Ethical investment enters the mainstream

Each superannuation fund may be doing it a little differently, but Damon Taylor writes that responsible and ethical investment is becoming increasingly mainstream.

There seems little doubt that the terms ‘responsible’ and ‘ethical’ are appearing more and more often when it comes to both superannuation and broader retail investment.

These are things which executives and investors, either direct or indirect, are caring more about and for Duncan Paterson, chief executive officer of Corporate Analysis Enhanced Responsibility (CAER), such consideration is long overdue.

“Over 50 per cent of the assets under management on the Australian Stock Exchange are managed by people who have signed on to the United Nations Principles for Responsible Investment (UNPRI),” he said.

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“And as a proportion of funds under management, Australia now has the highest uptake globally of the Principles.

“It’s been a tremendous success in this country,” Paterson continued.

“The UN Principles for Responsible Investment require signatories to acknowledge that they consider environmental, social and governance factors when making investment decisions, putting together mandates, considering how they relate to other stakeholders, things like that.

“So there’s absolutely no doubt that very serious consideration to responsible investment is being given by the mainstream in Australia.”

Looking to superannuation funds specifically, Fiona Trafford-Walker, director of consulting for Frontier Advisors, said that the focus on environmental, social and governance (ESG) factors was more mixed.

“It really varies by fund,” she said. “Some funds are still very focused on it but it’s not so much work they’re doing themselves at the asset allocation level as it is working with fund managers and knowing what it is that they’re doing,” Trafford-Walker continued.

“The focus is on how managers are choosing companies, how they’re assessing risks.

“They may even use it as a carrot for a new mandate and say to a manager ‘look, if you can really improve on your ESG understanding, then you will be looked at more favourably as long as everything else is okay as well.’”

But while super funds’ tendency was to manage the managers with respect to ESG, Trafford-Walker reiterated that such considerations were not always a priority.

“We have a number of clients for whom it’s either not an issue or they’ve got other things to do or, more commonly, they’re focused on the fallout from the GFC (global financial crisis), the European debt crisis, MySuper, and so on,” she said. “It’s all of those things that are much more immediate concerns.

“And that’s meant that things like ESG are pushed to the back a little bit.”

Of course, the more practical side of considering ethical, social and governance issues when investing revolves around performance and return advantage.

And for Phillip Vernon, managing director of Australian Ethical Investment, the relationship between ESG and long-term macro risk means that better performing companies can be identified as a consequence.

“We believe that there is a return advantage when you’re investing in these products over the longer term,” he said.

“You take ESG issues into consideration and you’re avoiding long-term macro risks.

“And so you end up with a portfolio that’s better placed to perform over the long term because it avoids those long-term macro risks – but it does go beyond risk mitigation,” Vernon continued.

“I think there’s also a recognition that it can actually be return enhancement as well because by applying the criteria, you actually identify better long-term, quality companies.

“You could even think of it as an additional tool from almost a quality filter point of view.”

Alternatively, Trafford-Walker said that the biggest challenge in measuring the relative performance of ESG investments lay in the fact that fund managers didn’t necessarily have both ESG and non-ESG products.

“Look, it’s not clear because ESG has really leapt the hurdle of negative screens and positive screens,” she said.

“And because it really is a way of thinking about risk management, you tend to find managers are either incorporating that or they’re not – it makes it hard to do a direct comparison product by product.

“That said, what I can say is that when we look at ESG, we say its about identifying risks and we haven’t seen any evidence that thinking in that way about portfolio has cost returns,” Trafford-Walker added.

“In fact, if anything you can intuitively say that its helped returns because you’re identifying risks that might not otherwise be picked up.”

Like Vernon, Trafford-Walker said that environmental, social and governance issues were generally long-term themes.

“Climate change, for instance, is a long term theme,” she said.

”On the other hand, governance is quite easy to pick and for people to say ‘look, there’s clearly value added from focusing on good governance.’

“Now, that’s not always the case because some companies do well no matter what, but for the most part you can say that a company that has poor governance through its processes is not going to be good for investors,” Trafford-Walker explained.

“On the social side of things, I don’t think the data is quite as good, but again, a company that doesn’t kill its workers, for example, is always going to be better than one that does.

“So you can make these assertions and, though the data might not yet be there to support it, know intuitively that they stand up quite strongly and will make a difference over the longer term.”

Indeed, it seems that a large part of the ESG investment battle relates to awareness and education. After all, is it not possible, even likely, that a super fund’s chief investment officer will not necessarily be aware of how ethical or socially responsible a given investment is?

For Paterson, such a scenario was an absolute given.

“When you look at the asset allocations that the majority of super funds in Australia are using, quite a lot of them will be in passive products,” he said.

“And given that they’re pooled mandates, it’s quite unlikely that those people investing in those sorts of products will have discrete control over what companies they’re investing in and what they’re not.

“They will almost certainly be investing in companies which are exposed to things which their members would, in all likelihood, be quite concerned about,” Paterson continued.

“Weapons manufacture, land mines, tobacco, gambling – these are the sorts of push-button issues which, increasingly, stakeholders are looking to the finance sector to consider.”

“And I think there’s a way to go before the sorts of information we hold is being used widely enough by asset owners.”

Trafford-Walker suggested that ESG understanding and data availability was constantly improving but that it was still not where it needed to be.

