In this guide
The increasing frequency and severity of extreme weather events locally and globally has made climate change all too real for many Australians.
So it’s no wonder a growing number of self-managed superannuation fund (SMSF) trustees are thinking about the impact their investments may have on the environment and society on the one hand, and the impact of climate change on their investments on the other.
According to the ASX Australian Investor Study 2023, 21% of SMSF investors bought or sold environmental, social and governance (ESG) investments in the previous year based on environmental issues.
Yet ethical/ESG factors were way down the list of top considerations for SMSFs when making investment decisions. Potential returns and risks, personal circumstances, diversification, professional advice received and fees were all more highly rated, although these issues and ethical/ESG investing are not mutually exclusive.
As there are various approaches you can take to investing with ESG in mind, it can be useful to develop a framework that offers some consistency about the approach you take.
What’s in a name?
The terms ESG, ethical, responsible and sustainable investing are often used interchangeably. While there is some crossover as well as differences between them, the important thing is to look at the underlying investment approach taken by a fund, company or investment product and whether it is true to label.
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The RIAA outlines seven approaches:
- ESG integration – Explicitly includes ESG risks and opportunities into financial analysis and investment decisions based on a systemic process and appropriate research.
- Exclusionary/negative screening – Excludes certain sectors, companies, countries or issuers based on harmful activities or misaligned values. Typical exclusions are fossil fuels, tobacco and nuclear weapons.
- Positive/best-in-class screening – Targets companies or industries assessed to have better ESG performance relative to benchmarks or peers.
- Norms-based screening – Excludes companies and issuers that do not meet minimum standards of business practice based on international norms and conventions such as the Paris agreement and UN Principles of Responsible Investment.
- Corporate engagement and shareholder action – Executing shareholder rights to signal desired corporate behaviours, including proxy voting guided by ESG guidelines.
- Sustainability-themed investing – Targets themes such as sustainable agriculture, water, green property and renewables.
- Impact investing – Investing to achieve positive social and environmental impacts, with measuring and reporting to demonstrate investor intention and underlying asset contribution.
Once you understand the approach being taken you make more informed investment selections and monitor outcomes.
5 steps to applying a framework to your SMSF
Here are some steps to follow if you wish to apply an ESG (or responsible or ethical) overlay to your investment decisions.
1. Identify your ethical and responsible investing values
For instance, you may wish to avoid assets exposed to gambling or animal cruelty. Or you may want to avoid putting money into businesses or assets whose activities harm the environment.
Once you have identified your priorities, you can apply that lens to new and existing assets in the fund to determine whether they are aligned to your values. But be aware these are complex issues and the right approach to investing is not always cut and dry.
For example, a company or fund that invests in renewable energy may have poor corporate governance or rely on slave labour in developing nations.
SMSFs with more than one member will need to work through any conflicting priorities and devise an investment strategy that satisfies all members.
2. Research existing and potential investments that align with your values
While the shift to sustainable or ethical investing is partly driven by changes to financial reporting and disclosure standards (see section Emerging financial risks and opportunities below), it is also being fuelled by investor demand.
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Find out moreTotal managed funds in Australia reached $3.6 trillion in 2022, with most managers declaring they practise responsible investment. However, the RIAA estimates only 36% of those managers demonstrate a strong and comprehensive approach to responsible investing.
The challenge for investors is to find out which investments and investment managers are true to their word and align with their personal values.
- The RIAA provides fact sheets, guides and research as well as lists of asset managers with a commitment to responsible investing.
- Lonsec has developed a sustainability score for investments it rates using the United Nation’s Sustainable Development Goal framework “to address risks and opportunities not captured in traditional ESG assessments”.
If you are considering direct investment in shares, you will need to read the annual report of companies you are interested in and search for any adverse news reports that might indicate a red flag.
If it’s a managed fund or exchange-traded fund (ETF), check out the fund’s website and PDS (product disclosure statement) for details of the underlying investments, investment approach and certification (if any) from bodies such as the RIAA.
Another consideration is whether the investment manager is a signatory to the UN’s Principles of Responsible Investment. Investors that sign up to these principles agree to consider sustainability when making investment decisions.
