Report to SEARCH AGM on Investment Management
26 November 2017
By Helen Hewett
Member, SEARCH Finance & Investment Committee
The SEARCH Committee is like a Trustee board of an industry superannuation fund. The Committee has the difficult challenge with investment management of balancing:
• The security of members‘ capital by managing risk; and
• Maximising investment returns so the organisation remains viable and can fund current and future political activities.
If the Investment management policy contains an Ethical screen, as the SEARCH policy does, this adds another dimension to the challenge. SEARCH‘s investment portfolio is modest in size and too small to allow the organisation to issue tailored mandates to individual managers. Instead the SEARCH Investment Adviser (Industry Fund Services) needs to ensure:
• The portfolio is diversified;
• Market, political and currency risks are managed to SEARCH’s risk tolerance (a moderately cautious investor), so capital contributed by members (past and present) is protected;
• Returns are maximised to deliver the Foundation’s investment objective of a 5-6% average return over 5 years; and
• The current and future capital draw down needs of the organisation can be met so SEARCH can continue to implement it‘s political action agenda.
This sounds fairly straightforward but it’s not easy, particularly when the portfolio is small as this in itself imposes limitations. Size confines SEARCH’s investment universe to pooled funds and the companies they invest in. To achieve diversification, the Investment Adviser needs to balance of growth and defensive assets to manage risk to tolerance. Growth assets include shares, infrastructure and property, and defensive assets include bonds and cash. It then needs to select the fund managers in each asset class able to offer the appropriate mix of underlying stocks so there is a spread of industries such as retail, industrial, banking and so on. The portfolio also needs to have a geographical spread across most of Australia and major markets such as the US, Europe and Asia.
It can be quite difficult to get the balance right and achieve the necessary diversification with a small portfolio. But it is critical this balance is achieved since diversification is a fundamental must have for prudent investment to protect against market and currency risk, and to maximise returns to members over the long term.
Industry superannuation funds
So how do small institutional investors discharge their duty to members to manage risk and returns, AND manage ethical investment concerns?
Before I retired I was CEO of an industry fund that had at that time almost $15 billion in assets under management. As you would know industry superannuation was a trade union initiative. These funds are managed by a board with equal numbers of union and employer nominated directors, often with some independent directors.
Today the biggest industry superannuation fund has $120 billion in assets under management and it returned an average of 11.41% pa over 5 years. There are 41 industry funds with $545 billion in funds under management. Many of these funds have $30 billion in funds under management, yet most if not all would struggle to manage their prudential obligations to members and to manage a complex ethical overlay to their entire portfolio.
Industry superannuation funds have been instrumental in driving ethical investment in Australia but even a small fund with just $2 billion in funds under management is a much bigger investor than SEARCH.
Small funds often start their ethical journey with a staged approach, continually strengthened overtime to increase ethical performance of the underlying companies they invest in. This allows funds to discharge their prudential obligations to minimise risk and maximise returns to members and manage ethical considerations. A number of small industry superannuation funds with $2-3 billion in assets under management still use this staged approach.
Industry superannuation funds because of their size and their collective approach are able to vote their shares and this has been a great asset to help manage the ethical behavior of companies they invest in. This powerful tool has been particularly useful when tackling issues such as executive remuneration, transparency and shareholder rights.
Ethical governance organisations
Industry superannuation funds have collectively established powerful ethical governance organisations like ACSI (Australian Council of Superannuation Investors). It works with superannuation funds in Australia and internationally who collectively manage over $1 trillion in assets. ACSI‘s objective is to influence policy on social, environmental and corporate governance issues.
Industry superannuation funds were also the founding members of the global organisation UN PRI (United Nations Principles of Responsible Investment), a fast growing co-operative of institutional investors, which includes fund managers and investment advisers such as IFS.
UNPRI has six key principles underpinning responsible investment that all members as signatories must adopt and report against.
Both of these successful organisations, ACSI and UN PRI are headed up by influential Australian women.
These organisations are at the forefront of driving serious change in the behavior of corporates, influencing global policy on environment, social justice, governance, public policy and disclosure.
