Environmental, social and governance investing is in vogue globally, but there seems to be a particular fascination for it in Australia.
Speaking at the recent Aberdeen Standard Investments Changing Investment World forum in Sydney, ASI’s global head of stewardship and ESG investment Euan Stirling noted that despite the variety of ESG interpretations in the market, actively changing companies for the better should be at its core.
What is ESG investing?
ESG investing acquired some inaccurate associations with non-financial issues during its early days, according to Mr Stirling.
“Many people perceived ESG investing to be about hugging trees and making daisy chains. This is absolutely not the case. When ESG risks begin to bite, they become very financial. And they do that very quickly,” he said.
While some see the primary focus of ESG being ethical investing, again, this was not Mr Stirling’s view. While he does support stock selection within ethical funds, he believed ESG investing to be about much more than that.
“It is about creating the right long-term outcomes for our clients through the prism of environmental, social and governance considerations. For example, if we invest in a business that is exploiting workers and treating them poorly, then returns will simply not be sustainable. The same for a business that produces toxic emissions.
“[Likewise,] if we invest in a business that is run for the benefit of one group or individual rather than the interests of our clients’ capital, then we can never be truly certain that the full benefits will accrue to our clients.
“Ultimately, ESG is about investing in the right companies and making fully informed decisions that will result in strong and sustainable risk-adjusted returns for clients. But after making those investments, it becomes about being a visible and active owner. These principles lie at the heart of ASI’s ESG investment philosophy across multiple asset classes,” he said.
Why bother with ESG factors?
There are a number of reasons to consider ESG factors in investment decision making but Mr Stirling said, first and foremost, it was simply the right thing to do.
“It does not make sense to invest client money when you only know part of the story about a business and its prospects; perhaps just the short-term financial analysis.
“Secondly, our clients increasingly demand that we consider ESG factors. In many cases, they care more about the environmental and social issues than some fund managers, who perhaps lack that broader perspective. These clients want superior returns, but they want them generated the right way.”
Mr Stirling added that the ability of ESG investments to outperform was backed up by sound numbers.
“In 2015, one of our biggest data suppliers, MSCI, asked whether ESG could add alpha. Can building ESG considerations into investment decisions improve a fund’s ability to outperform?”
The following chart shows that the answer is, undeniably yes. Everything above the zero is additional positive return. The dark-blue line indicates what can happen using a static measurement of ESG factors and the amount of value that can add.
However, the light-blue line shows that an active ESG change or momentum strategy can add even more value, with better risk-adjusted returns.
Can you generate strong returns and still invest for positive impact?
Sources: MSCI, ESG Research, 2015
ESG investing in practice
ASI established its corporate governance team in 1992. “We’ve been engaging formally with companies on environmental, social and governance matters for much longer than it has been fashionable,” Mr Stirling said.
“By keeping an open and constructive dialogue going you can learn many fascinating things about the workings of a company. We also believe that we can make a difference as investors by making companies better. It ultimately means that we can improve the returns of the investments we make for clients.”
The ASI approach to ESG investing involves researching the long-term implications of a company’s strategy and internal processes and building those factors into investment decisions. Mr Stirling notes that the activism component of ESG is not just about coming down hard on companies that are exploiting workers or heavily polluting, although that sometimes does help.
“For example, many banks in Asia are coming under significant pressure to withdraw support for palm-oil producers who are responsible for widespread deforestation.
“In Europe, the budget airline, Ryanair, has recently had to cancel hundreds of flights because of rostering problems associated with management’s dysfunctional relationship with staff. For years, the company had refused to acknowledge trade unions but is now being forced to begrudgingly.
“These are some examples of ESG issues but they don’t exist in isolation. They are part of the broader views of companies that we help our investment teams build. They are also a key element of the research process that forms the bedrock of our investment decisions,” Mr Stirling said.
The ASI approach to ESG
Mr Stirling said he pictures the ASI ESG team that he leads as the centre of the ESG universe with the different asset classes revolving around that.
