ASFI warns super performance test at odds with Future Made in Australia agenda

The Australian Sustainable Finance Institute (ASFI) believes there have been “unintended consequences” arising from the annual super performance test, such as encouraging short-term decision making and benchmark hugging and constraining investment flexibility.

Particularly, the test is “significantly” constraining the ability of super funds to adopt sustainable finance investment strategies at scale, it said.

In a submission to Treasury on the design options of the performance test, ASFI argued the test is “at odds with Australia’s national transition goals and inhibits appropriate management of systemic climate and other sustainability risks.”

“It may limit super funds’ ability to invest in accordance with member preferences, and potentially to invest in accordance with members’ best financial interests over the long term,” it said, noting this is “suboptimal” for members.

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“Increasingly, there may also be a tension between satisfying the current YFYS performance test and complying with the emerging sustainable finance policy framework which encourages super funds to develop and disclose climate transition plans, and government recognition of the importance of private capital to support Australia’s climate transition.”

Last month, the government’s 2024–35 budget officially unveiled its $22.7 billion investment that is the Future Made in Australia (FMIA) initiative, which sought to mobilise the support of institutional investors, including super funds, to secure Australia’s global position in the international move towards net zero.

However, in its current state, the super performance test is constraining sustainable investment at scale, including investment in renewable energy projects and other activities where capital is critically needed for the net-zero transition in Australia and in other markets, according to ASFI.

It observed the test limits funds from investing consistent with member preferences, even as Australians increasingly voice a desire for more climate and sustainability-related investments.

Moreover, the test discourages diversification and is “fundamentally at odds with managing climate and sustainability risks and pursuing climate-related opportunities as the economy transitions.”

“YFYS performance test benchmarks encourage funds to make similar investments to each other which exposes the sector to systemic risk. This includes carbon transition risk, particularly where benchmarks (such as the ASX 200 index) have relatively high carbon exposure,” ASFI said.

“Rather than enabling super funds to act as responsible custodians of Australians’ wealth, that take into account both the longer-term performance of their investments and the type of world into which members will retire, super investment is likely to lag behind the broader economy in its ability to transition.”

The industry body warned such benchmark hugging may not be in the best financial interests of members, particularly in the long term.

“In the short term, there are instances where ‘benchmark hugging’ may result in higher returns – for example, fossil energy stocks performed unusually well in 2022 due to factors such as the Ukraine war. However, the Reserve Bank of Australia has found that medium and long-term performance of ‘ethical’ funds is on par with other funds. Going forward, higher exposure to carbon transition and other risks may negatively impact performance,” it said.

This flies against the fiduciary duties of super trustees, ASFI pointed out, and will translate badly in members’ retirement savings.

In its submission, the industry body admitted there is “no easy solution” to these challenges and proposed that, over time and based on regular assessments of the consequences stemming from the test, the government should consider shifting to a qualitative approach.

ASFI said: “This would allow APRA to assess a more diverse range of factors that impact fund performance on a forward-looking basis such as: capabilities of the fund with regards to governance, teams, systems and processes; actions taken by the fund to improve capabilities where any concerns have been identified; performance of the fund beyond implementation performance.”

At present, it recommends inclusion of additional benchmark indices that allow for and reflect carbon transition and sustainable investment strategies.

Another option put forward could be a multi-metric framework, if it adequately incorporates sustainability considerations, ASFI said.

“This allows for a more multifaceted assessment of fund performance and reduces the ability of and incentive for funds to actively manage to meet any single metric rather than to achieve overall best financial interests,” ASFI said.

“If one of the multi-metric options is preferred, this should ensure metrics are chosen and structured to avoid unintended consequences that would reduce the ability of funds to invest in sustainable investment strategies or climate transition opportunities.”