Dancing with elephants

Saturday, 01 October 2022


    Australia's biggest super fund has committed to net zero emissions across its portfolio by 2050. Its chair is better known for his years as a senior political adviser, but whatever the role, he says it’s all about the problem-solving — and not ignoring the elephant in the room.

    When Dr Don Russell was appointed to the AustralianSuper chair role in September 2019, after a stint as a global investment strategist at BNY Mellon Asset Management Australia, then AustralianSuper CEO Ian Silk lauded Russell’s “deep understanding of the superannuation system and its role in the Australian economy”. Under the tenure of Silk, a former industrial relations worker and policy adviser who retired at the end of last year — replaced by chief risk officer Paul Schroder — AustralianSuper grew from a $21b fund with 50 employees to one with $260b under management and a staff of 1000 with offices offshore. Its membership base doubled from 1.2 million to 2.4 million in the same period.

    The ambition is to grow funds under management to more than $500b by 2026, as the fund looks to own more private assets after purchasing a string of energy infrastructure, port, toll road and airport assets — including Sydney Airport Corporation — in recent years. It has also become a powerful owner of shares in local sharemarket-listed companies, with industry funds owning about 22 per cent of Australian listed companies.

    For public company boards, there are now important questions around how AustralianSuper will approach issues like climate change as one of the biggest investors in the country. It is a fund that can exert significant pressure on companies over environment, social and governance (ESG) issues. Most importantly for its members, there are also questions about how the fund will approach valuing its $73b worth of unlisted assets, which include infrastructure, private equity and direct property, and also how it will run itself in an era of massive ongoing technological change.

    Integrating ESG

    Russell is an academic at heart, boasting a PhD from London School of Economics, and a Masters of Economics from ANU. “In the interactions I have had with Don, I have observed he is a very thoughtful and considered person who always has good insights to share about the issue at hand,” says Australian Council of Superannuation Investors (ACSI) CEO Louise Davidson AM. ACSI has long worked closely with AustralianSuper — Silk is a former president of ACSI — and both engage extensively with public companies. Russell says this has been assisted in recent years by AustralianSuper’s internalisation strategy, which sees half of its funds now managed by an in-house investment team. That strategy has allowed the in-house team to integrate ESG issues directly into investment decisions without needing to work through external fund managers.

    The strategy saves the fund from trying to influence how those external managers take ESG issues into account, particularly around climate change, which tends to be one of members’ main interests.

    The other supporting factor is its size. “We are now such a large investor,” says Russell. “With our scale, the only way that we could hope to continue to deliver for the members is if we were to increasingly bring the investment function in-house.”

    ESG is also baked into the super fund’s approach to investment capability building, as well as the performance of its equity portfolio. “We’ve built concentrated portfolios and developed skills and capabilities to understand a whole range of Australian businesses,” says Russell. “Part of that understanding is based around an understanding of how these companies deal with climate risk and other ESG matters.”

    Integrating ESG into investment decisions is a powerful force, according to Russell, but the work extends post- investment where the stewardship role is just as important. “We approach this from the perspective of performance,” he says. “Being able to influence companies, in their decisions around board governance, climate risk and disclosures are all mechanisms we see as improving investment returns. We’re heavily engaged in that because we think it lowers the risk associated with everything we’re invested in.”

    This approach will also apply to international investments as the fund brings more international asset management in-house, with more work still to do in relation to direct investments and private equity. “It’s an ongoing issue. That environmental advocacy around disclosure is an important part of what we do, but we approach it from the perspective of improving investment returns, not as an exercise in trying to bring an emotional overlay to everything we do.”

    Yet Russell sees the fund as anything but an activist behemoth determined to flex its muscles on issues like climate change. Instead, he believes it is playing a leading role in what he terms “taking the emotion” out of ESG. “Companies welcome our interaction with them,” he says. “We are a long-term investor and management teams that have good business models, that have embarked on strategies that will deliver for members, like having us on their share register. We are a force supporting management in their strategy.”

    This even applies to companies such as incumbent energy supplier Origin Energy, which are burdened with so-called “pariah” assets that are working on a plan to transition to a world of net zero emissions. “If the company has done its homework, if they really are on a course for transforming the very nature of their company — and they may well have pariah assets on their books at this time — they are companies we can feel very comfortable investing in, because we think that emotion is probably mispricing the asset in the current environment,” says Russell.

    Spreadsheets, not placards

    Russell believes AustralianSuper sits in contrast to other active managers, which are burdened by investment criteria that exclude certain categories of investment on ESG grounds.

    “We don’t turn up with a placard,” says Russell. “More likely with a spreadsheet and a set of analyses, which a management team or board may not necessarily agree with. But at least they know that we are coming from the perspective that we are trying to help them run their business better.”

    That doesn’t mean AustralianSuper will not take a stand where it sees recalcitrant behaviour. A good example was when mining giant Rio Tinto destroyed two ancient and sacred rock shelters in the Pilbara region of Western Australia as part of an iron ore mine expansion in May 2020. For months, its board tried to play down the concerns of investors on the issue before bowing to an eventual clean-out of the directors and management responsible.

