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Responsible investment - what, how and why?

by Simon O’Connor, Responsible Investment Association Australasia

If you’ve been reading the financial papers, it would appear that coal, gas and oil are on the nose for investors.

At least that’s the impression with recent announcements fossil fuel companies being divested by many investors – from large superfunds HESTA, Local Government Super and UniSuper, through to fund managers AMP Capital, Hunter Hall and Australian Ethical, religious groups including the Uniting Church, as well as universities of Sydney and the ANU.

This follows a period where 16 superfunds have sold their holdings of tobacco stocks valued at $1.2 billion, two major superfunds have invested in social services programs to keep families together (through social benefit bonds), investors are flexing their ownership muscle to improve the environmental impact of the production of palm oil and the workforce conditions of garment manufacturers in Bangladesh.

So what’s going on? Are our major investment houses and super funds all turning to ethical investing?

The rise of responsible investment

In Australia, 50 per cent of our top 50 super funds are self-declared responsible investors, along with eight of the top ten largest fund managers.

In its essence, this means simply that they all agree there is more driving investment returns than merely what is presented in the financial reports of companies. These investors acknowledge that increasingly, factors traditionally considered “non-financial” – the quality of management, the way companies treat their workers, the management of community concerns, the control of pollution, water consumption patterns etc – are contributing significantly to the investment outcomes of listed companies.

Think Leighton Holdings – late last year allegations emerged that the company was paying bribes to win contracts in its emerging market operations. In a day, based on allegations alone, the share price tanked by 10%. 

Take Telstra – earlier this year the company was quoted saying that ethics are its number one priority for its operations in China – Number 1! Why? Quite simply the company had lost hundreds of millions in an acquisition that turned sour after it was revealed their partner was undertaking corrupt dealings with the Chinese government.

Look at the coal seam gas industry – this is an industry that in past years was given a pretty clear and open run to explore and develop gas opportunities. The companies involved progressed paying insufficient concern for the communities within which they were operating. It could be argued they underestimated the community concern that has subsequently mobilised into very effective opposition, resulting in political backlash, knee jerk regulatory responses, that have had very material impacts on the ability of companies to deliver on projects. 

In short, the rise in commitment to responsible investment practices derives simply from the fact that there continue to be text book examples of companies destroying shareholder value due to ineffective management of “non-financial” issues.

The problem being, these non-financial issues rapidly become financial when mismanaged.

As a result, there is now close to $1 trillion in assets managed in Australia by signatories to the UN Principles for Responsible Investment. 

Responsible investment – the process of assessing environmental, social, corporate governance and ethical risks in additional to financial risks in a systematic manner – is now mainstream in investment practices and indeed is increasingly the benchmark of good investment practice.

So why are some responsible investors divesting of fossil fuels but others aren’t?

Under this broad umbrella term sit a number of investment practices that will result in different outcomes, and the use of different tools. (see break out box on different investment styles).

Ethical investment for example, typically uses negative screens to exclude industries deemed inconsistent with investors’ values. ESG (environmental, social and governance) integration on the other hand typically is a systematic process of assessing a broad array of risks across economic, political, regulatory, environmental and social, but rarely involves screening out of investments.

On the issue of fossil fuels there are a mix of investors, from ethical funds through to large mainstream institutional funds, who are realigning their fossil fuel investments. The buzz word seems to be divestment, but between divesting and doing nothing is where most of the activity is underway by responsible investors. For example:

  • Billions of dollars of investment are flowing into clean energy.
  • Investors are engaging directly with a number of listed companies to influence corporate responses to climate change.
  • Many investors are assessing their portfolio carbon risk, and taking action to lower that exposure.
  • Numerous investor trips have occurred in the last year to meet companies in coal, coal seam gas, coal transport, and LNG, whilst also engaging with communities, NGOs and other stakeholders to be fully informed.
  • Investor groups are actively working for stronger policy settings on renewable energy and carbon emissions.

It is this diversity of approaches to responsible investment that has resulted in the great diversity of responses by investors who have recently announced partial divestment from fossil fuels. In essence, all these investment organisations are reflecting the interests and views of their members.

A rising public interest in investing responsibly:

The unfortunate truth is that for the past decade, despite the strong uptake from institutional investors, the public demand for ethical and socially responsible products has remained stubbornly low, at around 1.5% of total assets under management.

