By Miriam Herold, Head of Research, Centrepoint Alliance
Australia experienced its worst ever bushfire season over the recent summer with hundreds of homes destroyed, dozens of lives lost and millions of native animals perishing. The scale of destruction caught the attention of the world’s media and turned its focus to climate change.
Investors are taking note, and there is increasing demand from clients for investment options which align to their values relating to environmental, social and governance (ESG) matters. In a recent survey, 69% of Australians indicated that they would rather invest in a responsible super fund that considers the environmental, social and governance aspects of the companies it invests in - in addition to maximising returns, rather than a super fund which considers only maximising returns1.
Responsible investing is not a new idea and investment strategies incorporating a socially responsible or ethical awareness have been around for decades. Europe has been the pioneering region in this investment space, and legislation has been introduced in a number of European countries requiring investment managers to address the United Nations Sustainable Development Goals. The trend has spread from asset managers to retail advisers and in 2019 regulation was introduced in the EU requiring financial advisers to establish their clients’ ESG preferences during suitability assessments2.
The millennial generation is more assured and vocal in terms of its values and preferences than any generation which has come before it. As their incomes and superannuation balances increase this will lead to even greater demand for a comprehensive range of responsible investments.
There is a range of approaches to responsible and ESG investment which have evolved in recent decades. The different approaches can be summarised as follows:
- Negative Screening
The simplest, and arguably crudest, approach involves the exclusion of companies, sectors or practices which do not meet a pre-determined set of criteria. This approach is often criticised and labelled as “green washing” as investment managers can merely take their mainstream portfolios and substitute a limited number of stocks to result in an “ethical” portfolio.
- Positive Screening
In addition to negative screening, the next approach on the spectrum of responsible investment incorporates sectors or projects being selected based on positive ESG scores or attributes.
- ESG Integration
This approach is driven, not by individual values and preferences, but by the expected impact of ESG considerations on a company’s financial performance and sustainability. With this approach ESG factors are included into the investment manager’s financial analysis in a systematic and explicit manner.
- Impact Investing
The newest and most focussed approach concentrates on investments aimed at solving social or environmental problems as a direct result of the investments e.g. issuing green bonds where the capital raised will fund projects that have positive environmental or climate benefits. Investments are often sustainability themed, such as renewable energy technology.
BlackRock’s founder and CEO Larry Fink made global headlines in January with his announcement of the world’s largest investment manager’s decision to divest fossil fuel companies from its active investment strategies and to launch passive index strategies excluding fossil fuel companies. The $US1trillion Norwegian Sovereign Wealth Fund also attracted significant attention last year, with it’s decision to divest investments relating to fossil fuel and oil and gas exploration. The issue was muddied somewhat, given the enormous wealth of the Scandinavian nation was driven by the nation’s extensive oil reserve riches and the Norwegian government in January approved and opened a new oil field in the county which will be its third largest.
There is no one size fits all approach to responsible investing as clients will each have their own individual preferences and requirements. Financial Advisers can therefore add enormous value by understanding their client’s values and preferences and implementing investments which best match these requirements.
1. From Values to Riches, Charting consumer attitudes and demands for responsible investing in Australia, November 2017.
2. First Sentier Investors