    “The way Rio approached all that was highly detrimental to the valuation of the company, and it was highly detrimental to the investors who had invested in the company,” says Russell. “We want to understand what risks lurk in the businesses that we are invested in — a realisation that their governance is inadequate or that they haven’t got systems to protect them from doing really stupid things around heritage assets, around protecting things that really should not have been put up as a consequential byproduct of investment decisions. We want to know about that and we want to help them, because they may have a very short-sighted view about the evaluation consequences of their behaviour. We want them to dig deep into their own processes because we don’t want to be the bunnies holding the asset when awful things happen.”

    Davidson says this position is very consistent with the approach taken by ACSI. “Our view is that ESG is really all about managing risk within investment portfolios. Our objective is to improve ESG performance at listed companies. We don’t do it for the sake of it, we do it because it makes good financial sense.”

    Russell says AustralianSuper is supportive of international sustainability standards on climate reporting coming in 2023, which are a major issue for all reporting entities. The Task Force on Climate-related Financial Disclosures (TCFD) — created in 2015 by the International Financial Stability Board — has already developed a framework to help public companies and other organisations disclose climate-related risks and opportunities.

    “We are very supportive, in the sense that the more that companies honestly and effectively set out how they’re planning to deal with climate change, that does reduce risk and does make it easier for investors,” says Russell. “Generally, we’ve been supportive of businesses embracing their TCFD responsibilities. And if the International Sustainability Standards Board standards reflect that, it’s sort of coming along behind the TCFD approach. I’m sure it will all be negotiated and discussed in great depth before it ends up as a formal standard. We’re not doing it to punish companies, we’re doing it to help them help themselves — to help them to be more effective in what they’re doing.”

    In fact, Russell says the only boards that should fear AustralianSuper on their register are those that are essentially box-ticking on compliance, with “no real idea” about the risks or strategies associated with their businesses. “That is a bad situation for us. We should be seen as a force for good. We are going to support good management, good boards and companies that know what they are doing. We will stick with them as long as they continue to deliver.”

    Committee involvement

    Russell has already borrowed from the best governance practices of the nation’s top public companies by improving committee processes that, he says, have enhanced the running of the AustralianSuper board. Specifically, he has elevated the roles of the chairs of working committees attached to the board to allow them to become “the eyes and ears of the board itself around the work of a particular committee”.

    Important matters are first considered by the board to determine priorities. However, the hard grunt work gets done in the committees, of which AustralianSuper has a number. Russell says more effectively empowering the board committee chairs overseeing this work has effectively empowered the whole board.

    “When matters that originated in the board and were worked on in the committees come back to the board, the directors who have not necessarily had any involvement with the workings of the committee now feel that not only were they involved in the board discussions and decisions about the broad outline of what is going on, but are actually well versed and familiar with how the committee has been working on particular matters.”

    One of the fruits of the new structure at work came in June, when AustralianSuper changed its fee structure from a fixed dollar fee per member to one with more of an asset based component. The new fee structure is $1 a week — less than half the previous $2.25 — plus 0.10 per cent of a member’s balance. The change means members with less than $50,000 in their super account will pay almost 60 per cent less in administration fees than previously.

    “When the final proposal came to the board, the directors, particularly those not on the working committee, were very pleased and comfortable with signing off on a quite different approach to the way AustralianSuper approached the issue of fees for the members,” says Russell. “It was done in a quick period of time. I don’t think we could have brought everyone along on such a contentious matter, where the board could be comfortable, without this structure. What boards get uncomfortable about is where they can see what is in front of them, but their instinct tells them there is more going on here than what they are being told. That is usually a reason not to do something, which can, and does, lead to paralysis.”

    Increased investment

    An outstanding performance from its unlisted asset portfolio in the 2022 financial year has encouraged AustralianSuper to increase its unlisted exposure to almost a third of the $260b fund, and it now wants to invest a further $13b into private equity globally in the next two years. The total allocation to unlisted assets is now $73b, a 52 per cent increase on the $48b in June 2021.

    Amid the turmoil in global equity markets, the allocation helped AustralianSuper’s flagship balanced option post just a 2.73 per cent loss over fiscal 2022. The loss followed a record high return of 20.4 per cent the previous year and members have still received strong 10-year annual returns of 9.32 per cent on the balanced option, where most invest.

    Russell acknowledges the valuation of unlisted assets is always challenging, especially where members are switching across asset classes and during times of great market turbulence when, he says, the normal quarterly process is either too slow or the prices have changed too much.

    “You’ve clearly got sterile pricing in a range of assets and that’s when you actually have to have an overlay process to bring a proactive set of views about how the unlisted assets should be valued in that particular setting.”

    At the onset of the COVID-19 pandemic, Australian Super began involving its investment committee in valuation discussions to refresh pricing around the fund’s illiquid assets. It now has a new process to rely on in times of market turbulence, in addition to the standard quarterly asset valuation process applied to unlisted assets.

