Understanding materiality thresholds in responsible investment
What are materiality thresholds?
Derived from financial accounting, materiality thresholds are set limits for exposure to certain industries. By setting these thresholds, funds define how much a product will be exposed to these industries.
Materiality thresholds may be used in combination with chosen approach(es) to responsible investing and, risk/return considerations. They allow for greater flexibility to progress their responsible investment strategy (i.e., integrating Environmental, Social and Governance (ESG) factors into the process).
Example
For example, an equity fund with a strategy of negative screening based on a fossil fuels exclusion threshold that has constructed a portfolio with the aim of excluding investment in companies that derive >5% revenue from coal, oil and gas industries (from mining / extraction to refining and power generation).
OR
A fund with “Socially Responsible” in its label that applies a negative screen with a 5% revenue threshold on the following:
(1) coal, oil, tar and oil sands extraction and production
(2) gambling and adult entertainment related activities, including production, casino operation and distribution
(3) predatory lending.
The same fund may also apply a 0% revenue threshold on the following:
(1) tobacco and nicotine alternatives production
(2) controversial weapons and nuclear weapons development and production including biological and chemical weapons, depleted uranium ammunition/armour, anti-personnel mines or cluster munitions/sub-munitions and their key components.
Why materiality thresholds are often used in Australia
As a nation with significant market exposure to heavy emitters, fossil fuels and supply chain, materiality thresholds become particularly crucial in Australia. The country’s reliance on industries with substantial environmental impact, coupled with the pressing need to address climate concerns, underscores the importance of strategic and responsible investing.
Materiality thresholds offer a systematic approach to managing risks associated with these industries, ensuring that investments align with ethical standards and contribute positively to sustainability goals, as well as being able to offer a diversified portfolio while delivering market-like returns within the context of the Australian share market.
In addition, as Australia does not have a legislated product labelling regime, there are no minimum requirements for products which label themselves as sustainable or ethical (or similar).
Diverse approaches in responsible investing
Investment managers can take diverse approaches to responsible investing, including in relation to climate considerations, with many incorporating materiality thresholds.
Some opt to exclude specific products or sectors, like fossil fuels, while others actively seek companies contributing to transition solutions through renewable energy, energy-efficient practices, and sustainable land management. Alternatively, some engage directly with companies on their climate impact rather than excluding them from portfolios.
Materiality thresholds in RIAA’s Certification Program
RIAA takes a rigorous stance against greenwashing through our Certification Program. This program aims to enhance the transparency and accuracy of financial services products in Australia and New Zealand, ensuring clarity, transparency, and truthfulness in their claims. RIAA Certification requires clear and consistent definitions of terms used in product labels, such as “Sustainable,” “Green,” and “Impact,” along with strategies, policies, processes, and disclosures demonstrating aligned responsible investment practices.
Every financial product certified by RIAA incorporates materiality thresholds. These often involve negative or positive screening of companies and industries based on revenue, positioning on a preferred benchmark, positive sustainability credentials, or market capitalisation. Materiality thresholds allow product issuers to focus efforts on specific sustainability topics (such as climate action, coal, oil, and gas holdings, and biodiversity, as well as gambling, modern slavery, and the production and distribution of alcohol), while balancing the Australian market’s effects on returns.
Looking under the hood
RIAA always suggests looking under the hood of any fund, at their responsible investment practices, the materiality thresholds in use, and ‘portfolio holdings’ or companies that make up the fund, to check that they are aligned with the specific issues deemed important to you as an investor.