A Perspective on Responsible InvestmentBy Ryan Cook
Responsible Investment Association Australasia
The past 12 months have proven a watershed moment for responsible investment globally. While the Covid-19 pandemic was the overwhelming disruptive force at play across global markets (alongside the US presidential election) this disruption tested many underlying economic assumptions, while also allowing for reflection upon some ‘business-as-usual’ investment practices.
Within the investment sector the terminology environmental, social and governance (ESG) is often applied to investment practices which aim to incorporate such parameters alongside financial measures when making investment decisions. ESG factors encompass a wide range of themes; broadly aligned with the United Nations Principles for Responsible Investment (UN PRI). The UN PRI outlines ESG factors:-
- Environmental factors are issues relating to the quality and functioning of the natural environment and natural systems.
- Social factors are issues relating to the rights, well-being and interests of people and communities.
- Governance factors are issues relating to the governance of companies and other investee entities.
Detailed ESG summary available at: https://www.unpri.org/sustainability-issues/environmental-social-and-governance-issues
The concepts of materiality and the related interdependency of ESG factors are also important considerations for investors, climate change being a prominent issue which encompasses all ESG factors. While reduced greenhouse gas emissions (GHG) may be captured under environmental factors; social factors such as the impact of coastal communities associated with sea-level rise, and governance factors such as net-zero organisational commitments, are important interdependency considerations for making an investment decision making process.
The approaches to responsible investment utilising ESG factors may vary. From negative and positive screening through to the impact of investing, the Responsible Investment Association Australasia has produced a spectrum aimed at capturing the range of approaches (Figure 1).
Methods such as negative screening is a process to exclude company’s holdings that do not meet a basic pre-determined criterion for investment. A common example is screening of investment portfolios to exclude companies involved in the tobacco industry, specifically tobacco production.
Figure-1: Responsible Investment Association Australasia
Conversely a positive screening investment approach may seek to target investments in companies involved in ‘green’ technologies such as renewable energy infrastructure. From a responsible investment perspective, the approach taken by an investor could be viewed as somewhat agnostic. The important consideration is that ESG factors are embedded in the investment decision making process and are transparently disclosed for investor scrutiny.
By some estimates, as of February 2021, the market for global money invested in ESG assets had topped US$100 trillion, rising from US$6 trillion in 2006. With green stimulus packages flagged to aid economic recovery post covid-19 some view ESG investing as the “growth opportunity of the century”. Though a cautious approach must be taken in assessing such claims. However, a seismic shift towards ESG investing principles appear to be gathering momentum.
Actor deliberations over the performance of ‘ESG-themed’ investments in comparison to with ‘non-ESG themed’ investments are becoming increasingly salient. However, the divergent modes for assessing investment performance, determining asset valuations and a range of other variables has resulted in a diaspora of opinions. For example, analysis from Morningstar highlighted ESG factored investment exposing investors to potentially reduced risk. By way of contrast the Financial Times may publish opinion pieces espousing the ‘the fallacy of ESG investing.’
While contrasting opinions likely remain, a recently published meta-analysis of 1,141 peer reviewed papers by NYU Stern’s Center for Sustainable Business in partnership with Rockefeller Asset Management found ‘ESG drives better financial performance. The research outlined six key takeaways:
- Improved financial performance due to ESG becomes more noticeable over longer time horizons.
- ESG integration as an investment strategy performs better than negative screening approaches.
- ESG investing provides downside protection, especially during a social or economic crisis.
- Sustainability initiatives at corporations appear to drive better financial performance due to mediating factors such as improved risk management and more innovation.
- Managing for a low-carbon future improves financial performance.
- ESG disclosure without an accompanying strategy does not drive financial performance.
Source: ESG and Financial Performance: Uncovering the Relationship by Aggregating Evidence from 1,000 Plus Studies Published between 2015 – 2020
Focussing upon evidence of risk from an ESG perspective a prominent recent sectoral example is the volatility of the global oil industry in 2020. Driven by a combination of significantly reduced global transport because of the Covid-19 pandemic and increasing societal scrutiny on GHG emissions and net zero commitments, investors divested or reduced their exposure to oil industry holdings at record levels. This partly resulted in oil industry titan Exxon Mobil’s removal from prominent financial indices such as the S&P Dow Jones in August 2020, a position the company had previously held for 92 years. Whilst the pandemic was at least partly responsible for this outcome the ESG climate perspective may have expedited this result.