With companies and fund managers under increased pressure from regulators and investors to display their ‘green’ credentials, there’s a growing risk and awareness of ‘greenwashing’.
3. Conduct due diligence on the fund or company’s assets
In the interests of accuracy and transparency where ESG claims are concerned, over the past two years ASIC has turned its attention to greenwashing in the financial sector.
As of May 2024, ASIC had issued 17 infringement notices totalling more than $230,000. It also won its first greenwashing civil penalty action, against Vanguard Investments, and had two other proceedings underway in the Federal Court against Mercer Super and Active Super.
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The spotlight on greenwashing by the regulator, industry participants and observers has also raised awareness among investors. According to the RIAA report From Values to Riches 2024: Charting consumer demand for responsible investing, consumer concerns about greenwashing grew from 72% to 78% in the two years to 2024.
The upshot is that investors may need to do their own due diligence before accepting so-called sustainable or ethical investments at face value, using the research tips listed earlier. However, the nature of global supply chains and company structures can further complicate the process.
You may need to explore other companies in which the asset has an interest, businesses that provide them with services and to which businesses they may be related.
For instance, electric vehicles rely on lithium batteries to run. The lithium is mined using chemicals, which can contaminate the soil around the mine. Conversely, electric vehicles help reduce reliance on fossil fuels. Weigh up considerations like this before deciding how to invest.
4. Devise an appropriate investment strategy
When choosing your investments, factor in the asset’s financial performance, fees, liquidity and benchmark asset allocation. Balance these variables with the SMSF members’ risk profiles, goals, objectives, retirement expectations and personal circumstances.
5. Make sure your adviser is on the same page
SMSF trustees who want to invest sustainably and ethically, and who consult a financial adviser about investment decisions, also need to feel confident that their adviser is on the same page.
All financial advisers are required to comply with the Financial Adviser Standards and Ethics Authority (FASEA) Code of Ethics Standard.
This requires advisers to act in the best interests of their clients. Product recommendations must be appropriate to meet the client’s objectives and consider their broader, long-term interests. This includes any social or ethical preferences they might have.
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Find out moreIf you feel your preferences are being ignored or your adviser lacks knowledge about ESG and sustainable investing, it may be time to switch advisers.
Emerging financial risks and opportunities
Even if sustainable or ethical investing is not a top priority for you, the sustainability of investment returns will be.
An increasingly important issue is how much physical damage could be caused to an asset’s property or business by storms, floods and fires that occur as a result of climate change. Rising insurance premiums are an early warning sign of the potential costs.
The degradation of land and water resources also pose a risk to business activities and communities.
Regulatory risk is also something for trustees to consider.
If Australia fails to reach its carbon reduction targets, for example, we could potentially be locked out of European markets for some of our exports.
There are positive steps afoot though that will bring Australian into line with best international practice.
In April 2024, the Australian government introduced legislation into parliament mandating climate-related financial disclosures through amendments to the Corporations Act. Detailed sustainability and assurance standards are to be made and maintained by the Australian Accounting Standards Board and the Australian Auditing and Assurance Standards Board.
Under the proposed legislation, to be phased in between 2025 and 2030, large corporations, asset managers and super funds will be required to report climate-related risks and opportunities.
ASIC, which will be responsible for administering and enforcing the new reporting regime, says many larger entities have been preparing for this for some time.
In 2023, nearly 75% of ASX200 companies were committed to or already voluntarily reporting climate-related information against the taskforce on climate-related financial disclosure (TSFD) framework. This was up from 66% in 2022 and just 10.5% in 2017. Remember, it’s not all about risk. Some companies’ opportunities will rise as climate risks increase, and more evidence-based, transparent reporting will help identify those opportunities. Examples include companies that will benefit from the transition to clean energy, or technologies that will help maintain the health of the environment and/or communities.
The bottom line
Investing along ESG, sustainable, responsible or ethical lines is rapidly gaining momentum in Australia. Even if you have not taken these issues into account in the past, it makes sense to explore how your investments may be affected by climate change risks, given the expectation they are rising and are likely to impact asset values in the future, and ESG risks more generally.
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