Returns from socially responsible investing justify effort

More than a decade down the track, Australian superannuation funds are continuing to pursue socially responsible investment and, as Damon Taylor writes, they are doing so in the knowledge that the returns have usually justified the effort.

From socially responsible investment (SRI) to ethical investment and more recently to consideration of environmental, social and governance (ESG) risk, responsible investment has already had its fair share of incarnations.  

Yet while the last several years have seen terminology and definitions differ, the logic and philosophy behind responsible investment has not – and for John Shead, head of portfolio strategy, Asia Pacific for State Street Global Advisors, its presence within Australian superannuation and financial services is now well and truly mainstream.  

“At State Street, we’ve been involved in responsible investing in one shape or form for many years,” he said.

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“And if you were to look at our book of business globally, the vast majority of our responsible or ESG-type portfolios are screened portfolios or portfolios where a client has directed us to track a particular ESG index or directed us to give preference to positively rated ESG securities. 

“So the vast majority of our portfolio by AUM (assets under management) is really responding to client requests to improve ESG,” Shead continued.

“However, we’ve been researching ESG within our active investment products for many years now as well.

“We’ve published significant pieces of research, we’re signatories to the UNPRI (the United Nations Principles for Responsible Investment), it’s integrated into parts of our active equities process and embedded within our passive equities portfolios, so within the broader context of being a responsible fund manager, it’s just one more part of everyday business.” 

Offering a superannuation perspective, Peter Lambert, CEO of Local Government Super, explained that responsible investment had been noteworthy for the fund since 2002 when a decision was made not to invest in tobacco. 

“But the interesting thing is that responsible investing often gets turned into ESG investing because if you believe that there are particular environmental, social or governance risks in a specific company or industry, those risks are often very closely aligned to what a responsible investor would find morally unacceptable,” he said. 

“So, for example, we took the decision to initially exclude tobacco from our investments largely because we felt that tobacco was a sunset industry, an industry that will face increasing legislative risk as the years progress. 

“But it just so happens that many of those risks are aligned to the fact that tobacco is harmful to society in general,” Lambert continued.

“So we expanded that list of industries that we felt compelled not to be involved with to gambling, armaments, old growth logging, uranium mining – and largely on the same principles. 

“These were industries that, because of the nature and magnitude of their activities, were ultimately becoming less attractive as investment vehicles.” 

Explaining a similar entry into responsible or ESG investment, Louise Davidson, Environmental, Social and Governance investment manager for Cbus, said that her own fund’s focus was to integrate the consideration of such risks into every single investment decision made by the fund’s executive. 

“So the approach that we take primarily is to mainstream the integration of ESG across the entire portfolio,” she said.

“And that doesn’t necessarily mean using screens but what it does mean is making sure that our external fund managers are appropriately considering environmental, social and governance risks and opportunities as part of their investment decision-making process.  

“So as an example, we’ll work with our listed equities managers, talk to them on a regular basis about examples they can provide us, cases where an ESG issue has changed their investment decision-making process or the way in which they’re thinking about ESG in a thematic sense,” Davidson explained.

“And similarly, for our infrastructure and property managers, we talk to them about the ways in which they’re managing ESG risk in their portfolios for those much more tangible assets. 

“So what I would say is that our focus is all about increasing returns by better managing ESG risks. We don’t have an ethical portfolio, we don’t take decisions based on ethics, we take decisions and expect our managers to take decisions based on managing material financial risks.”  

But whether Australian superannuation funds are motivated towards responsible investment via risk or via what may be considered that fund’s own moral compass, the impact on returns must also be considered. In fact, for Lambert, despite the growing prevalence of responsible investment, the question of whether it compromises returns continues to be a key concern.  

“It’s always the stumbling point that funds point to but I don’t know that too many funds, if they are using it as an argument, have done the research to back it up,” he said.

“So in the case of tobacco, I doubt they’ve done the research to be able to say that excluding tobacco and finding either a comparable investment or sector that is similar and replacing it, was actually harming returns.  

“Its an argument that’s often used, that our job is to get the best returns and clearly that’s the case, but I very much doubt that such suggestions are based on evidence and fact.”  

According to Steven Carew, head of investment outcomes for JANA, the difficulty for trustees lay in the fact that from an investment perspective, they were there to produce positive returns and better retirement outcomes for their members. 

“As a trustee, they’ve got a fiduciary responsibility to produce strong investment returns for members but, on the other hand, we’ve seen the development over recent years of this concept of the responsible steward of capital, and that large institutional investors have social responsibilities about how they invest,” he said.

“So trying to balance those things can be quite difficult, but I think what you’re seeing is that where funds are excluding certain sectors, they tend to be sectors where there’s a social consensus that that particular sector is not desirable. 

“And in reality, these are sectors that are reasonably small, and not investing in them is unlikely to have a material impact on investment results.” 

Alternatively Shead, like Lambert, said that it was really a question of research and evidence and that at this stage, neither was definitive. 

