Home / News / The verdict is in: YFYS curbs ESG

The verdict is in: YFYS curbs ESG

New research confirms the “anecdotal concerns” of the superannuation industry that the current design of the Your Future Your Super test makes responsible investing a no-go zone.

New research shows that mainstream implementations of ESG, sustainability and carbon transition activities creates relatively high levels of performance test tracking error, increasing the chances of a “false positive” test failure. The research stems from a collaboration between FTSE Russel, the Australian Sustainable Finance Institute, the Responsible Investment Association of Australasia (RIAA), and the Conexus Institute.

“This important research shows unequivocally that there remains an inconsistency with the structure of the current YFYS performance test and the ability of super funds to invest for the long term in a manner consistent our national legislated climate targets of 1.5 degrees,” said Simon O’Connor, RIAA CEO (photo at top). “This fundamental inconsistency must be fixed or it risks damaging the retirement outcomes of all Australians by incentivising short term tracking error over and above the long term financial interests of members.”

Previous research by Conexus determined one per cent to be a reasonable proxy for a sustainable level of performance test tracking error. Building from that, the new research says that it “appears that it is not presently possible” for a super fund to offer a sustainable/responsible investing option based on exclusions without creating “an untenable level of YFYS performance test risk”. Super funds would also be unlikely to be able to create portfolios that align with carbon transition consistent with meeting the Paris Agreement goals for limiting global temperature rise to 1.5 degrees Celsius for the same reason.

When looking at unlisted “green assets” a one per cent new exposure to small, dedicated investments in greenfield opportunities, private equity and infrastructure created 0.2 per cent of performance test tracking error – 20 per cent of the sustainable level.

For credit portfolios, analysis of Paris-Aligned Benchmarks (PABs) for the asset class suggests “a relatively small level of tracking error” (0.2 per cent) though there is no standalone benchmark for credit, meaning the performance test tracking error created by investing in credit “likely far exceeds the marginal tracking error created by following PABs”.

“In short, trustees face a difficult challenge: they have multiple portfolio objectives but a limited budget of performance test tracking error to implement these with,” the research says. “These objectives include return enhancement, risk management, diversification, and accounting for ESG, sustainability and climate transition.

“Trustees are faced with a difficult decision between living with a heightened likelihood of failing the YFYS performance test at some point or having to pare back the degree to which these activities are implemented, which may be inconsistent with investing in accordance with the long-term financial interests of members, and/or with members’ sustainability preferences.”

Print Article

‘Light at the end of the tunnel’ for emerging market debt

After a damaging year, the “massive technical headwinds” for emerging market debt are easing. And the biggest opportunities might be the smallest parts of the benchmark.

Lachlan Maddock | 7th Dec 2022 | More
A cathartic moment after turmoil of 2022

The chaos of 2022 has reset valuations to the point where they’re hard to ignore, according to J.P. Morgan Asset Management. That doesn’t mean the future of markets is any less cloudy.

Lachlan Maddock | 7th Dec 2022 | More
Although expected, rate rise weakens market

The Australian share market eased on Tuesday as the eighth consecutive rate hike from the Reserve Bank saw the cash rate lifted by 0.25 percentage points, to 3.1 per cent – up from 0.1 per cent in just seven months. The rate hike was mostly expected, and the central bank indicated that further tightening was in store in…

Drew Meredith | 7th Dec 2022 | More
‘In good markets and bad’, Super Fierce finds top 15 funds
Lachlan Maddock | 15th Jul 2022 | More
‘An art, not a science’: 15 years of PE lessons from QIC
Lachlan Maddock | 5th Aug 2022 | More
Time for a reality check on 15 per cent super
Lachlan Maddock | 1st Jul 2022 | More