There are concerns that changes to the Your Future, Your Super performance test will fail to improve the situation for ethical or religious funds.
When the performance test was first introduced in July 2021, funds that focused on ethical, sustainability, and ESG were concerned they would be penalised by the performance test.
This was because the funds were designed to meet an ethical criteria for members rather than a financial performance one that meant they would not necessarily align with the YFYS benchmark test and put themselves at risk of failing.
In the event a fund failed the test, this could force them to close to new members and be merged with another larger fund.
Christian Super had merged with Australian Ethical last November after failing the test and Australian Catholic Superannuation merged with UniSuper in December 2022 for the same reason. (Another religious-focused super fund Catholic Super had already merged with Equipsuper in 2019 prior to the performance test being implemented).
This then prompted knock-on effects where this fund they have merged into may not necessarily hold itself to the same ESG standards.
However, updated proposals for the test put forward by Minister for Financial Services, Stephen Jones, in April 2023 proposed no changes or specific feedback to the issue and the problem did not feature in the explanatory documents.
This was despite it being raised in the summary of consultation feedback from respondents provided to the Treasury during the consultation period.
“Values-based products, such as environmental, social and governance (ESG) products, were a key example raised where the test creates a risk that these products will fail and close. This is because the investment strategy (such as negative screening) deviates from the benchmark indices, increasing tracking error and constraining the trustees’ ability to meet its members’ objectives,” it said.
“Proposals to address this concern generally involved using alternative benchmarks for ESG products or a supplementary test using self-identified benchmarks.
“However, others noted that these changes are unlikely to be feasible in the short term because: there is no consensus on the definition of ESG products; limited options for standard market ESG benchmarks; and it is not possible to implement a supplementary test in time for the next test. Others proposed that a more holistic design change to the test could be developed with consideration for values-based products.”
The matter of ESG funds was raised a subsequent time in the paper regarding ‘financial interests’ when it stated: “It was suggested that the narrow focus on ‘financial interests’ discourages trustees from deploying sustainable investment strategies. Some stakeholders raised concerns that short-term financial interests and long-term environmental and social outcomes present conflicting fiduciary duties for trustees.”
The Responsible Investment Association of Australasia (RIAA) included more than 13 super funds in its membership, including eight that were recognised as being Responsible Investment Leaders.
In its submission to the Treasury’s consultation in October 2022, the organisation said the test was having a ‘major impact on market dynamics and constraining investors’ decision-making, including in ways that work against the long-term interests of members and the government’s climate and other policies”.
It acknowledged that if the test was extended to Choice products, this would encompass a greater diversity of responsible investment offering that includes single asset classes and smaller ethical funds. Unlike default funds, these were funds where a member had actively and deliberately sought to have their money managed in that way.
“By not recognising the deliberate choice of consumers to follow a particular investment strategy, in many cases informed by their specific ethics or based on faith, the performance test may fail products that are in fact delivering on member’s investment choices or consistent with their specific beliefs,” it said.
Jones stated earlier this year in an interview with Industry Super Australia that the test would likely to be extended to Choice funds from August as all registrable superannuation entities (RSEs) had a “minimum obligation” to pass the test.
“If you are part of the RSE, if you are part of this universal system that I’ve talked about then there are some minimum obligations that should apply. My view is that the onus should be those that aren’t currently to be performance tested to justify why not. We should hold people to account for the performance of their part of the system,” Jones said in April.
The concerns about Choice funds also weighed on the Financial Services Council (FSC) that highlighted the performance test might limit more heavily weighted ESG funds that held socially responsible or impact-based investments. These type of funds did not currently exist for MySuper members but were seen in the Choice products.
“Members often seek out specifically designed ESG products to incorporate broader, social, environmental and/or ethical objectives other than or alongside pure investment performance. ESG products are increasingly prevalent in the Choice sector and vary widely in their composition and investment methodology,” the organisation said in its submission to Treasury.
“Given this diversity, the existing benchmark may be misaligned with intended outcomes of these products and are not a reliable source against which the member experience of the ESG options can be easily measured (at least over the shorter term) given the non-financial objectives of many of these options.
“As such, it may not be possible to adopt a similar performance testing approach for ESG products to that currently in place for MySuper, as utilising the existing benchmarks would not provide an accurate measure of performance.”
Reacting to the results from the consultation, Susan Quinn, RIAA head of policy and advocacy, said: “Some have said that there should be carve-out for SRI products, that different metrics should underlie the test or that APRA should have discretion to apply a test with qualitative features and more metrics. There are significant challenges in applying regulator discretion when a numerical result against a ‘blunt’ benchmark is the cornerstone of this consumer protection.
“RIAA would welcome a close re-examination of what underlies the performance test and whether it reflects the direction of responsible investment approaches now and into the future. This is especially important given the government’s commitment to involving super funds in pursuing Australia’s national and international sustainability goals.”
Super Review reached out to the FSC post Jones’ announcement and it confirmed its views remained the same as in its original submission.