“We’ve done a lot of research on ESG factors and it would be true to say that we haven’t yet seen overwhelming evidence that ESG factors positively influence returns in all markets, in all environments,” he said.

“However, there’s probably more evidence that ESG factors have a positive evidence than evidence that ESG factors have a negative influence – and there’s good philosophical or conceptual reasons why that might be the case.  

“So we don’t actually see this as being a question of avoiding compromise because, in reality, there is no investment philosophy that is able to ensure that returns aren’t compromised,” continued Shead.

“Every investment philosophy involves a belief set and ESG is a perfectly rational, quite well credentialed way of investing. 

“When our clients pursue ESG, they do so because they believe, quite rationally, that that will improve investment outcomes.

"And similarly, when we include it in our active investment processes, we do so on the basis that we do believe it will actually improve investment outcomes, whether in terms of risk or in terms of returns.” 

Of course as Shead rightly points out, if returns are one side of the responsible investment equation, risk is the other. Indeed as risks that are often long term and macro in nature, there is an equal temptation to push ESG aside in favour of short- to -medium-term returns. 

The line, according to Lambert, is “yes, climate change is out there but it is a problem for a later date”. 

“As super funds, we are clearly long-term investors and what that means is that if you believe in the science of climate change, for example, we should be tilting our portfolios away from industries that are likely to be affected by climate-change mitigation strategies,” he said.

“Yet people will still say that when that happens, that’s when we’ll start taking those sorts of measures. 

“And that’s all well and good but unfortunately, no one rings the bell to say ‘now is the time!’” explained Lambert.

“So I think if you’re a long-term investor, and we should all subscribe to being long-term investors, then you have to make decisions now and let these things play themselves out in whatever timeframe will occur. 

“Because when an ESG-type disaster takes place, it happens in an instant and you don’t want to run the risk of being the investor equivalent of the last man standing.” 

Interestingly, the final aspect of responsible investment has little to do with performance, risk or fiduciary responsibilities and far more to do with those for whom the superannuation system was designed.  

And while member sentiment hasn’t been overwhelmingly supportive of such trends, Davidson believes there is every chance that it will be in the future. 

“I think member support of responsible investment varies quite a bit depending on the type of membership that different funds have,” she said.

“So in Cbus, for example, I think our members would have a really strong interest in how well our property managers and infrastructure managers manage workplace safety because that directly affects them in terms of workplace safety and wellbeing. 

“And likewise, a fund that has members who work in the health industry might have a different set of concerns,” Davidson added.

“But I think in the end, there will be increasing member and civil society scrutiny on superannuation funds because superannuation is a tax-advantaged vehicle, it’s a long term savings vehicle for ordinary people. 

“They don’t want to have to be focusing all the time on what is happening with the money, but I think there is a community expectation that’s growing that super funds are not just there to rip money out of the economy but rather to ensure that money is invested responsibly.” 

Offering a similar perspective, Lambert said that popular opinion was undoubtedly a sleeper issue for responsible investment. 

“I think the reality is that popular opinion hasn’t been supportive of this in the past,” he said.

“But I think it will in the future as members become more savvy in getting their message across, whether that be through social media or through non-government organisations (NGOs) rallying their own membership to write to funds and put pressure on them to take certain actions. 

“So I think historically it’s been fund executives or, as is more often the case, boards taking leadership positions and, to some extent, anticipating what the views of their broad membership would be,” continued Lambert.

“However in the future, I think those funds who are unresponsive to these issues will actually find that the members will start driving them down that path. 

“And at the end of the day, there has to be a view that we’re not faceless organisations, that we do have a moral compass and that in all of our activities, we’re working to reflect the values that we think our members have.” 

So what then is the future of responsible investment? For Carew, it is a journey and one which the super industry has made good progress on – but one which is nowhere near complete. 

“Look, the positive thing is that super funds are really engaging with their managers on these issues, having these discussions and requiring them to demonstrate that they’re taking ESG considerations into account,” he said.

“Now we would say that some managers still have a long way to go in this space, but what we and our super fund clients try to do is talk to them about stocks they’re looking at or stocks they may have purchased, work through with them some of the risks that they’ve considered, how they took them into account, what sort of risks they evaluated and so on. 

“And that’s not really dramatically different from what we would have done in the past, but I suppose ESG is helpful insomuch as it gives a framework or a context to engage with managers about that.” 

Perhaps ironically, Davidson said that the ideal outcome for responsible investment would be that it didn’t actually exist as a topic of conversation in the future. 

“The popular saying is that ideally, I won’t have a job in five years time because this will be such a mainstream thing,” she said.

“There won’t need to be anyone like me who’s kind of standing at the sides and encouraging the rest of our team and our external fund managers to remember these issues. 

“But while I think we all agree that ESG should just be a mainstream part of the investment process, we’re not there yet and I’m pretty confident that I’ll have a job for a while to come.”