Mechanism doesn't directly apply to super funds, they will be indirectly implicated if they invest into companies covered by it because they will be expected to explain how such investments are consistent with their own sustainability and net-zero targets.

Regulators such as ASIC, APRA and the ACCC will also be watching these super funds very closely to make sure that any claims these super funds have made regarding their sustainability strategies are true.

Super funds that are suspected by regulators of making false or exaggerated claims, or claims they cannot prove, could face allegations of greenwashing.

On top of this, the Commonwealth government has already told super funds they will also soon be expected to publish details of their own GHG emissions produced in their direct business operations, through their electricity suppliers and in down-stream activities such as by the companies into which they invest.

Sustainable Development Goals

The Sustainable Development Goals (SDG) are a set of social and cultural goals and targets set up through the United Nations. The list of globally agreed SDGs and their implementation framework was formally adopted in 2015 by a vote of the General Assembly.

The 17 core SDGs are detailed below. The SDGs were first officially recognised at the 1992 Rio de Janeiro, Brazil, Earth Summit, where more than 178 countries adopted Agenda 21, which was a comprehensive plan of action to implement the SDGs.

The Earth Summit was followed by the Millennium Declaration signed in 2000 at the UN headquarters in New York. This declaration included the establishment of eight Millennium Development Goals (MDGs) that aimed to reduce extreme poverty by 2015.

Many ESG superannuation funds are now actively incorporating the SDGs into their investment strategies. Some are even using them to design investment options.

The Modern Slavery Act

As part of Australia's commitment to support the United Nations Guiding Principles on Business and Human Rights, the Modern Slavery Act was passed by the Australian Parliament in 2019. It requires all large businesses operating in Australia, including superannuation funds, with annual revenue of $100 million or more, to lodge a Modern Slavery Statement with the Australian Border Force.

Practices that constitute modern slavery can include human trafficking, slavery, servitude, forced labour, debt bondage, forced marriage, and the worst forms of child labour. About 80 super funds have so far published a Modern Slavery Statement, and if your super fund is one of them, reviewing it provides a great insight into its philosophy and investment strategy.