Arguing against responsible investment strategies is becoming an increasingly difficult thing to do, with fund performance and investor ambitions aligning, writes Nicholas O’Donoghue.
Suggestions that responsible investments are a folly that require fund managers to sacrifice performance to give their investors a ‘warm fuzzy feeling' are being debunked by an ever increasing mountain of evidence showing they match, or outperform, traditional funds.
While pockets of resistance remain, market forces will come to bear on those who fail to assess environmental, social and governance (ESG) risks before making their investment decision, advocates claim.
Responsible Investment Association of Australasia (RIAA) chief executive, Simon O'Connor, said there have been "streams of research" confirming the strength of responsible investment funds over recent months, with data from SuperRatings showing Australian sustainable share options were outperforming the average by almost one per cent per annum over the last three years.
"Those that continue to hang on to that myth that investing with your values means lower returns really still have their heads in the sand," he said.
"Investors are increasingly awakening to the possibilities that you can invest in line with the issues that matter to you and still deliver really strong retirement outcomes or financial returns."
ESG becoming mainstream
For O'Connor responsible investing practices have become part of the mainstream, with major international institutions embracing ESG principles.
"We're seeing ESG factors increasingly impact upon valuation," he said.
"We're seeing textbook examples of how ESG factors are critical to a number of industries in Australia, whether it's utilities, or banks or miners... understanding ESG factors is really core to understanding appropriate valuations of companies nowadays.
"We're seeing mainstream portfolio managers and analysts doing this as a matter of course. Now they may not call it responsible investment, but in all the broker research and the analyst research, you're seeing a lot more consideration of what we call the ESG factors, but for them it's just value drivers."
Meeting investor ambitions
While fund managers have been embracing responsible investment strategies to secure returns, many Australians want their investments to do more.
"Sixty per cent of Australians believe that superannuation funds should consider environmental and social impacts as well as the profits of the companies they invest in," O'Connor said.
"So a majority are now expecting, as a minimum, that their investments do no harm... these are not your traditional ethical investors, there are just expectations of the average Australian that this stuff is considered, that this stuff matters."
Echoing O'Connor's view, Good Super managing director, Andrew MacLeod, said ethical/responsible investment was the way the market has been going.
"The consumer wants these sorts of products," MacLeod said.
"If you are a good ethical and impact investing fund that is looking at companies that understand the ethical framework in which they're operating, you're investing into an expanding customer-base, not a contracting customer-base.
"I don't care whether your think that's a good thing ethically or not, it's a good thing from a business perspective."
For supporters of responsible investment strategies, the success of ESG-focused funds has come as no surprise, particularly over the longer term.
Local Government Super (LGS) chief executive, Peter Lambert, said responsible investment minimised risks, by avoiding investments in businesses that have the potential to deliver an environmental, social or governance-related disaster.
"Responsible investment is looking at risks that are embedded in companies and particular industries that play out over time," he said.
"If you're a long-term investor and you look at making decisions to mitigate against those risks, then you need to be patient and not expect there's going to be a seismic shift in the next year... what you're saying is ‘I want to modify the portfolio now to protect members from one of these event when they will occur', as inevitably they will."
Coal and tobacco going up in smoke
While coal and tobacco companies are still performing adequately, Lambert said LGS had moved to ditch companies that have exposures to both products due to ESG concerns.
"No one is saying that the world we live in today doesn't need coal," he said.
"But what people are saying is in the future, as governments are forced to act to mitigate against climate change, their focus will be on carbon, as carbon being the key contributor to climate change.
"And from there you look at the main producers of carbon and coal is carbon intensive, and therefore you're just playing out a theme; how it's not an attack on coal per say, it's simply saying that climate change is real and governments will have to do something to mitigate against climate change or the impacts will be irreparable.
"And when you look at who is going to be in the spotlight, you cannot avoid the fact that coal is seen to be a significant contributor of carbon emissions."
Those reasons have pushed LGS to divest their holdings in coal producers, and Lambert believes other funds will follow, if not for environmental reasons, then because of the anticipated actions of governments against carbon producers.
"We were the first fund in 2000 to restrict tobacco in our investment holdings and it really took another 10 years before any other fund decided to take a similar approach, and now it's not an uncommon thing to find," he said.
"We were the first fund now to divest coal from our portfolio; now I can't see this taking 10 years before it becomes fairly commonplace."
Writing's on the wall
For Good Super's MacLeod, the writing is on the wall for those who invest in coal going forward.
"Even BHP Billiton has said they're not going to develop new coal mines", he said.
"So if you're a superannuation fund with long-term patient capital, you can either say ‘I'm not going to invest in coal because I ethically don't like it,' or you can say ‘I'm not going to invest in coal, because over the long-term it make absolutely no sense'".
With evidence mounting in support of responsible investment strategies, RIAA's O'Connor said 80 per cent of superannuation trustees believed ESG fits with their fiduciary duties or "to not consider ESG would be a breach of fiduciary duties".
"What we're starting to see is the institutions, the big asset owners, are starting to demand a deeper understanding, and more rigorous approach to ESG," he said.
AB chief investment officer, Roy Maslen, agreed that responsible investment principals were integral to a funds management business.
"As a fiduciary, we have an obligation to manage client assets in accordance with the objectives and risk tolerances specified by each client," he said.
"Typically, these objectives are to maximise the financial return of their portfolios within approximate risk parameters. With this in mind, we consider ESG factors within the context of the risks [and opportunities] they may represent in investments."
Read part two of Nicholas O'Donoghue's report: E’s not just for environment in ESG investing