Targeting ESG outcomes in investment strategies

By Geoff Sanders, Penny Nikoloudis, Hannah Biggins, Alexander Batsis, Jessica Baker
Environmental, Social & Governance Superannuation

Striking the ESG balance in investment strategies 5 min read

It is now accepted that ESG risks need to be taken into account in the same way as any other investment-related risk for superannuation trustees, fund managers and institutional investors when developing and implementing their investment strategies (and in making individual investment decisions).

However, as superannuation fund trustees and managers of other investment products increasingly look to ESG-focused investment strategies proactively as a way of attracting members and investors, trustees and managers are now grappling with the perhaps more vexed question of how to appropriately design investment options and products that are expressly ESG-focused or aligned. The key ESG question they need to ask is not only what they need to be doing in making ESG a focus of their investment decision-making, but how far can they go in doing so?

In this Insight, we identify some recent developments in the area of 'responsible investing' and provide guidance on the balance trustees and managers need to make in setting out to develop, market and invest in ESG-focussed investment strategies and products.

Key takeaways

  • When establishing ESG-focused products, superannuation trustees and fund managers must carefully develop and market investment strategies that accord with investor expectations and all applicable legal and regulatory requirements.
  • For non-superannuation fund managers establishing products, investing in a way that is consistent with the commitments made to investors (ie being true to label) should be the North Star. Ultimately, the fiduciary and other duties imposed on non-superannuation managers should be able to be appropriately scoped by the circumstances of that particular product.
  • In contrast, superannuation trustees have a trickier balancing act in developing and marketing ESG-targeted investment options, given the sole purpose test and best financial interests duties they are required to meet.
  • In all cases, fund managers and superannuation trustees will need to be very much alive to greenwashing risks when offering and promoting ESG-focused products.

The context: ESG in sharp focus

The consideration of ESG opportunities and risks has become widely accepted as an essential component of developing and evaluating an investment strategy. Superannuation member expectations are moving beyond this to an increasing demand for investments that specifically target ESG impact. Certain ESG-aligned investments are also increasingly considered as critical assets that contribute to Australia's future economic prosperity and sustainability—these include assets in green energy and infrastructure, and digital and data-related assets.

In response, superannuation trustees, fund managers and institutional investors are increasingly establishing ESG-focused funds and investment strategies that are designed to deploy capital into ESG-aligned investments, including those directed towards Australia's energy transition. As just one example, the Australian impact investing market (a subset of the broader ESG trend) has grown substantially in the past few years, with investor commitments reaching $1.54 trillion in 2021.[1] APRA's newly released Prudential Practice Guide SPG 530 Investment Governance provides further guidance on this integration of ESG into the formulation of broader investment strategies by outlining how ESG risk factors should be considered as part of a superannuation trustee's overall risk management.

There is also increasing political influence. Jim Chalmers' February 2023 essay outlines his idea for 'values-based capitalism'. His approach envisions increased collaborations and co-investments between the public and private sectors in key industries that are central to solving some of Australia's pressing problems, including clean energy, social housing and infrastructure.

However, as is common with ESG, there are strong countervailing views in some quarters, with superannuation funds and other investors receiving equal pressure from some stakeholders to prioritise financial returns over any perceived desire to drive ESG outcomes in their investment decision-making. This pressure is perhaps most stark in the United States, where a 21-state coalition has challenged the ESG practices of two proxy advisory companies, Institutional Shareholder Services, Inc. and Glass, Lewis & Co. They allege they are focusing on non-financial outcomes to the detriment of financial returns for investors. This position recently advanced in Florida, where Governor Ron DeSantis legislated to block the consideration of ESG factors in investment decisions, requiring such decisions (and proxy voting decisions) for state pension assets to be made on the basis of pecuniary factors only.

Creating ESG-focused investment products: balancing investor demand with regulatory restrictions

Given those opposing trends, there may be confusion amongst trustees and managers as to how proactively they can pursue the establishment of ESG-focused products—whether it be an ESG-focused investment option within a super fund, a standalone retail investment product or anything in between.

