The ravages of last year’s bushfires swiftly followed by COVID-19 have created a sense of palpable change among Australian investors. These two recent events triggered and made worse by a cohort of ESG risks like climate change, lost biodiversity and poor working conditions have pushed sustainability centre stage, a roundtable of industry-wide experts who connected via video conference recently have discussed.
While it has been a difficult time for all investors, the tragic events of recent months have one silver lining, according to Richard Jackson, financial planner at Richard Jackson & Associates. He’s noticed a new openness to change among his client base because of the bush fires, the virus and rising geopolitical risk. It could be a good time to be discussing more alternate ways of investing, including ESG, he said.
“My clients are very open to change at the present time, more than usual,” Jackson said.
“There have been some big events in the past six months that have rattled their cages. It is hard to argue that climate change is not harmful when half the state is on fire. That has really shifted attitudes for a lot of mainstream Australians, we’ve crossed the threshold,” Jackson continued. “They are open to change, what form that should take they don’t know. But if the argument was expressed in the right way they would be very open to the fact that sustainable investing is something they would benefit from.”
Retail flows into ESG products trail both domestic institutional investment and flows abroad. European retail investors put some USD$33 billion into ESG in Q1 compared to USD$319 million in Q1 by Australian retail investors, says Grant Kennaway, director of manager research at Morningstar.
One reason for the slow take up of ESG strategies among retail investors is the enduring misconception that they must sacrifice returns to invest responsibly, the participants discussed.
“My clients are worried they will run out of money before they die. They assume responsible investment implies inferior risk-adjusted returns,” Jackson said, whose clients are mostly self-funded retirees. “They just think they can’t afford to do it. That creates a risk for advisers [because] if you raise it then you are prodding something they are uncomfortable with and no adviser wants to do that.”
The long game
Elsewhere, Nigel Stewart, chairman of boutique advice network Stewart Partners, said that building ESG demand is incumbent on the advisory community. At Stewart Partners sustainability, educating clients and setting them on an ESG journey is central to strategy. Every adviser must engage their clients on climate change, he urged.
“This is not something that is going away,” he said.
When speaking with clients Stewart observed there tends to be limited opportunities in the market to invest and a lack of understanding around the wording and definition of sustainable investing.
This is where Stewart says the advice and research community needs to help people understand what ESG is and the methodology of how managers are incorporating ESG.
There also tends to be a lack of clarity around what clients are looking to achieve by going down this pathway, he added.
“If performance is equal, if not better, it ameliorates the concern they have [that] they are taking a hit,” Stewart said. “High expense ratios and high costs have also been a problem in the past. They are all issues I see with clients. But I think educating the clients what to look for is the key.”
Education would also help solve other misconceptions of ESG too, the group raised.
Many retail investors wrongly assume that their advisers are already investing their money responsibly and are consequently not explicitly seeking ESG labelled products, participants said.
“They are assuming that investment managers are making these decisions, that they are on top of them,” flagged Karen McLeod, adviser at Ethical Investment Advisers.
McLeod also sits on the certification committee at the Responsible Investment Association Australasia, and she said an issue a lot of advisers and retail investors have is that products coming to market are not up to standard for what investors want.
“The product coming to market is not quite what an average investor is seeking and there is a lot of greenwashing. They are being short changed in that sense,” she said. “There are a lot of great investments available, but they might be confusing for an investor or adviser to find and unpick. This needs unpacking and to be made more easily discernible to find the right solution for a client.”
Panellists also called for better communication with clients so they understand how their money is invested alongside clear labelling of a fund’s carbon footprint. Investors struggle to see the sustainability characteristics of the funds they are invested in, said Jackson, who pressed for more action on integrating ESG into normal portfolio construction in the retail space.
“Most retail advisers have straightforward ways of building portfolios, and ESG sits off to one side. It’s difficult to integrate the two in a meaningful way,” Jackson said. “At a retail client level it’s difficult to have insight into the sustainability characteristics of the fund and how to integrate that into the normal portfolio construction tools. The way forward is to remind the clients that not engaging with these things carries a lot of risk, and they are always keen to manage risk well.”
The institutional investors that joined the conversation spoke about how successful ESG policies that provide a robust enough framework to navigate extreme events are enshrined in beliefs and purpose that then drives asset allocation. It’s the kind of framework put in place at the $125 billion Aware Super fund, and the head of responsible investment Liza McDonald spoke of how climate change was singled out as one of the biggest risks and opportunities to the portfolio over 5 years ago.
Many managers are responding to the increasing demand among retail investors, including T Rowe Price, whose director of research for responsible investing based in London, Maria Elena Drew, joined the discussion. T Rowe Price has developed its own proprietary model which integrates the social, ethical and environmental profile of companies into its research platform and flags any controversies that companies may be involved in.
Employee safety and treatment is one of the categories the investment firm’s proprietary model evaluates. It can help T. Rowe Price’s portfolio managers identify potential employee related risks, which can be significant and financially material, said Drew, who explained how the pandemic has exposed social risks around the lack of sick pay for employees and catalysed inequality issues.
