The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In this edition, Martyn Myer – immediate past president, Myer Foundation – and Helga Birgden – global head of responsible investment, Mercer – make the case for ASX ESG investments.
A bit of background
You may have heard environmental, social, and governance (ESG) investing referred to as ethical or responsible investing. That's because ESG takes into account environmental, social and governance factors as material to investment returns.
Last year, the Myer Foundation partnered with Mercer's Responsible Investment business to help achieve its goal of having 100% of its portfolio invested in companies with high ESG rankings.
Now on to our interview with Helga Birgden and Martyn Myer.
Why should Australian investors seek out sustainable investments?
Martyn: Given the current climate change issues, it's humanity that's in trouble, not the planet. If we don't get it right, all bets are off. What sort of planet are we going to leave our children and grandchildren? There are lots of things that we can be doing that won't break the bank. There are lots of things that we have to be doing, not should, but have to.
Helga: These [ESG] investments can outperform too. Not all responsible investment strategies outperform over all periods. But because we're long-term investors, focused on returns and truly sustainable investment solutions, we see outperformance. 37% or $1.15 trillion of assets of a total of $3.4 trillion are managed under responsible investment categories according to the RIAA [Responsible Investment Association Australasia]. The Australian equity universe has done very well for those that applied sustainable characteristics.
For example, a sample of the Mercer Fund's highly rated responsible investment Australian equity strategies have outperformed against the S&P/ASX 300 Index (ASX: XKO) benchmark over the last 7 years to December 2020. As of the middle of last year those [responsible investment] equities delivered annual returns of 10.4% over the last 3 years, compared to 5.2% from the ASX 300.
Martyn: If you invest with ESG principles in mind in a sophisticated way, you invest with economic and social tailwinds behind your investment instead of headwinds. It means that lots of things you're investing in are growing far faster than GDP. So, you're investing in growth, but for a very sound reason.
Now there are plenty of ESG funds that apply very simple screening techniques, they sort of do it after the fact. Whereas the sophisticated funds that Mercer helped us find do it from the beginning, it's integrated into their whole investment management process.
Helga: It's very important to take a nuanced view and a sophisticated view, because not all strategies are equal. Income strategies, for example, have lagged over the last couple of years. What we're talking about here is understanding the investment thesis and portfolio construction in detail. And recognising the importance of the sustainability characteristics around climate and sustainable development, etc.
What are the biggest concerns investors should have about the impact of climate change on their ASX portfolio?
Martyn: If you're in the wrong assets you could end up in stranded assets. I don't mean just in climate terms. If you think in governance terms, Crown Resorts Ltd (ASX: CWN) is a classic example. Look what happens when the governance of the board and the most senior management level is bad. They're about to lose their licenses around the country. It could destroy billions of dollars in shareholder value. And you can boil that down to poor governance. Westpac Banking Corp (ASX: WBC) had similar problems, Rio Tinto Limited (ASX: RIO) had problems like that. Even Facebook Inc (NASDAQ: FB) and its interaction with the federal government.
So it's not just climate issues. If you're not investing with these sorts of things in mind, you could invest in companies in danger of blowing up their business models or becoming stranded assets and destroying shareholder value.
Helga: One of the biggest concerns for investors is about what should be in their portfolios in the light of current policy commitments in Australia. We are framed to reduce our pollution by 15% by 2023 if we are to meet the Paris Agreement goal. That's only 2 years away. And 45% absolute carbon emissions reductions in the next 9 years. For investors that's pretty significant.
A study by Deutsche Bank AG (NYSE: DB) showed that companies that have strong climate change news, which can be evidenced, outperformed as much as 20% cumulatively over the last 12 years. There is the economic reality that climate is being priced in. And Australian equities are going to need to make up an important part of carbon reduction in portfolios.
We now see some of the leading companies committing to net zero targets like Santos Ltd (ASX: STO), Woodside Petroleum Limited (ASX: WPL), and Wesfarmers Ltd (ASX: WES). And the institutional investor community as well, such as HESTA Super, UniSuper, Aware Super.
There's a reason they're doing that. APRA, ASIC, the RBA have all called out to banks, insurers and superfunds to look at their exposure to the physical risks of climate change.
A lot of the global commitments on emissions stretch out to 2050. What are the more immediate impacts of national emissions reduction plans on ASX share prices?
Martyn: Here in Australia, the financial markets and the corporates are moving much faster than the federal government. The state governments are moving faster too. They've all committed to zero emissions by 2050, but they've also committed to 50% or more reductions by 2030.