    “There’s a responsibility on the funds to be proactive, which means that investment committees do have to insert themselves in the evaluation process,” says Russell. "We did activate a process, which was proactive and involved consultants and advisers, to refresh the pricing around a range of the illiquids. That was entirely appropriate. We did it in a way that brought a measure of structure and science, so we now have triggers around what to do in unstructured markets, when levels of pricing are not necessarily reflective of what’s going on.”

    In this context, says Russell, rising geopolitical tensions continue to be central to AustralianSuper’s scenario planning. Russia, he believes, has become “uninvestable” amid the ongoing war with Ukraine. He also admits to being worried that “something shocking could happen” where China follows suit.

    “A consequence of a whole range of tensions around the world is that we are seeing the return of the nation state and investors are going to have to be more conscious of the behaviour of individual countries, and how they relate to each other,” he says.

    However, when it comes to market volatility and geopolitical turmoil, Russell believes that the key for members is simply to hold firm. “Our focus should be to help members realise the benefits of remaining invested in volatile times, not switching in and out of cash,” he says.


    Decarbonising the AustralianSuper portfolio

    Net zero by 2050
    Board-approved commitment for the investment portfolio

    $1.2 billion
    Renewable energy investments

    Reduction in carbon intensity between 2013–20 Aggregate equities portfolio (carbon to value)

    Australian equities carbon intensity relative to market benchmark (carbon to revenue)

    of AustralianSuper's top 20 emitters have made net zero commitments

    $665 million
    Listed equities portfolio’s contribution to United Nations Sustainable Development Goal 7 (clean energy) in 2020

    Strategising for the future

    Going forward, Russell sees both risks and opportunities around how AustralianSuper is working to manage its increasing scale while improving its customer experience. The internalisation process will continue as the fund builds more investment teams in London, which Russell firmly believes will remain the primary financial centre of the world.

    He has strong views on AustralianSuper’s role in the retirement income covenant, a new federal parliamentary construct that requires super trustees to create income strategies that provide more granular detail about how they can assist members in retirement. The covenant aims to provide funds with the flexibility to design and tailor their strategies to meet the needs of members.

    Nick Sherry GAICD, another of the godfathers of the super sector and chair of the $6.4b TWUSuper — the fund for the transport industry — believes super funds should be doing more to provide holistic retirement advice to clients, including estate requirements and helping them access quality home care services.

    Russell stresses the super system is still to reach maturity and will only do so when the entire workforce is contributing nine per cent of its wages into savings for three-to-four decades. But in the interim, he says, the covenant provides a timely catalyst for the funds to develop strategies on what they can do for their members who have come to the end of the accumulation phase.

    “The funds, having built up large balances, can’t just wave members goodbye, write them a cheque and say ‘Good luck’. They expect some sort of assistance, and that’s what the funds are grappling with,” he says. “The regulators are quite rightly not being prescriptive. All people’s retirement is different. You don’t want governments dictating that now you have your asset, this is what you’re going to do with it.”

    Just deal with it

    When you ask AustralianSuper chair Dr Don Russell what his greatest career lesson is, the reply echoes his former prime ministerial boss Paul Keating. It also stands in stark contrast to the standard modern political, and often corporate, paradigm — to manage rather than directly confront difficult issues.

    “It’s better to identify and deal with problems than to spend a lot of time pretending to deal with them,” he says. “It certainly delivers huge returns in a political context, because the bar is so low that the political leadership identifying problems and dealing with them is seen as so remarkable.”

    Russell also believes this philosophy equally applies to businesses and other private sector institutions. “You’re always better at identifying the problems and then dealing with them than trying to develop public relations or media strategies, which appear to be dealing with things,” he says. “It’s the basis of success. Dealing with problems efficiently and effectively underlies most successful institutions and most successful companies.”

    Working with Keating in the early 1990s, Russell confronted one of the biggest problems ever facing the nation — an avalanche of retiring baby boomers who had little to live on beyond the aged pension. In response, he became one of the architects of the superannuation guarantee charge, introduced by Keating to federal parliament in 1992.

    Russell says he and his fellow architects of the scheme, including ACTU head Bill Kelty AC, knew what they were doing was “momentous”.

    “Financial assets give people options,” says Russell. “It was designed to empower the community in a way that had not been a feature of Australia and still isn’t a feature of most countries. We also wanted to leave the decisions very much in the hands of the individual and were always conscious it was their money. We certainly had done the arithmetic because the arithmetic inevitably drives you to a very large pool of money, which has to be invested. But thinking in the abstract, it’s all very well doing the numbers. The reality is always much more powerful and important than how you felt at the time.”

    Back then, the industry fund movement, underpinned by billions of dollars in inflows from union-aligned employees, was just a concept. Over the decades these funds, led by AustralianSuper, the first fund in Australia to reach $200b in members’ assets under management, have become a disruptive force that has put competitive pressure on the incumbent retail funds.

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