“Over the last couple of years our team would flag controversies that companies have had with employees. Some analysts would wonder how this was financially material to the investment case but when COVID-19 happened they started to understand the value of that,” Drew said. “It gives you a really good insight, not just into how they deal with employees but how they run the whole business. If that is how you are willing to treat your employees where else are you taking shortcuts?”
Another thing to come out of COVID 19 is that it has catalysed a lot of inequality issues, particularly in the US around racial divisions.
“This is an area we have been quite active in our engagement with companies,” Drew said. “We have a lot of growth funds and invest heavily in tech companies and we’ve been concerned about the development process of AI technologies and whether they are really reflecting all of society or embedding biases.”
The role of policy to drive change
Beyond product development the panellists reflected on the need for investors to help drive policy to encourage innovation and create a level regulatory playing field. In contrast to Europe where a new green deal will drive investment – described by Helga Birgden, a partner at Mercer who heads up the company’s responsible investment efforts globally, as “a light in the darkness” and a model for others – policy in the US and Australia is not encouraging enough innovation.
Left to their own devices, markets are bad at pricing negative externalities, lamented Chris McAlpine, investment analyst at WA Super, while Susheela Peres Da Costa, head of advisory at Regnan, agreed that policy is essential to spur companies – and investors – into action. “Regulation alters what is profitable,” she said.
T Rowe Price’s Drew agreed and pointed to the example of recycling which is not profitable without rules in place to encourage it, while carbon capture technology needs a high enough carbon tax.
“When you think about performance in climate change and sustainability there are three different tracks. Those investments that are profitable today like renewables versus fossil fuels – you see the valuations in renewables [is] much higher than in fossil fuels. Then there is the whole innovation category that could be profitable in the future but has a lot risk. Then there is a third category that is regulation dependent,” she explained. “It’s one of the things that makes sustainability tricky from an investment point.”
In another sign of growing momentum behind impact, T. Rowe Price is actively developing an investment framework that links to the UN’s Sustainable Development Goals (SDGs), aiming to launch its first global impact fund in the first quarter of next year. One of the challenges of developing an impact investing framework is showing clients exactly how the fund is delivering positive environmental and social impact in a listed equity universe. It is easier to measure impact in smaller, less complex private investments in comparison to the listed and large cap world, said Drew.
“We have three pillars that all link into the SDGs. One is environmentally focused, the other is more socially focused and one around innovation. We will show the percentage of companies within the portfolio that are linked to each one of these, as well as more anecdotal indicators.”
Panellists discussed the importance of long-term investment and warned that extreme climate events will usher in the same volatility as the pandemic triggered.
Mercer’s Birgden suggested investors decide now what assets to bring into and take out of their portfolios to successfully navigate the transition to net zero.
In what might be a tool for advisers to help navigate ESG with clients, she suggested investors think about their portfolios in terms of grey (risk) and green (solutions) – as well as those investments that fall between the two (companies capable of transition). She also referred to the importance of decarbonisation “at the right price”, flagging the need for a portfolio that both delivers on investment objectives and decarbonisation.
The roundtable also discussed the broader corporate environment and the role of investors in creating change. Industries wanting to preserve the status quo will try and “manufacture” a climate friendly narrative, warned Stuart Palmer, head of ethics at Australian Ethical Super, naming Australian gas group Santos as one culprit. He said investors should engage more with polluting companies to force root and branch reform. It involves investors not buying their story; saying it is not aligned with net zero by 2050 and urging companies to come up with another strategy, he said.
Some corporates are not only lobbying to prevent policy change around climate. Palmer also voiced his concerns that companies lobby against policy change that is meant to improve wealth distribution and tax policy. Vested interests risk obstructing big picture, systemic reforms in this area, he warned.
Positively, panellists also noted how some of Australia’s listed companies are taking a more active role engaging with government and helping to drive public debate. Companies have withdrawn advertising from Facebook because of the company’s inability to police hate speech, observed Peres Da Costa, who said the traditional idea of corporate citizenship and philanthropy amongst listed Australian companies is evolving into a realisation that they have a bigger impact on the world.
The message from the chief executive of the Principles for Responsible Investment, Fiona Reynolds, who joined the conversation from London, was simple: without responsible investment, we will all suffer.
“Individuals will all pay the price for inaction on climate change and the longer we delay the more cost it will be on all of us,” she said. In what she called a “disconnect,” the idea that institutions can invest money without thinking about the world in which their beneficiaries are going to retire “makes no sense.”
In a nod to the dearth of opportunities, panellists also called for more innovation to develop investable companies and solutions for retail investors. In a conversation that chimed with earlier calls for policy to encourage innovation, panellists called for more investment opportunities around green bonds and recycling, for example.
“The companies my clients want to invest in simply don’t exist yet,” said McLeod. “The place we need to start is at the universities. Innovation needs to come from here so we can find companies to buy.”
McLeod’s practice specialises in ethical investment, and her clients are SMSFs as well as family trusts and mums and dad.
“Our investors are quite astute and educated investors, they are professionals in environment or science or health and see these issues in their work, and they want their money to be put to work in areas that resonate for them. My clients are looking for solutions. From here things will only get more complex so we need to look at how we deliver the investments clients want for the future and still deliver on returns.”