This article was written based on a request from UQBS marketing by the CHOICE Superannuation. Below is the interview transcript.

Some super funds exclude companies from their portfolio where they make more than a certain % of revenue (may be 5,10 or 20%) from fossil fuel production; are these kind of exclusions likely to effect change in the industry or are they more like greenwashing?

Super funds have multiple investment products for retirees and fund members to choose from. Having an ESG product that excludes companies that generate a % of revenue from fossil fuel production is an additional investment product that allows retirees/investors the choice of ensuring that their retirement/investment portfolios reflect their ESG beliefs; thus, having such an ESG investment product is not green washing. It is simply giving fund members more choices to invest according to their principles.

Is it reasonable for funds to argue that holding on to their shares in fossil fuel companies and engaging with them is more of a responsible approach than divesting to investors who may not care about the impact these companies have on climate change?

To begin with, investors who do not care about the impact fossil fuel companies have on climate change should not be investing in ESG investment products. Thus, the default choice for a superannuation fund should not be an investment portfolio that is ESG focused.

ESG funds should engage with companies with fossil fuel interests to understand their medium and long-term plans and whether they are exploring alternative ESG energy sources. Via engagement, if the actions and goals set by these companies are deemed to be insufficient by the portfolio manager, the decision to divest can be made.

Superannuation funds should have a clear mandate stating the goals and objectives they are achieving for their members. If these goals are to maximise risk-adjusted returns, then according to financial theory (Markowitz Portfolio Theory), it is a mathematical tautology that having exposure to the broadest investment universe is a sound approach.

Where a super funds divests from, or excludes, investment in the fossil fuel industry, does the reduced diversification of their portfolios mean significantly higher risks for fund members?

Exclusion of investment in the fossil fuel industry reduces your risk-adjusted return. I would not say it results in significantly higher risks for fund members, as the the fund should be well diversified in all other aspects.

Fund members should be given a choice of different investment portfolios. If they choose to invest in an portfolio that does so according to ESG principles, they should be informed that their portfolio may under perform investment portfolio with a mandate that allows more freedom and flexibility for a portfolio manager to invest in all types of companies and assets regardless of their characteristics.

A reputable study that explores the impact of ESG investing found in an article in the Journal of Portfolio Management.

How significant are the limitations on shareholder activism in this industry given many of the biggest carbon emitters are private or state-owned companies?

Shareholder activism is limited where the biggest carbon emitters are private or state-owned companies; however, I would also say that if they were not, it is challenging for a small number of activists to convince the majority of shareholders to vote their own board members to change the behaviours of the biggest carbon emitters immediately.

Activists should still make sure their voices are heard and understand that they can make changes in the medium to long-term. Shareholder activists should play the long game, and understand that board of directors and managers of the biggest carbon emitters do not like the negative publicity they will obtain from these activists. As such, company changes are likely to be enacted to minimize bad publicity and exposure of poor ESG practices.

Are there any viable ways to quantify the impact of super funds engaging with the fossil fuel industry?

The most straight forward approach is to evaluate how many of these superfunds have ESG investment portfolios and what their criterion is for inclusion in the ESG portfolio.

Is ESG screening a useful mechanism for super funds to optimise returns while also taking into account environmental and social goals?

ESG screening is an appropriate methodology to quickly build an investment portfolio that is ESG focused; however, it can be overly simplistic. Many companies do believe in having ESG objectives but achieve them differently and on varying time frames. Thus, having a deep-dive in engaging companies and understanding their approach and goals in being more sustainable and environmentally friendly in the long run is the better approach.