In investment terms, the next decade represents a great opportunity to earn alpha, using these [ESG screening] techniques. But I think after a decade this stuff will be so mainstream that there won't be the opportunity to add alpha out of it. There's this golden window of opportunity to use these tools and find the funds and the companies that are doing ESG really effectively. And you can have 3–5% per year in alpha. But it won't last forever. It will all become mainstream and priced in. And those companies that don't do it will have gone bust or disappeared or taken over.
How do you weigh up the different factors in E, S, and G investing? Is any one more important than the other?
Martyn: We don't emphasise one over another. Having said that the Myer Foundation is very focused on climate. But we've found that the very best companies and funds are integrating all of these 3 issues. If the governance isn't good, then you're never going to get the other stuff right.
Helga: At Mercer, we rate strategies for E, S, and G. In order for a manger's strategy to rate well on ESG they have to show their research, portfolio construction, portfolio holdings and manager policy is consistent within their portfolio, how they are managing all 3 E, S, and G risks and opportunities. But, as Martyn rightly points out, governance is absolutely core. Assessing the financial risks associated with ESG requires a comprehensive approach, so that shareholders know what they're getting.
How do you qualify the social aspect of ESG from an investor perspective?
Helga: The social aspects are increasingly important. They are key topics like diversity inclusion, workplace safety, income inequality, financial inclusion. For example, what we call 'just transition'. With the move to a net zero economy, we have to look after workers in the fossil fuel industry. So job reskilling and training, and mental health are all important to companies as we transition. Modern slavery risk in supply chain is another big issue we've done a lot of work on at Mercer for investor clients.
Key areas of concern include gender – how companies approach and promote gender equality and women's empowerment across the value chain – and human rights. Issues like digital inclusion, making sure everyone has access to information we may take for granted, are increasingly important.
Martyn: Older people and minorities more often don't have access to digital technologies. That can affect things like information and access to the vaccines, as they're seeing in America.
How much concern is greenwashing and how can investors address this?
Martyn: The Myer Foundation struggled when we decided we wanted to go 100% [ESG]. How could we possibly do all the due diligence necessary to find those funds who are not greenwashing. Who are instead doing it in a sophisticated way. That's when we asked Mercer to help us, they've tracked all of these strategies for 15 years or more. They helped us scan more than 10,000 strategies, and we really came down to the best 25 we could find in 3 asset classes.
But there's no doubt greenwashing is going on. And they should be called out, and I think they will be over time. They won't get the rating from companies like Mercer.
Helga: We have to be very alert to greenwashing. But I think most investors have a very good 'BS' filter, especially in Australia. We're good at spotting it a mile off. It comes down to research and the ratings process. We have an independent team of 250 people researching every day into manager strategies and how they are implemented. The ESG aspects are core to their assessment.
The best way for investors to avoid greenwashing is to make sure you have access to good research and work with industry groups. For example, the Responsible Investment Association of Australasia has some great information and resources. But greenwashing is certainly going to be around for a while, with so much interest in the [ESG] subject.
For companies low on the ESG ratings, could less demand from increasingly responsible investors and ESG focused exchange-traded funds (ETFs) lead to improved dividend returns for those still buying shares?
Martyn: In the short-term, the answer is probably yes. But it's the sort of risk that I wouldn't want to take. A superfund would be concerned about the issues of stranded assets, business models being blown up or social licenses to operate getting ripped up.
We're long-term investors. We've been in equities for nearly 100 years. I think you just can't take those sorts of risks. Even in the short-term, the volatility is just going to get worse.
Helga: It really comes down to the investor's purpose and time frame, etc. But, yes, that may be the case. If investors don't allocate capital to those sorts of companies, there will always be another investor who will step in. But there is abundant research showing that the cost of capital for such companies goes up.
Martyn: I should stress here that a lot of uninitiated investors think that there's a trade-off here. They think if they invest along ESG principles they sacrifice returns. We actually see that entirely in reverse. If you do it in a sophisticated way it adds a lot of value.
Where do you see the most opportunity for responsible investing on the ASX in 2021?
Helga: There are great opportunities around green property and energy efficiency. You don't need to be investing in something new. There is a lot of robust investment in existing technologies and very strong returns in the whole energy efficiency theme.
If an investor is wanting to de-carbonise their portfolio, they do have to be aware of timing in the short-term. There is such a things as de-carbonisation at the right price. At times it's not tactical. There might be times when there's market exuberance around green stocks. You need to be savvy about that.
Martyn: Of course, none of this obviates the need to follow good investment principles, to have a diversified portfolio of various asset classes.
