Should different YFYS metrics apply for sustainable funds?

With responsible, sustainable, and ethical superannuation funds soon to be evaluated under the same performance test as their MySuper peers, there are concerns investment approaches like screening and impact investing could result in tracking errors that inadvertently put them on the back foot. 

Currently out for consultation, trustee-directed superannuation products could be subject to the Your Future, Your Super (YFYS) test by the Australian Prudential Regulation Authority (APRA) by 31 August 2023.

These were accumulation Choice products with strategic asset allocations to more than one asset class, such as socially responsible investing products, where the trustee or a related entity would have control over the design or implementation of the investment strategy of the product.

According to the Responsible Investment Association Australasia (RIAA), a closer look was needed at what underlay the performance test.

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“We know that many funds’ Choice products will meet or exceed the performance test benchmark. There may be others that do not comfortably meet the benchmark,” the association stated.

“The Government’s latest proposal of more detailed asset classes could better accommodate the diversity of investment approaches among choice products and improve the accuracy of benchmarking. But the proposals are unlikely to address the core concerns for some ethical Choice products.”  

Research by RIAA, with the Conexus Institute and FTSE Russell, modelled three responsible investment approaches against the performance test, assuming ‘sustainable’ tracking error of 1 per cent.

It “brought some hard data to the debate about whether the test is appropriate for the range of investment approaches that superannuation funds take”, RIAA said.

The socially responsible growth option applying RIAA’s ‘avoid significant harm’ requirement for certification produced a tracking error of 1.5 per cent, meaning SRI options could result in an unsustainable tracking error risk.

The carbon transition-aligned portfolio with a Paris-aligned benchmark and Australian equities’ low-carbon proxy produced a tracking error of 1.8 per cent, meaning Paris-aligned portfolios could have untenable tracking error risk.

Finally, using the universal ownership of equities plus unlisted ‘green’ assets approach, passive equities, and unlisted assets in sustainability and energy transition, which produced a tracking error of 0.2 per cent, the risks of expanding the test could be significant for some funds.

“There are significant challenges in applying regulator discretion when a numerical result against a blunt ‘benchmark’ is the cornerstone of this consumer protection,” the association said.

“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 superannuation funds in pursuing Australia’s national and international sustainability goals.”