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Does investing responsibly make a difference?
Introduction
Most professional investors now evaluate companies’ environmental, social and governance (ESG) credentials as part of their investment process to help ensure business models and cashflows are sustainable.
More than 50 years ago, the pioneers of responsible investing shunned ‘sin’ stocks, namely those associated with tobacco, alcohol, gambling and munitions. Since then, responsible investing has evolved from negative screening to assessing companies across a broad range of factors.
Environmental impact such as carbon emissions.
Social outcomes like protecting human rights.
Governance including transparency, accountability, and fairness.
By 2018, 80% of institutional investors incorporated environmental, social and governance (ESG) considerations into their investment process, according to a survey of 475 global investors commissioned by State Street Global Advisors.1.
Why ESG matters
At one level ESG investment is driven by individuals’ desire to make the world a better place. Over the decades, society’s awareness of climate change has grown markedly, as has an understanding of the impact of bad corporate behaviour on employees, customers, suppliers and the broader community.
At the same time, most professional investors have come to realise that companies that don’t do the right thing have higher risk of underperformance. There is a higher risk that their business models and cashflows won’t last the distance. Corporates with weak ESG metrics are likely to find it challenging to attract investors and will pay higher funding costs over time.
Our ESG approach
In an earlier article in this series, we discussed credit risk and the need to manage it actively. We engage with all the companies in our fixed income portfolios. Rather than solely relying on financial statements, we meet with companies to better understand not only their business risks, financial risks and management approach, but also, ESG risks specifically.
We believe integrating ESG considerations into our credit analysis leads to better risk-adjusted returns. We have been explicitly monitoring ESG issues as part of our credit analysis since 2013 and reporting on these since 2016. This way, we ensure we only invest in companies with a sustainable future.
Our credit analysis includes examining corporate behaviour, companies’ legal and regulatory risks, their environmental impact (both direct and indirect), and governance practices. From this, we assign a proprietary ESG rating. We avoid, suspend trading in or divest from companies that are unwilling or unable to mitigate their ESG risks.
ESG lens to COVID-19
Since March, we have been trying to understand how the companies in which we invest are tackling the COVID-19 crisis. We must form a picture of how Australia’s corporate landscape will look post-COVID and align our portfolios accordingly.
But even following the recent market drawdown, many companies that continue to invest in their ESG strategies are proving resilient and attracting more investment. It stands to reason that a company with robust governance structures and a better understanding of all risks may be better placed during a crisis than its peers.
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1 https://www.ssga.com/investment-topics/environmental-social-governance/2018/04/esg-institutional-investor-survey.pdf