In the recent year we have observed a significant increase in public scrutiny of the investment industry, with institutional investors hearing from their members on issues much more regularly. Partly this is due to the rise in civil society movements using the power of social media to run email campaigns targeting large investors.

But equally it reflects a logical progression of the rise of the more engaged consumer, who pays greater attention to their purchasing choices more broadly – for example, in the supermarket aisles choosing Fair Trade coffee, free range eggs, healthier food options etc. – with this translating into consumers asking more questions of how their life savings are managed.

Annually our organisation measures the growth in this industry and, in the most recent Responsible Investment Benchmark Report 2014, for the first time in a decade we saw a small but significant upswing in demand to 2.5% of total assets under management.

Our polling indicates that the vast majority of Australians simply expect that their investments are managed in a manner that does no harm. This may not translate into Australians choosing ethical investment options, but it does indicate the reasons that superfunds such as HESTA and Local Government Super can be concluding that ceasing investments in companies that are contributing to climate change, and that are highly exposed to the trends that are penalising high emissions intensive companies, are investments worth excluding from their portfolios.

Ethics and risk

On the issue of fossil fuels, we have a situation where the ethics and the economic risks are converging.

Ethical investors are increasingly concluding that divesting of fossil fuels is the only way forward for reasons described by Desmond Tutu as “it makes no sense to invest in companies that undermine our future.”

For those investors looking at the hard-nosed investment risks, many are concluding that investments in the highest emissions intensive companies, namely thermal coal, are looking just too risky. Whether its UBS, Citi, HSBC or other major investment houses, the consistent thesis is that a structural shift in the way we produce energy is underway, as renewable energy becomes cheaper and faster than any had anticipated, and as regulations on emissions tighten in most countries (expect Australia), this has significant ramifications for Australian export thermal coal.

Despite, as the argument goes, coal likely to have a big role to play in generating energy for many years yet, it’s the slow down in growth of coal consumption and replacement by renewables that will be enough to challenge the export businesses of Australian coal producers.  Indeed, we’re already seeing the impact of that slowing of demand with no reprieve in sight.

So does it stack up on performance?

Coal, as described above, is merely a case study on where responsible investors are assessing the broad range of risks at play that are influencing investment outcomes. Large super funds like Local Government Super and HESTA are making well informed investment decisions that are backed up by sound research and analysis – it’s their conviction that reducing their exposure to fossil fuels will deliver superior risk adjusted returns over the long run.

So does a responsible investment approach deliver such returns? Well, pleasingly, with responsible investors doing more research for every investment decision they are making, this is translating into superior results over the short, medium and long term. (See performance chart below).

Our annual research on the size, growth and performance of the industry consistently has highlighted the strong performance, and often outperformance of responsible investment funds against the benchmark and mainstream funds.

The positive to all this is that you can invest responsibly and make good returns for your retirement.

RESPONSIBLE INVESTMENT STYLES:

1. Screening of investments – There are three distinct approaches to screening; exclusionary/negative screening (systematically excluding industry sectors or companies based on specific values based criteria), positive/best-in-class screening (investing in sectors or companies selected for positive sustainability performance relative to industry peers) and norms-based screening (screening on the basis of international norms as defined by the UN, such as the UN Convention on Cluster Munitions).

2. Sustainability themed investing –commonly refers to funds that invest in clean energy, green technology, sustainable agriculture and forestry, green property, or water technology.

3. Impact/community investing – targeted investments aimed at solving social or environmental problems whilst also delivering financial returns.

4. Corporate advocacy and shareholder action – Employing shareholder power to influence corporate behaviour including through direct corporate engagement, filing or co-filing shareholder proposals and proxy voting that is guided by comprehensive ESG guidelines.

5. Integration of ESG factors – involves the systematic and explicit inclusion by investment managers of environmental, social and governance factors into traditional financial analysis and investment decision making based on an acceptance that these factors represent a core driver of both value and risk in companies and assets.

What should investors do?

  1. Decide what issues are most important to you.
  2. Where is your money currently invested? Look at your portfolio, ask your super fund or financial adviser how they are investing to manage those issues important to you
  3. Do your research. There are lots of managed funds, super funds and financial adviser options out there.
  4. Spend the time, read the product statements and be sure you understand the fees.
  5. From talk to walk – is it time to move your money to a portfolio, fund or adviser that better reflects the issues that are important to you? 

Start by looking at the funds and advisers Certified by the Responsible Investment Association – here: http://www.responsibleinvestment.org/certification-program/

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