Not withstanding the powerful influence of workers‘ capital through industry superannuation funds, it’s not perfect. As we know some companies, often the big ones but not always just the big companies, will try and cheat workers out of their entitlements, put workers lives at risk through poor safety and steal their livelihood by taking their jobs.
That’s why we need strong trade unions and organisations like SEARCH.
So what can SEARCH do to manage its investment portfolio prudently and manage important ethical issues?
Firstly, remember that SEARCH is restricted to investing in pooled funds, because of the size of its portfolio. The Foundation also has to consider its ethical duty in relation to protecting and growing the capital of members, as some of this capital represents member bequests and donations to underwrite important political work.
Secondly, make sure the Foundation‘s Investment Policy including ethical considerations are achievable and won’t erode any significant value in investment returns overtime or breach the risk tolerance of the organisation.
Don’t expect an ethical investment screen will always rule out companies not adhering to our optimal ethical investment criteria. This isn’t the way the screens generally work.
Ethical screens are mostly used in two ways and both play a valuable role.
1. After managers have done their evaluation of financial performance and governance, the screens are then applied to those remaining in the pool for consideration. Both the positive and negative are used to help managers pick the best companies managing ethical issues covered by the screen in each sector, industry and geographical area. The screens help managers to select companies that positively impact and to help avoid companies that negatively impact. It would probably be difficult to get the necessary exposure to sectors, industries and geographical areas if screens were used to only eliminate companies and industries.
2. Arguably the most important role that ethical screens play is enabling engagement. Engagement is a very valuable tool that helps ethical institutional investors to influence corporate behavior and help deliver important political gains in areas such as clean energy and climate change, for example. This is a critical element of the UN PRI strategy and the SEARCH Investment Adviser IFS only uses managers who are signatories to the UN PRI principles.
Examples of shareholder engagement in Australia are Westpac and NAB. At the last Westpac AGM shareholders asked the Chairman to rule out support for the proposed Adani Carmichael mine in order to clearly and publicly demonstrate the integrity of the bank’s climate commitments. Then not long after the AGM, Westpac’s 2020 climate action plan was released ruling out lending to the mine. NAB has committed to finance environmentally positive activities to the value of A$18 billion by 2022. This is part of an international pilot group of 12 global banks developing tools to measure, manage and report climate risk and performance.
Some ethical investors argue that if we want to achieve climate change, the banks will be crucial. This is because large banks globally need to support the massive shifts in capital needed to combat climate change. The International Energy Agency estimates that in order to limit warming to 2C more than US$1 trillion needs to be invested in clean energy EVERY YEAR from now until 2050. And for that reason alone a number of large banks meet the ethical screens of many institutional investors.
There are also a few other things SEARCH may wish to consider:
- Reviewing investment policy from time to time to ensure it continues to meet the organisation’s objectives.
- Investment Policy could include the requirement for all of the Foundation’s investment managers and its Investment Adviser to be signatories to UN PRI. IFS the Foundation’s current Investment Adviser is a signatory and it only uses managers who have signed up UN PRI, but there is no such stated requirement in SEARCH policy. This way SEARCH members know engagement and measurement is taking place and each manager will be reporting to UN PRI on corporate behavior and engagement.
- The Investment Adviser could be required to sign-off on compliance to the agreed mandate in its quarterly report, and to also obtain sign-off on compliance at manager level. This way the Foundation through it’s Investment Adviser, knows the ethical undertaking given by each pooled fund manager at the time of their selection, is appropriately applied throughout the duration of the investment. The manager could also be asked to report details of any non-compliance.
If SEARCH has a layered process of application of ethical considerations members will know policy is being implemented at all levels of the portfolio, at stock selection and throughout the holding period. It’s not easy for prudent investors in pooled funds such as SEARCH, with ethical considerations. But ethical investment is important and it is possible to manage an achievable policy that has growing ethical expectations. Many pooled funds, even the ethical pooled funds are unlikely to offer the broad range of ethical considerations the Foundation may ideally want. But this is changing everyday and pooled funds are trying to cater for the growing expectations of institutional investors.
Member, SEARCH Finance & Investment Committee