Claudia Kwan, co-portfolio manager at Northstar Impact Funds, challenged Australia’s investment system to evolve if it is to unlock the institutional capital needed to tackle pressing social and environmental challenges.
“Your Future, Your Super just doesn’t allow everybody in the system who’s intentional and wanting to allocate to be able to allocate,” she said.
Indeed, the Australian Sustainable Finance Institute highlighted in June 2024 that there have been “unintended consequences” from the annual super performance test, particularly in regard to super funds adopting sustainable finance investment strategies at scale.
Further research from global index provider Scientific Beta suggested that funds are facing challenges when trying to adhere to environmental, social and governance considerations.
The Your Future, Your Super (YFYS) performance test limits super funds’ ability to divest from high-carbon Australian companies by enforcing tracking error constraints. Unlike Europe, Australia lacks a YFYS-compliant low-carbon benchmark, leaving funds with limited low-carbon investment options.
Also speaking at the RIAA conference, Aware Super’s chief investment officer, Damian Graham, noted that while the YFYS test isn’t a direct barrier to investing in the energy transition, it complicates how these investments are assessed and managed.
For example, he noted, infrastructure indices tend to overlook energy transition assets, meaning such investments are typically off-benchmark and carry added performance risk under the YFYS framework.
“If you look at the index for infrastructure, it doesn’t have a leaning towards energy transition assets, and any time you are making investments in that area, it’s an off-benchmark position,” Graham said at the conference.
“I think you doubly have to have a very strong conviction that that’s a good investment to make. You’re taking on more risk versus YFYS. But even before YFYS there were other benchmarks where you continually had to think about the active risk. So it’s just another flavour of that in my mind.”
Touching also on the limitations of the YFYS performance test on longer-term sustainability outcomes, the CEO of Rest Super, Vicki Doyle, stated: “I think the YFYS test was important for the time.”
Beyond sustainability limitations, she noted that the test – which benchmarks super funds against indices such as the S&P/ASX 300 and MSCI World ex-Australia to assess whether their returns align with their strategic asset allocation – is particularly challenging in today’s environment of uncertainty.
“I think that the indexes might be challenging in a world that is uncertain and I think we have to give due consideration to that,” Doyle said at the RIAA conference.
“I had the benefit of hearing from Wellington on geopolitical issues, etc, and they talked a lot about the volatility as companies really are exposed to these geopolitical issues … Some will boom and some will bust and that creates volatility.
“It also means that it might be quite a bit harder to create indexes that take into [account] these structural changes … I think we will have to think about that.”
Doyle also shared that 93 per cent of Rest Super members expect their fund to be invested ethically and responsibly.
Looser mandates needed
Drawing on her early career experience in Asia, Kwan reflected on China’s ability to reshape its economy and social landscape through coordinated investment.
“I started my career in Asia. I spent most of it at Morgan Stanley in the time where China pulled 500 million people out of poverty and now dominates 80 or 90 per cent of the supply chain of clean energy,” she told attendees at the conference.
“That was a front row seat at what I think is probably one of the best impact investors that we’ve seen, and probably ever will see, but they had the mandate,” Kwan added.
Kwan remarked that while capital remains abundant, the system limits its deployment into impact investing. As such, she called for systemic support to enable funds to deploy capital where it is most needed.
“The call to action is the system from all levels really has to support everybody in allowing them to contribute into their capacity that they need to, and giving them the time horizons that are necessary for that, so that everybody can be successful,” she said.
Additionally, Kwan argued that unlocking capital requires mandate flexibility – even if just a portion of portfolios is allocated to deliver social or environmental returns alongside financial ones.
“My view is that the key catalyst to unlocking this capital in the place we need to go is to allow for it,” she said.
“It doesn’t need to be 100 per cent but it might be a ‘sleeve’ whereby a certain amount of capital needs to have a social, environmental return alongside a financial return, or provide a different financial return hurdle, or a different time horizon.”
Speaking alongside Kwan, Kristina Hermanson of Nuveen Natural Capital said that while impact investment options (or “sleeves”) exist, they are still constrained by the YFYS framework.
“Having a little bit more leeway for patient capital and focus would certainly be helpful,” she said.