Non-superannuation fund managers

Non-superannuation managers—eg a responsible entity (RE) of a registered scheme, trustees of a whole fund or other investment managers—will decide the extent to which they pursue ESG-focused opportunities that are central to their investment strategy. Ultimately, this is likely to be determined by the nature of the product and their commitments to investors (ie what investors expect and what they have been told significantly influences the nature of the manager's duties).

Trustees, REs and investment managers must satisfy their fiduciary (or, depending on the investment structure, broadly equivalent) duties to act in the best interests of members, and within the terms of any trust deed or registered scheme constitution or investment management agreement. However, it is generally accepted that those duties are shaped by the terms of the trust instrument or contract itself, as well as the regulatory and commercial context of the particular fund or investment. This importantly includes any disclosure made to investors as to the nature of the investment mandate. For that reason, a non-superannuation trustee's, RE's or investment manager's mandate to pursue ESG-focused investments needs to be clearly disclosed to, and ultimately positively selected by, the investors that choose to invest in that fund or strategy. As a result, funds that are specifically established to pursue sustainability-themed investments of whatever kind would typically be able to pursue that strategy, even at the expense of risk-adjusted returns, if that’s what investors have understood when they invested (ie when effectively disclosed, it may well be perfectly acceptable for the pursuit of financial returns to be treated as being secondary to the ESG or social impact objectives of that product).

Superannuation funds

In contrast to non-superannuation investment managers, superannuation trustees are always going to be somewhat more constrained by the Australian regulatory system in their ability to offer ESG-focused products to their members.

Those limitations are fundamentally driven by two key pillars of the Australian superannuation regulatory regime—the 'sole purpose' test and the covenant to act in the 'best financial interests' of fund members:

  • Sole purpose test: the Superannuation Industry (Supervision) Act 1993 (Cth) (the SIS Act) requires superannuation funds to be maintained solely for one or more of the prescribed 'core purposes', with those purposes centred on the provision of retirement benefits to members.
  • Best financial interests duty: under section 52 of the SIS Act, trustees must perform their duties and exercise their powers in the best financial interests of the superannuation fund's members.

As such, while superannuation trustees can offer ESG-targeted investment options (and members may be motivated to proactively select ESG-focused investment strategies), they are ultimately constrained as to the extent they can do so. In particular, irrespective of any disclosure to members (or the fact that relevant members might be proactively selecting the investment option), superannuation trustees are required to design their investment options (ESG-focussed or otherwise), and ultimately make investments, with a view to prioritising risk-adjusted financial returns for the relevant members.

That's not to say investment options can't have a (big or small) element of ESG-focus at their heart—we firmly believe they can—but it does mean each investment decision needs to be made with a view to achieving an appropriate risk-adjusted investment return on that investment. In essence, trustees will need to balance the upside of developing and marketing an investment option (or, indeed, an entire superannuation fund) that responds to the desires of some superannuation fund members to invest in an environmentally friendly and/or ethical manner, with the need to provide a suitable retirement outcome for those members.

Further, it is important to note that if the trustee can achieve that lofty aim (which may well involve an assessment that the risks associated with a particular investment are reduced by its ESG characteristics, leading to the acceptance of a lower return expectation), the fact that the investment in question may also have some other non-financial ESG positive outcome is entirely permissible within the SIS regulatory regime.

… and don’t forget about green (and blue) washing risk

With recent market developments, no matter what the broader regulatory overlay for a particular investment product might be, ensuring that the statements made to members or investors about the ESG practices, investment strategy and desired outcomes don’t fall foul of greenwashing (or bluewashing) risks is key for any trustee or manager. There is a risk that greenwashing or bluewashing risk increases in practical importance the more a particular investment product seeks to play off its ESG credentials.


  1. Responsible Investment Association Australia, Responsible Investment Benchmarking Report Australia 2022.