Increasingly the discussion around the board rooms of Australia’s blue-chip companies and heavy-hitting institutional investors is not about how to boost profits and share prices – but how to do good. Not that the conversation is particularly about generosity or altruism: they’ve realised that adopting environmental, social and governance (ESG) principles makes sound financial and strategic sense.
“It’s been a slow burn over the past decade, but now ESG is considered an important part of investing well,” says Responsible Investments Association of Australasia CEO Simon O’Connor. “In the past couple of years it has really stimulated because we have just seen how relevant these non-financial considerations have become to share price movements.” Also known as ethical investing, responsible investing or impact investing, ESG has evolved far beyond a fringe ethos catering to a minority of green-tinged or socially conscious consumers. Traditionally, ethical investment has meant refraining from investing in harmful industries such as tobacco or armaments, or environmentally destructive practices. Under the ESG banner, it entails much more: the “social” element covers aspects such as employing non-discriminatory hiring practices, affirmative action, treatment of workers (including remuneration), and avoiding products or services derived from slave labour. The “governance” part relates to how organisations – especially listed companies – comport themselves. Increasingly they are being brought to account: Australian Ethical, the country’s biggest pure play ethical fund, recently divested its AMP holding amid revelations that the assurance giant was charging customers fees for non-existent services.According to the RIAA’s report, $1 out of every $2 invested by the institutions — $622 billion — is done according to broad responsible guidelines. “That’s much higher than in the US and closer to the European experience,” O’Connor says. A further $64.9 billion is invested according to core responsible investing principles. A similar RIAA survey of 53 super funds released shows that 81 per cent are committed to responsible investing.
Appraising ESG should be fundamental to assessing the risk and return trade-off needed for any investment — especially at a time when investors are likely to achieve lower returns globally. The core thesis of investing is to achieve a risk-adjusted return and the risk landscape is now more complex than it was. For the Australian market, the key is understanding that value can be destroyed by environmental issues, or when the share value of a fast food company dives because it has been underpaying workers. While corporate and institutional investors have led the way on ESG, governments have not proved effective advocates. But the winds of change are blowing.It has been noted that “commercial imperatives” were behind the push to ESG and climate change as a financial risk. “Institutions that fail to adequately plan for this transition put their own futures in jeopardy, with subsequent consequences for their account holder members and policy holders.Rio Tinto, who has been exiting the coal business, is seeing shareholders agitate for it to reconsider membership of industry bodies that support the coal industry.
The push is coming from both consumers and the institutions responsible for investing trillions of dollars of retail savings. It is now important to see the investment community ramping up their willingness to take a visible, active stance on these issues. The trend was highlighted at recent annual meetings of QBE Insurance and Rio Tinto. In the case of QBE, a resolution to improve the insurer’s disclosure of climate risks received close to a 20 per cent vote in favour. In the case of Rio, 18.7 per cent of holders approved a motion exhorting the miner to reconsider its membership of industry bodies advocating for the coal industry.
Global research suggests that ESG adopters perform just as well as traditional investments and in some cases are demonstrably superior. For instance, a global meta study by Deutsche Asset Management distilled the findings of 2000 separate performance studies. It concluded that deploying ESG principles helped returns 64 per cent of the time, and had a neutral or positive effect 93 per cent of the time.According to the sources, “core” responsible funds returned an average 13 per cent over five years and 6.3 per cent over 10 years, compared with 11.6 per cent and 4.4 per cent for the benchmark S&P/ASX300 accumulation index.
Australian Ethical reports that its flagship retail fund gained 14 per cent over the past five years and 7.8 per cent over the past 10 years. The benchmark small ordinaries index returned 9.2 per cent and 2.6 per cent respectively. Australian Ethical CEO Phil Vernon says about half of all super funds have adopted some sort of responsible investment screens. Climate change, shifting consumer preferences and a hardening of attitudes towards big companies have all played a role. “We talk about the rise of the conscious consumer — substantial issues are becoming front and centre of their mind,” he says.
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