The simple and clear notion of investing to achieve an appropriate risk-based return has been engulfed by a wave of priorities, some complementary and some conflicting, that have reminded the purists of what superannuation’s true goal is.
Most recently, and especially last week with BHP divesting itself of oil and gas assets (to be replaced with agriculture input potash), climate change is now among the noisiest environmental, social and governance issues being proffered as a legitimate goal for superannuation.
Adequate and worthy retirement income
The notion here is that such investments provide members with the goal of retirement income that is adequate, as well as worthy and appropriate.
If superannuation trustees think they can turn a deaf ear to outside calls for attention and simply focus on adding value, they would be wrong. The Australian Prudential Regulation Authority now expects fund trustees, as fiduciaries, to consider climate implications as part of their operations, which means they are now required to take legal and economic decisions based on a mandated regulatory view.
This requirement naturally raises the question of prudent investment, and whether this demand might detract from investment performance. And further, whether the mandated climate considerations as a legitimate investment screen have any adverse implications for members, either in terms of compliance or inferior long-term performance.
Alon Brav and J.B. Heaton addressed this issue in a recent paper, albeit in the US context, but their point is nevertheless well made.
From an investment point of view, they advocate that a transition from the current high-carbon to a sustainable low-carbon economy carries substantial risk. Fiduciaries who fail to adequately address this risk may fall foul of the law over their obligations irrespective of their intentions.
Investment decisions based on social good rather than economic merit run the risk of an emotionally fuelled price frenzy.
US courts have remarked about the Employee Retirement Income Security Act that “good faith does not provide a defence to a claim of a breach of these fiduciary duties”.
Aside from the issue of legitimacy, investments in climate assets may introduce an added element of cost.
Solar farms, for example, are typically heavily subsidised by government. Investment in such assets exposes fund members to the risk of subsidies being turned off, or of political interference in the running of the underlying business. Such actions, if they were to eventuate, highlight issues of sovereign risk.
Senior executives from several leading industry superannuation funds regularly claim that their members now expect their funds to lobby for better environmental and social outcomes from the boards of companies they invest in.
However, making investment decisions based on the underlying asset’s social good rather than its economic merit runs the risk of prompting an emotionally fuelled price frenzy.
John Cochrane at Stanford University’s Hoover Institute warns of possible “green bubbles” as investors rush to embrace environmentally focused businesses.
Possibility of poor investments
Citing the sharemarket crashes of 1929 and 2000 as examples, he contends that these were caused not by declining industries, but rather by bubbles as investment turned to speculation in the “new technology”, respectively epitomised by electrical appliance manufacturers and technology start-ups.
It may well be that regardless of the merits of the climate science, the supply and demand imbalance and the presence of unsustainable government subsidies could make them poor investments.
Ruchir Sharma of Morgan Stanley further addresses the cost aspect of climate-focused investing. He contends that renewable technologies require more wiring than those that burn fossil fuels, and solar or wind power plants use up to six times more copper than conventional power generation.
This presents a critical problem in the transition phase between old and new technology. That is how to supply sufficient resources, derived in the traditional manner from mining and oil extraction, to build the new technology plants.
His point is poignant: society’s intolerance of mines and oil rigs may not necessarily produce the desired environmental and social outcomes.
At the end of the day, any technological disruption motivated by climate change needs more than just good deeds applied to the planet to ensure that it is economically sustainable, regulatory compliant, and in the members’ best financial interests under the Superannuation Industry (Supervision) Act 1993.
David R. Gallagher and Graham Harman are with the RoZetta Institute, a university-owned commercial organisation focused on solving industry problems.