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Self Managed Super Fund (SMSF) Article
Self Managed Super Funds and Socially Responsible Investing

By Tony Negline.

This article may be out of date.

30th September 2009

Super fund trustees must act in their fund's beneficiaries best interests at all times especially when investing their trust's assets.

It may come as a surprise to many small fund trustees to learn that the Federal Government believes that super fund trustees are failing to act in their beneficiaries' best interest by not using Socially Responsible Investing (SRI), sometimes called Environmental, Social and Governance (ESG) investing.  "ESG issues pose a core investment risk with the potential to impact heavily on long-term viability of investments," said Senator Sherry, the Federal Minister formerly responsible for superannuation.

"ESG and other extra-financial factors should be incorporated into the investment decision-making process of superannuation trustees," he said.

So what is SRI?  SRI is not one type of investment technique.  There are many different SRI investment styles including:

• Negative screens which removes investments involved in activities deemed to be unacceptable.  Typical excluded activities are tobacco, armaments, alcohol and gambling
• Positive screens involve actively seeking out investments that deliver a positive impact on society, the environment and other relevant areas
• Sustainability analysis involves a "quantitative and qualitative study of all companies on the stock market to determine their environmental, social, governance or ethical performance" which "is often combined with positive and / or negative screening but can be used on its own" (source: Responsible Investment Association of Australasia website)
• Best of sector involves potentially investing in all economic sectors but only investing in companies deemed acceptable because those that take ESG seriously are assumed to be the better managed and therefore more profitable in the longer term

Some SRI managed funds use some or all of the above investing styles and some investment managers may use their shareholding voting rights to promote their SRI investment principles.

How does a super fund trustee determine what their beneficiaries best interests are?

The Courts have addressed this issue in a few cases.  Arguably the most famous decision involves Arthur Scargill who for many years was the leader of the UK National Union of Mineworkers (NUM) and also a NUM representative trustee for the mineworkers’ pension fund.  During the 1980s, Scargill’s lead massive and prolonged coal miners’ strikes in an attempt to overthrow the Thatcher Government.

In 1983 all the NUMs trustees of the mineworkers' pension funds refused to approve investments which contained exposure to international and coal-competing assets.  They argued that such investments were “to the detriment of coal and would be against the interests of the … beneficiaries”.

All the pension fund's employer trustees disagreed and, after much toing and froing between both sides, sought a judicial resolution of the resulting stalemate.

The following extracts from the written judgement in the case are highly relevant to the understanding what is meant by the beneficiaries best interests:

• If the purpose of a trust is to provide financial benefits then the beneficiaries best interests are "normally their best financial interests".  Any power a trustee has to invest trust monies "must be exercised so as to yield the best return for the beneficiaries, judged in relation to the risks of the investments in question".  The likely income and capital appreciation must be used to assess the return from an investment
• "Trustees must not refrain from making the investments by reason of the views that they hold."
• "Trustees may even have to act dishonourably (though not illegally) if the interests of their beneficiaries require it."
• It may be that in a trust all the actual and potential beneficiaries are adults "with very strict views on moral and social matters, condemning all forms of alcohol, tobacco and popular entertainment, as well as armaments".  In the unlikely event this occurs it may not 'benefit' these beneficiaries to know that they are obtaining a larger financial return because the trust has some investments which they would find objectionable.  These beneficiaries may believe that it would be better to receive less than to receive more from what they consider to be evil and tainted sources.  "I would emphasise that such cases are likely to be very rare, and any in case I think that under a trust for the provision of financial benefits the burden would rest, and rest heavily, on him who asserts that it is for the benefit of the beneficiaries as a whole to receive less by reason of the exclusion of some of the possibly more profitable forms of investment." (emphasis added)

The judge in this case approvingly cited another case known as Buttle v Saunders in which a property had to be sold and the trustees had accepted an offer but the actual sale had not been completed when another higher offer was made.  The trustees rejected the later offer because they felt honour bound to accept the first lower offer.  "The duty of trustees to their beneficiaries may include a duty to 'gazump' however honourable the trustees," said the judge in the Scargill case in relation to Buttle v Saunders.

It would seem therefore that trustees need to put their personal views and ethics to one side when deciding how their trust monies are invested and therefore acting in their beneficiaries financial best interests.

At least 79 large super funds have signed up to the United Nations Principles of Responsible Investment.  This means that these funds have made undertakings to incorporate ESG issues into analysis and decision making processes, be active owners and seek appropriate disclosure from entities in which they invest.

Sherry has asked the Australian Prudential Regulation Authority to review its guidance to super fund trustees asking that trustees to take greater account of SRI in the investment process.  At the time of writing the APRA had not released the revised guidance to super fund trustees.

In February, Senator Sherry announced that the Federal Government would provide $2.5m to help establish a Responsible Investment Academy.

The new Minister responsible for superannuation has said that he does not favour mandating where super funds invest.

Some superannuation lawyers say that 25 or 30 years ago some people might have agreed with Scargill but most people now would think his objections are quaint.  Perhaps ESG investing will suffer the same fate in the near future.

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