“The approach we’ve taken and the approach that our clients who actually think about ESG have taken is really to build some examples and case studies to really get managers understanding why it’s important,” she said.

“Not surprisingly, fund managers tend to be trained financially – they don’t always make the connection with an environmental risk or a social risk.

“So when we do our analysis, we say to them ‘look, if you’ve got a company who’s shipping things in from somewhere else versus one that’s not, they’re emitting carbon to ship that in, that’s got a cost, what does that mean for them?’” Trafford-Walker described.

“So they can start to price those things when they think about it.

“So you can build a bit of data that way, but if you want to go out and buy a magical data set that tells you ‘buy this stock and don’t buy that stock’, unfortunately that doesn’t exist in a generic sense.”

Not surprisingly, the data and tools Trafford-Walker alludes to, where they do exist, are not without cost. So will those super funds choosing to sleep better at night be paying more for the privilege?

The answer, according to Vernon, is that it depends on how they apply it.

“Obviously, it is an extra process and it deserves a premium and hopefully the returns will be there over time,” he said. “But the costs associated with it, particularly now when the information is becoming a little bit more available and so forth, are not unreasonable.”

For Trafford-Walker, the cost involved in investing more responsibly becomes prohibitive not because ESG investment is inherently special or unique but because an investor has choose to do something that is considered outside the ‘norm’.

“It’s like all investment products; some of them are expensive but some of them actually cost the same as any other equity product,” she said.

“It’s more about the manager’s business than it is about ESG.

“So, for example, you might have a manager who you could go to and say, ‘I want a portfolio that’s got a focus on this particular thing’ and the manager would say ‘well, that’s more work and so it’s going to cost you more,’” Trafford-Walker explained.

“It’s not because of what you want them to do specifically, it’s just that you want them to do something that’s not standard.”

Offering a different perspective, Paterson said that the cost generally lay in staffing and resourcing.

“The kind of costs that organisations like CAER add on top, they wouldn’t be significant for a reasonable-sized asset manager or asset owner,” he said.

“It’s really about the staff time, so having a dedicated resource within the organisation who is the ‘go to’ person for environmental, social and governance issues.

“That’s been one of the main areas of push-back that you get from asset owners.”

However, Paterson said that for a number of super funds, staff resources were already likely to be in place and to be dealing with ESG issues – to at least a limited extent anyway.

“The reality is that there are a number of functions within an asset owner which are going to be having to deal with these issues increasingly over time,” he said.

“In fact, it’s quite likely that every asset owner already has some resource in this area, its just a matter of ramping that up.

“So, for instance, governance and proxy voting – it’s pretty much standard practice these days to have staff in place to handle that process,” Paterson continued.

“But over time, we’re going to see more and more of those issues being tied to engagement on ESG and votes will be based on ESG.

“That’s already an area where the staff resource they have in place to deal with that issue is going to start thinking about ESG issues in future.”

But for Paterson, the sleeper issue with regard to responsible investment is member awareness. And, more specifically, it’s the cost of ignoring that awareness in a social media environment.

“People aren’t switched on to it yet but in a social media environment, asset owners are going to be increasingly under pressure from members,” he said.

“So they’ve been operating in a fairly comfortable environment to date where the members have had no idea really where their money goes and they’ve been very happy to stick with the default option.

“However, with the growing awareness amongst the NGO (non-government organisation) and activist community about the role that commercial investment plays in things like deforestation, things like climate change, environmental risks of all kinds, they’re starting to recognise that asset owners are investing in these companies that are doing the things that they’re concerned about,” Paterson continued.

“And we’ve already seen a number of quite sophisticated stakeholder engagement programs where super fund members have been working with platforms that are built by NGOs to target that fund.

“And at the moment, these superannuation funds simply aren’t equipped to handle 50 or 100 complicated questions about environmental, social and governance issues.”

So while responsible investment is perhaps not the conversation topic it should be in 2013, for Vernon it is clear that its awareness in the mainstream is improving. 

“There’s no doubt that we’re doing better in terms of awareness levels,” he said.

“And amongst the general population, I think recent times have highlighted the constraints within the world; resource constraints, climate change, food security, adverse weather patterns and so on.

“We have information that says that roughly 19 per cent of the investing public really would like to invest ethically and sustainably,” Vernon continued.

“A significant portion of that would even be prepared to compromise on returns but the balance, provided they can be satisfied that they’re getting good returns over time, they actually do want to invest in this way.

“So I think we’re slowly getting there, we’re slowly getting to a point where people actually can save and invest according to their personal values and get a competitive return over the long term.”

Trafford-Walker said that of all the themes running through a super fund’s portfolio, ESG had been the one constant in various forms for 10 to 12 years.

“It started off with the governance side of things and now it’s progressed to social and environmental,” she said.

“It periodically gets knocked out of the way by other things that happen, like the global financial crisis, like member switching, like the Aussie dollar falling through the floor and so on, but it is a constant theme that is continually having more and more time spent on it.

“And from here, it’s really for people like us and like our clients to keep talking about it, to keep raising the issue and importantly, to allocate money based on it,” Trafford-Walker continued.

“Because if managers know that mandates are coming if they think about these risks, and if they can prove that they’re genuinely worrying about it and not just paying lip service and box ticking, then clients will allocate money.

“So yes, there’s a long way to go but I think there’s been definite progress.”