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Divestment vs Engagement

The reoccurring question in Responsible Investing is whether you can have impact by investing in equities. Whether an investor does or does not decide to invest in a company has little bearing as to whether the operations of a company will continue.

We’ve seen a raft of institutional investment managers divest from fossil fuels over the last few years. Most super funds now have climate change policies and face mounting pressure from lobby groups to move away from fossil fuels entirely. For example, HESTA has said it is working on its climate-change-transition-plan, and the $53 billion super fund already has exclusions on companies that derive more than 15% of their revenue from thermal coal[1]. The retail funds appear to have escaped the same level of scrutiny, for now anyway.

There are two main reasons to divest. First, an investor does not morally wish to invest in an industry that is environmentally damaging. Ethical investment managers will almost certainly avoid traditional greenhouse gas emitters, along with the so-called sin stocks.
Second, an investor believes fossil fuels are a bad investment as renewable energy and renewable technology will replace tradition fuels sources such as coal and oil, making them eventually redundant. This analysis largely falls under Environmental, Social and Governance (ESG) scope.
The MSCI All Country World Index ex Fossil Fuel (MSCI ACWI ex Fossil Fuel) versus MSCI All Country World Index (MSCI ACWI) is a good case study for the latter point.  The MSCI ACWI ex-fossil fuel index has outperformed the MSCI ACWI index across all time frames since its launch in 2014 with lower volatility[2].

There appears to be a fundamental shift in the way we look at our investments in recent times. Many investors are considering the impact of the companies they invest in, and to a larger extent how the companies conduct themselves – essentially what ESG analysis is determining. And it’s worth mentioning returns are often not sacrificed, in fact sometimes enhanced – according to Responsible Investment Association Australasia (RIAA), sustainable funds were performing better through the pandemic than the broader market funds.

But it is also worth noting that whether you do or don’t invest in an oil company it won’t change the number of wells they drill. In the same way it will have no bearing on a renewable energy producer if you do or don’t buy their shares. So how do we, as investors, have an impact with our investments? The answer to most of us is not divestment. It is engagement.

Heather Brilliant, the former CFA Institute Board of Governors, defines engagement as “proactively, constructively, and collaboratively engaging with the management teams of the companies in which we invest.”[3] There is growing evidence that engagement on ESG issues can create shareholder value.

Engagement is conducted by actively managed funds; such as eInvest’s Future Impact Small Caps fund (IMPQ). The team looking after this fund will regularly engage with companies on ESG, along with risks and opportunities. The team can ensure companies have a proficient climate change strategy, make sure the board and management aren’t overpaying themselves and promote safety guidelines, to mention a few. For example, the IMPQ team have had over 1,200 meetings in the last 12 months and 150 of them were engagements on ESG activities. We may also participate in industry or investor collaborative engagement projects from time to time and have joined Climate Action 100+[4]. Such are the virtues of active management.
With our company engagement we have successfully pushed a company we own to appoint another female board member and a new female director. We have also engaged with another company on their supply chain to ensure it meets the Modern Slavery Act requirements[5]. These are factors we believe are important to a company’s conduct, which we often see reflected in good financial performance.

Passive investment does not allow an investor to engage with companies, and by extension will not allow an investor to have meaningful impact through equities investing.

A passive investment will tend to track an index or a solution that targets a specific theme where a basket of stocks is bought and only changed on a quarterly or semi-annual basis. It may be able to avoid certainly sectors or industries, but that’s where the management discretion stops. The other alternative is a managed fund that screens out the ‘sin stocks’ of alcohol, tobacco, gambling, sex-related industries, and weapons manufacturers. But to an earlier point- whether an investor buys shares in a company or not, the operations and conduct of said company will not be changed.

So, if an investor wishes to create impact in their equity investments, divestment is not the solution, and by extension neither is a passive fund. They would be best placed to put their money with an active manager who is willing to engage with companies to ensure they are allocating capital in the right places, considering their ESG risks and driving positive change.

Disclaimer: Please note that these are the views of George Whiting, Investment Specialist, eInvest and were prepared for information purposes only. Accordingly, reliance should not be placed on this presentation as the basis for making an investment, financial or other decision. This information does not take into account your investment objectives, particular needs or financial situation.

To find out how to invest in our active ETFs, visit here. The product disclosure statement for the eInvest Future Impact Small Caps Fund and more can be found at www.einvest.com.au

[1] https://www.hesta.com.au/about-us/media-centre/HESTA-announces-net-zero-by-2050-aim-climate-change-plan.html

[2] https://www.msci.com/documents/10199/d6f6d375-cadc-472f-9066-131321681404#:~:text=The%20MSCI%20ACWI%20ex%20Fossil,oil%2C%20gas%20and%20coal%20reserves.

[3] https://blogs.cfainstitute.org/investor/2019/12/17/investing-in-the-age-of-engagement/

[4] https://perennial.net.au/our-story/corporate-social-responsibility-esg/

[5] https://d1ojo2h1269cp1.cloudfront.net/wp-content/uploads/2020_ESG_Report.pdf