The circles in the diagram below intentionally overlap to show the tangible connections that are so important to the process. Support from the entire organisation is critical to the success of ESG.
The ASI ESG capability has benefited enormously from the marriage of the Aberdeen Asset Management and Standard Life Investments teams, according to Mr Stirling.
“Aberdeen Asset Management evolved to have ESG experts in all of its equity teams which has been mirrored at ASI across the other asset classes. Standard Life Investments strength was its central team, which has now been boosted by the addition of the Aberdeen central team, taking the ASI central team headcount to more than 20,” he said.
Mr Stirling said that, considering all the ESG staff in equity, credit and real estate teams, there were more than 60 people at ASI working in this area, which was unparalleled in the investment industry.
Active ownership and ESG integration
ASI’s actions have resulted in companies, such as Indian mining company Vedanta, restructuring their boards to appoint more independent non-executives, thereby reducing risk to shareholders. This was achieved through a sustained engagement and voting campaign.
ASI has also successfully achieved this with publishing company, St Ives; utility provider, Telecom Plus and a range of other companies.
ASI has consulted with European chemicals group Covestro on its sustainability strategy. According to the Covestro management team, ASI’s interventions will directly inform their risk matrix and sustainability strategy for the future.
Kier Group, a UK construction and contracting company, consulted with ASI on its sustainability strategy and labour relations. The feedback from management reflected on the positive impact that ASI’s efforts had.
In Australia, ASI has consulted with CSL, Technology One and Challenger on remuneration policies. Mr Stirling notes that by being an active steward of investor capital, ASI is changing companies for the better.
“You really can have your cake and eat it too. The creation of investment funds that produce strong returns and a sustainable future in equal measure should bring a smile to any investor’s face,” he says.
ESG panel discussion
Following his presentation, Mr Stirling was joined for a panel discussion by Nick Bishop, ASI’s head of Australian Fixed Income and Devan Kaloo, global head of Equities. The discussion was moderated by Kate Hillyar, Institutional director.
Ms Hillyar asked that, in light of campaigns such as that by Australian oncologist Dr Bronwyn King, for portfolio managers and super funds to go tobacco-free, “why don’t we just ban tobacco?”
Mr Stirling said the role of ASI is simply to represent the interests of clients and not all of them are ready for a tobacco ban to happen.
“We do run tobacco-free portfolios and can actually include or exclude whatever stocks that clients want according to their values,” he said.
Mr Bishop raised the challenges of running ESG portfolios in the fixed income space. The major one is that a lot of the issuers of the debt are not listed entities.
“They might be a government, a private company or a super-national, for example. So, it is more difficult to get the level of disclosure needed to make the critical ESG assessments.
“Markets around the world are wrestling with the challenges that come with applying ESG to things like infrastructure, private equity, private credit and fixed income in general. You have to be well-resourced to do that properly,” he said.
Mr Kaloo suggested that within the ESG spectrum, there were issues that needed to be raised – such as engagement and how equity owners of companies have a responsibility to drive positive change.
“That’s the whole ethos of stewardship,” he said.
Ms Hillyar asked the panel where the ESG proof points were for clients. “How do clients know that managers are actually doing what they say they will?”
The truth comes in the transparency of the way that an investment manager operates, according to Mr Stirling.
“We produce a wealth of information and data on our website and in our quarterly updates about the engagements that we have with companies and regulators. We are constantly trying to drive change and create the right environment for the right return profile.
“The companies that we deal with know that the conversations that we have with them will ultimately be the subject of public discussion,” he said.
Mr Kaloo added that investment managers must be able to clearly demonstrate that ESG is embedded in their investment process.
“Regardless of whether you are creating a product or not, there needs to be an assessment about the ESG risks that the companies in your portfolios are facing. These risks have a habit of coming back and biting you with a significant financial cost,” he said.
Euan Stirling, Global Head of Stewardship and ESG Investment
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