Those who refrain from considering ESG factors in investment decisions may also risk jeopardising their fiduciary responsibilities. Fiduciary responsibility are the ‘acceptance of responsibility: to act in the best interests of another person or entity.’ Recent litigation by a member of an Australian superannuation fund (‘McVeigh v Rest’) serves as a prominent example. Whilst a settlement was reached in November 2020 the case resulted in a major investment sector actor Retail Employees Superannuation Pty Ltd (Rest) acknowledging climate change as a material, direct and current financial risk to the fund. Global industry-led initiatives such as the taskforce on climate related financial disclosures (TCFD) aim to provide investors with a framework to assess and mitigate climate-related financial risks.
Switching focus from downside risk to upside perspectives on responsible investment, the role of impact is increasingly entering the realm of investment considerations. While the concept of impact investing has existed for some time it was largely the niche domain of philanthropy and select specialised investment funds.
The Global Impact Investing Network (GIIN) defines impact investing as ‘investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return. Traditionally, impact investing has been associated with long-term patient capital invested in targeted initiatives, such as social housing. More recently a wide spectrum of investors are increasingly eager to verify and validate investment impact using a variety of metrics. An increasingly common approach has been to map investment impact in-line with the United Nations Sustainable Development Goals (SDGs). The ubiquity of the SDGs and the broader ecosystem of initiatives supporting such mapping, including the UNDP SDG Finance Sector Hub (https://sdgfinance.undp.org/about), aims to connect private investment capital with development initiatives effectively.
Despite such initiatives significant challenges remain in the flow of private investment capital to developing nations. Analysis from the Organisation for Economic Co-operation and Development (OECD) indicates private capital flows to development assistant committee (DAC) countries were erratic between 2000 and 2018 (Figure 2).
From a responsible investment perspective concerns also arise in relation to the transparency and labelling of investments purporting to generate positive impact or deliver ESG sustainability claims. A practice often referred to as ‘greenwashing’ (or
Figure 2: OECD Data – Private Flows
‘rainbow washing’ in SDGs) is increasingly coming under the purview of industry regulators. In the UK, the Financial Conduct Authority even flagged moves to protect investors from greenwashing in 2019. Within Australia the Australian Securities and Investments Commissions (ASIC) indicated a focus on investment product issuers engaging in greenwashing as part of the regulator’s 2020-2024 corporate plan.
At a societal level, the shift in wealth to millennials is proceeding apace. Some actors suggest Wall Street needs to pay close attention arguing investors under the age of 35 are ‘twice as likely as others to sell a holding if they consider a company’s behaviour to be environmentally or socially unsustainable. Domestically, initiatives such as the Australian Sustainable Finance Initiative (ASFI) aim to establish a roadmap for realigning the finance sector to support improved social, environmental, and economic outcomes. This shift in societal norms may be partly representative of millennials inherent acceptance of existential global threats posed by climate change, biodiversity loss and unfettered consumption practices.
From an investee company perspective, integrated sustainability reporting outlining ESG factors such as labour practices, and environmental performance are also increasingly required to attract and retain investment capital. While the overall level of companies issuing such sustainability, reporting reached record levels in 2020, the world’s largest asset manager BlackRock issued statements indicating a desire to harmonise sustainability reporting globally , to enable effective investment comparisons.
Challenges may also be apparent in the trustworthiness of company self-reporting. In January 2021, the world’s largest oil producer Saudi Aramco Oil Co was found to have excluded GHG emissions generated from its refineries and petrochemical plants, potentially understating the company carbon footprint by up to 50%. Despite such instances overall trust in sustainability reporting is increasing according to the Global Reporting Initiative (GRI), although significant geographical variances remain.
While undoubted challenges remain to align investment capital with more responsible investment practices, the market signals are overwhelmingly positive. Both from top-down (regulatory) and bottom-up (social licence) perspectives, what is apparent is that investors and the broader financial system are re-shaping to address this new paradigm: one that aims to view impact and success outside of purely financial returns.
The views represented in this article are my own and do not necessarily represent the views of the Responsible Investment Association Australasia, my employer.