The surge in responsible investing

Why it might be time for you to put your portfolio under the ESG microscope.

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When the head of the world’s largest asset manager makes a bold prediction, it pays to listen. In this case, it’s BlackRock chief executive Larry Fink’s conviction that, in the very near future, all investors will measure a company’s value based on environmental, social and governance (ESG) factors – that is, by their impact on the environment and society and, ultimately, how they’re run. Indeed, Fink sees this occurring within five years, largely driven by millenials .

Nevertheless, Australia’s individual investors still have some way to go, says Greg Morris, Head of NAB’s Global Investment Desk.

“More and more people are starting to think about where their monies are being invested, what companies they’re invested in [and] what those companies are actually doing with their shareholder funds. But here in Australia, we’re in the very early stages of that journey.”

Sustainable investment surges

This isn’t for lack of choice. Globally, sustainable investment assets in the five major markets stand at US$30.7 trillion, according to the Global Sustainable Investment Alliance’s 2018 review, with a large volume and variety of products available to individual investors.

Meanwhile, the Responsible Investment Benchmark Report 2018 ­– co-authored by the Responsible Investment Association Australasia (RIAA) and KPMG – found that more than half of all professionally managed investments in Australia are now invested as responsible investments, the sector reaching $866 billion in assets under management at the end of 2017, up 39 per cent from $622 billion in 2016.

However, the same report found that the largest factor deterring additional growth was lack of understanding and advice, followed by a lack of awareness by the public. Lack of demand from individual investors was also a material concern.

ESG explained

Yet ESG factors have become increasingly important to many people, Morris points out, in line with growing awareness of such issues as single-use plastics, child labour and diversity on company boards.

So what exactly does ESG investing involve?

At its most basic, it’s about screening potential investments based on a set of standards. “Traditionally, ESG has been a negative screen,” Morris explains. “You screen out the companies that you don’t want to invest in based on ESG criteria.” This is the approach most individual and even wholesale investors still take.

However, ESG investing can also be about positive screening. “This is where ESG is about investing for betterment or good, rather than simply screening out stocks or sectors,” Morris says.

“For example, in the past, if you employed a negative screen to mining stocks, you might well have screened them out due to environmental concerns such as carbon emissions. However, with positive screening, you might choose to include them because it puts more weight on all the initiatives and strategies that many of these large mining companies are undertaking to improve education, community and social infrastructure. It really is investing for betterment.”

What about performance?

There is growing consensus that ESG investing can help investors outperform the market.

The findings of the Responsible Investment Benchmark Report support this, with KPMG’s Mark Spicer, Director, Climate Change & Sustainability Services, noting: “There is no need to sacrifice performance when investing responsibly. Instead, the opposite appears true, with [responsible investment] driving long-term sustainable value and outperforming equivalent funds.”

Morris agrees. “In the past, many people believed that there had to be some trade-off by investing ethically. That is, by screening out specific sectors and stocks, such as ‘sin stocks’ (alcohol, gambling etc), it would impact performance and their returns. There’s an increasing realisation that this isn’t necessarily the case.”

Room to move

While Morris considers Australian individual investors to be in the early stages of ESG investing, he does see something of an “awakening”.

“A lot of it is being driven by the next generation,” he says. “The kids are starting to ask, ‘Hey, Mum and Dad, how are you investing your savings and retirement monies, as well as, possibly, my inheritance?’, for example. As a result, I believe it will come more and more to the fore over the coming years.”

Yet for those of us who wish to do good in the world, to help secure our children’s future, it can appear slightly daunting. How can you feel confident a particular company is a suitable investment?

Morris acknowledges that this can be problematic for individual investors, particularly those who are self-directed. However, it isn’t impossible. It’s where NAB’s Global Investment Desk (GID) can help, he says.

“If you want to start a conversation about your options, you can sit down with someone from GID to explore all the considerations in constructing a portfolio based around ESG factors.” Moreover, GID can point you in the right direction within the NAB Group, whether you’re self-directed or looking for some direction or guidance on how to construct and/or manage your monies.

As Morris says, while it may appear slightly overwhelming, “it’s important to start thinking about these things – how the money that you’re investing now could actually impact on the world that your children live in. You want to start creating your own ESG overlay on your portfolio – be that your savings, investments or future retirement monies – one that’s aligned with your own beliefs, morals or values.”

Understanding where you’re going

Of course, the starting point with any portfolio is to be absolutely clear on what you’re trying to achieve. “How do you want to construct the portfolio? What are the sorts of building blocks that you want to put in place around that portfolio construction? ESG might be one of those building blocks,” Morris says.

From an ESG perspective, you also need to decide whether you are looking to negatively screen out companies or sectors – be that stocks or bonds or whatever other asset class you’re interested in – or whether you’re looking at a more positive screen, or a combination of the two.

Morris has recently had many of these conversations, particularly with the younger generation.

“Times are definitely changing for ESG investing,” he says. “To date, most of the clients have been focused on environmental considerations rather than social or governance ones. However, we’re starting to see a change in mindset, with much broader questions being asked by investors on all of these matters. That can only be a good thing for the future.”