How to choose an ethical super fund

how to choose a sustainable superannuation 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?

Millions of super fund members throughout Australia  have become aware of the influence their fund's investments can have fighting climate change, minimising pollution, boosting the generation of renewable energy, reducing deforestation, discouraging the consumption of tobacco products, reducing inequality and discrimination and the sale of armaments, and fighting modern slavery.

When super fund members do this, they are choosing to invest 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 it favours investments that do good.

There are two main ways in which super fund members can choose an ESG super fund:

  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, but how does it impact their account balances? To investigate this, Rainmaker Information analysed the investment returns of diversified balanced and growth super fund investment options and equities super fund investment options, over one, and three and five years, contrasting how ESG investment options performed compared to the overall market.

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.

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. Simply claiming to be ESG is no guarantee of quality.

Overall market vs ESG performance in 2022

Overall market vs ESG performance, 2022

ESG super funds are active investors not activists

When a super fund commits to follow ESG principles, and especially when it becomes a signatory to one of the various global ESG protocols, it is agreeing to become an active investor. This means it is agreeing to run itself and its investment strategy according to ESG principles, and seeks to positively influence the companies in which it invests by participating in shareholder meetings and taking active positions on company and public policy.

To invest this way often requires super funds to make considered judgments about what they should invest into, over what timeframe and whether they should engage with that company, and how - because it will be important for them to be able to measure and demonstrate that impact.

To divest or not ... that is not the question.

Divestment is when a super fund sells down its investment in a particular company or industry to reduce its carbon impact or its negative social impact. For example, it may divest from a coal mining or armaments company. However, if an ESG super fund wishes to influence the corporate behaviour of that company, it needs to be a shareholder, otherwise why would the company listen to it?

This is why some ESG funds stay invested in companies that at first glance appear to not match their ESG values, even though they may be heavily criticised for doing so. Conversely, some ESG super funds have been accused of grandstanding when they announce a divestment because, while they may have reduced their carbon impact, they haven't actually reduced the economy's overall carbon impact. So it's a balancing act. There is no right, best, wrong or worst strategy. As a result, ESG super funds need to consider their own circumstances when making these decisions. But regardless of their decision, they must be prepared to explain it to their fund members.

Greenwashing - beware the pretenders

ESG investing has become very popular and there's 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 has developed a framework that describes what to look for in an ESG super fund.

In summary, all ESG superannuation funds should be able to demonstrate their commitments to high standards of governance and investment transparency.

They should publish information and reports on their ESG activities and the impacts they are having, they should describe clearly their investment processes and, above all, they should have a strong investment track record.

Portfolio holdings disclosure

One of the most important ways to judge the credentials of a superannuation fund that claims to follow ESG investment principles is that it openly tells its fund members which investments it holds.

This doesn't just mean it tells you it holds shares, properties and bonds, but which company shares, what properties and which bonds? Super funds that disclose this information are said to practise what is known as portfolio holdings disclosure.

It's now compulsory for superannuation funds to practise portfolio holdings disclosure, and if they do it clearly it's one of best markers of a good ESG fund. It also helps you check what your superannuation fund isn't investing into.

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

Rainmaker ESG Leader ratings

Rainmaker in 2022 introduced its Rainmaker ESG Leader fund ratings. To qualify to receive this specialist rating, Australia's 200 super funds were assessed against the 18 ESG criteria described below. Only 30 funds (15%) of funds qualified to receive this new Rainmaker rating.

Rainmaker Information ESG Leader Rating

Rainmaker's ESG Leader rating assessment matrix

  Dimension Description Evidence points to look for. The fund:
A Governance The fund publicly declares its commitment to ESG principles.
  1. Fund declares itself committed to ESG principles.
  2. Fund publishes a statement of values
  3. Fund publishes information about its ESG credentials
  4. Fund has a diverse leadership team
  5. Fund is an ESG protocols signatory
  6. Fund actively engages with stakeholders
B Investment transparency The fund discloses what it invests in and how it engages with companies into which it invests.
  1. Fund complies with Portfolio Holdings Disclosure laws
  2. Fund publishes proxy voting reports
C Publishes ESG reports The fund reviews and discloses its environmental, climate change and social impacts.
  1. Fund publishes environmental impact reports
  2. Fund publishes carbon disclosure/impact reports
  3. Fund publishes social impact reports
  4. Fund publishes a Modern Slavery Act statement
D Investment processes The fund discloses the investment practices through which it implements ESG.
  1. Fund articulates its investment process
  2. Fund publishes details of its investment screens
  3. Fund publishes details of screen thresholds
E Performance The fund's default option achieves at least above average investment performance.
  1. Fund achieves competitive investment returns
  2. Fund demonstrates investment risk management
  3. Fund may offer ESG investment options

How Australia's international treaties impact your super fund's ESG strategy

Australia's international ESG commitments can be split into two main groups: climate action commitments and social and governance commitments. Climate action commitments include following the Kyoto Protocol, the Doha Amendment, and the more recent Paris Agreement that involves the move to net-zero.

Social and governance commitments include following Australia's commitment to the United Nations Sustainable Development Goals (SDG) and Australia's own Modern Slavery Act.

Superannuation funds and investment managers that claim to practise ESG have integrated many of the principles contained in these treaties, agreements and protocols into their investment philosophies.

The Paris Agreement and net-zero

Australia's climate action commitments centre on the Paris Agreement, which 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 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 greenhouse gas (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 GHG emissions, or rather 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.

United Nations Principles for Responsible Investment

Superannuation funds and investment managers around the world committed to ESG and responsible investing worked with the United Nations to in 2008 launch an investment framework based on the principles contained in these treaties, agreements and protocols. This framework is known as the Principles for Responsible Investment. Two-thirds of Australia's superannuation system is overseen by super funds that follow this framework.

Sustainable Development Goals

The Sustainable Development Goals (SDG) are a set of social and cultural goals and targets set up by 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.

The 17 sustainable development goals
  1. No poverty
  2. Zero hunger
  3. Good health and wellbeing
  4. Quality education
  5. Gender equality
  6. Clean water and sanitation
  7. Affordable and clean energy
  8. Decent work and economic growth
  9. Industry, innovation and infrastructure
  10. Reduced inequalities
  11. Sustainable cities and communities
  12. Responsible consumption
  13. Climate action
  14. Life below water
  15. Life on land
  16. Peace, justice and strong institutions
  17. Partnerships for the goals

 The history of superannuation in Australia
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