By Scott Donald, UNSW

SYDNEY: 14 November 2013 -

Conventional wisdom has it that superannuation funds and charities are precluded from investing in a way that supports social or environmental objectives.  That is not true.  They must invest with a financial objective foremost in their minds but that does not mean that all social or environmental opportunities are out of bounds.  Recent developments in the Impact Investing space are creating opportunities specifically designed to permit investment fiduciaries to participate without breaching their duties.

Other people’s money

The superannuation system contains the savings earmarked by the nation’s workforce for spending in retirement.  A little over $1,600,000,000 at last estimate.  Ensuring that that money is invested wisely and productively is vital for individual members, who will need the proceeds to live on when they retire.  It is also vital for the economy as a whole, which needs it to be invested efficiently so as not to distort the process of capital allocation.  It is those ends that the sole purpose test and the trustee duties articulated in the Superannuation Industry (Supervision) Act are directed – to ensure that trustees of superannuation funds remain focussed on the financial objectives of their members, undistracted by other objectives, however apparently laudable.

A similar situation pertains to the investment of charity monies.  Donors who want their money to be applied directly to the relief of whatever cause is represented by the charity can provide their donations to the charity for immediate application.  However when they provide it, whether by will or inter vivos, on trust for the charity, they expect the capital to be employed in the pursuit of income that can be applied year in, year out to the cause.  So here again the focus is on financial returns.  There are however two exceptions not available to superannuation funds.  The first exception is where the legal instrument establishing the trust expressly permits consideration of specified social or environmental issues, and the second, smaller wrinkle is that the trustees of charitable trusts can specifically eschew investment types that are directly repugnant to the charity itself – tobacco companies in the case of lung cancer charities, armaments manufacturers in the case of charities dealing with victims of wars. 

In the terminology employed in the impact investing community, absent specific terms in the trust deed permitting consideration of non-financial criteria, trustees must seek investment opportunities that are ‘financial-first’.

The practical challenge

In the past many have no doubt deterred by these legal impediments.  There are however a range of other hurdles that are arguably more important.

The most important of these is the simple practical reality that most superannuation funds and charities are simply too big to dedicate a great deal of time and attention to small, unusual investment opportunities.  The weekly cash inflows of major super funds in particular measure in the tens of millions of dollars each.  Each week, every week.  They cannot afford to spend time analysing and making decisions to invest in small amounts.  They have not the resources nor the processes to manage at that level.  Most charities are smaller, but they have even more resource constraints (in terms of time and access to investment expertise) than superannuation funds.

The other big problem is that both superannuation funds and charities are required to meet high standards of accounting probity.  They have to have accurate, regular, independent valuations and an ongoing flow of reporting to be able to feed into their monitoring and risk management protocols.  To invest money without those processes in place puts the trustees immediately in breach of their duty to take care, to act with prudence. 

Sowing the seeds for Impact Investing

Increasingly governments are recognising that rather than attempt to compromise the integrity of the superannuation system by forcing fund trustees to make investments the return from which is potentially uncompetitive, they should underwrite social and other activities in ways that permits trustees of superannuation funds, and charities (though the actual money there is smaller), to participate and still discharge their duties prudently.  Recent examples in Australia include the three funds seeded by the Social Enterprise Development and Investment Fund, the social benefit bonds piloted by the NSW state government and the National Rental Affordability Scheme.  In each case the financial returns are to some extent supported by government involvement.

These opportunities have two potential attractions.  First, the returns are likely to be uncorrelated to those achieved by other investments, which means there may be attractive diversification opportunities. Second, they also provide the opportunity, well demonstrated by funds like Christian Super, for funds to connect with members'  concerns, values and aspirations.  In a regulatory and commercial environment where pressure will be placed on superannuation funds to justify not merging into ever larger, more homogenised financial conglomerates, such opportunities for inspiring member loyalty are surely invaluable. Charities, likewise will welcome the ability to reflect their broader missions through their investment portfolios.

The key though is for governments, and those seeking capital for social impact programmes, to recognise the financial-first imperative that drives super fund and charity trustees.  Those fiduciaries have a duty to their members and charities that must come first if those sectors are to have sustainable integrity.  But the initiatives that are growing up under the Impact Investing banner are increasingly sensitive to that priority.  They are packaged in ways familiar to institutional investment markets, and are subject to governance regimes of the types expected by institutional investors.  Some will perform well, some no doubt less well; that is inevitable.  It is also true of all investments.  As Putnam J said almost a century ago – ‘do what you will, your capital is at hazard.’  But the packaging and underwriting technologies that are being developed today in Australia and overseas mean that a greater range of activities, including many with targeted social and environmental impact, are becoming viable complements to the mainstream investment categories that today dominate super funds and charity portfolios. 

A detailed report, Impact Investing: Perspectives for Australian Superannuation Funds, can be found here.

Scott Donald is an External Consultant to Herbert Smith Freehills, who supported the production of this report alongside Evans & Partners, the Ian Potter Foundation, Macquarie and the University of Sydney.  Nothing in this article should be taken to represent legal or investment advice.