Sustainable investment and ESG analysis has become topical over the last few years as investors have looked to companies who exercise more responsibility in their business practises. But not so encouraging is investors unwillingness to properly commit to the trend, particularly in the wholesale and retail segment.
To start we should make the distinction between ESG analysis, ethical investing, and sustainable investing – at least in our view. ESG analysis will look at the environmental, social and governance aspects of a company to see whether they will have a material impact on the business going forward. This is a risk mitigation tool and is directly linked to the financial performance of a company.
The Environmental considerations will include; energy usage, pollution, environmental damage, waste, climate change awareness. The Social considerations include; diversity, child labour, OH&S protocols, stakeholder relations, community engagement. The Governance considerations can include; board diversity, board independence, transparency, conflicts of interest.
Ethical investing, while also using ESG analysis, tends to look at the business purpose of a company and whether the company is ‘doing good’. This will often be based on ethical or moral principles, rather than financial performance. Not to say ethical investing doesn’t consider financial performance, but the main focus tends to be whether a company is doing the right thing.
Ethical investing uses negative screens, so will typically avoid the ‘sin stocks’ of gambling, alcohol, smoking, weapons and fossil fuels. Investors often associate ethical investment with limited return capabilities as sections of the investable universe are being excluded.
Sustainable Investing, is investing in companies that benefit from the transition to a more sustainable economy. They’re companies that are solving challenges to macro themes like pollution, climate change, demographic changes, resource inefficiency, limited education, poor healthcare and gender inequality.
In this regard the world is changing, and there are companies providing innovative and progressive solutions to the aforementioned challenges. The thesis here is that these companies should benefit as their products and solutions become increasingly more required in a more sustainable world.
So why should we be investing in sustainable investments? According to Morgan Stanley’s head of global sustainable finance, Matthew Slovik “the myth that sustainable investing requires a financial trade-off has been surprisingly sticky, despite research demonstrating that companies with strong social or environmental practices outperform their peers on a variety of measures”, he adds “by looking at thousands of mutual funds across multiple asset classes, we found that sustainable investments can help investors meet a variety of financial objectives for generating returns and managing risk.” 
McKinsey add “we support the world‘s leading investors in developing sustainable investment strategies that couple competitive financial returns with wider environmental and social benefits” 
Mercer themselves believe “including some exposure to investment managers that identify longer-term environmental and social themes and trends, and the companies delivering solutions to the environmental and social challenges we face is likely to lead to improved risk management and new investment opportunities”.
In the institutional space, we know ESG considerations are an increasing part of mandate criteria, albeit from a low base. This may be something to do with 9 out of 10 Australians feeling it important that their financial institutions invest responsibly and ethically across the board, according to RIAA.
But the retail investors still seems reluctant to commit capital, at least in meaningful size, to this area of the market. It is not a must-have allocation like, say, fixed income, or US equities for a balanced diversified portfolio. And that’s not to say that it is an availability issue, because it isn’t. 44% of Australia’s $2.25 Trillion in assets managed are managed in accordance with the Principles of Responsible Investment.
According to RIAA there were 14 new retail funds added to the certified responsible investment funds like in 2019, taking the total to 88. The challenge is understanding which funds are aiming to deliver what – ESG, Sustainable or Ethical. It is very likely that the disconnect between retail and institutional is in fact a result of education, or lack thereof. It appears to me that the average non-institutional investors will incorrectly assume Ethical Investing is Sustainable investing, and by extension associate sustainable investment with sacrificed returns.
Credit Suisse predicted sustainable investing to be a megatrend years in the making. According to Andrew McAuley, Private Banking CIO, “Sustainable investing is a long-term trend that every investor needs to consider,”. “Ultimately, stocks with poor environmental, social and governance (ESG) credentials will trade at a discount.”
So, in a time where we are rebalancing portfolios and adjusting for a new post-COVID 19 portfolio world, the question is whether every portfolio should allocate to sustainable investments. In the finance industry there are marks for being early, and all signs are pointing to the huge potential of the currently nascent sustainable investment industry. The challenge is lack of education. So how can we educate ourselves:
- Courses: Principles of Responsible Investment Academy Course, Cambridge Institute for Sustainability Leadership, EdX courses
- Groups and associations: PRI, RIAA, Carbon Action, 30% Club, B Corp, Climate Action 100+
- Pages: ESG Clarity, The Good Trade,
- Investment Platforms: Goodments, Clover
- Immerse yourself with industry professionals.
Please note that these are the views of George Whiting 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.
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