For precisely this reason AMP Capital searches for ESG insights and seeks to incorporate them into investment decision making – whether these relate to oil spills, poor human rights records, questionable remuneration structures, or anything in between.

Milton Friedman, the eminent economist from the last century, spoke only one language. His was the language of making profits. To quote Friedman himself, “The business of business is business”.

No mention here of governance and environmental management affecting efficiencies and profits. Likewise some investors might not care about environmental, social and governance issues, as long as they are able to make a good return on their investment. After all, not all companies will have a giant oil spill in the Mexican Gulf, so why speak in a language that extends beyond profits?

To read AMP Capital’s Governance Report, click here.

26 July 2012

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At the moment, there is much talk about inflation in Asia, especially in China and India. How big an issue is it when it comes to investing in the region?

China and India are high-growth countries and because of that they tend to have inflation. There are times when inflation spikes but the reasons vary. One type of inflation that people get particularly concerned about is food inflation. Food inflation is usually temporary in nature. It will usually be about a bad crop or a shortage of supply. So I’m not that worried about food-related inflation; it’s usually resolvable. Other factors could be more of a concern. The thing to note is that authorities across the region are taking steps to limit inflationary pressures.

What we focus on when looking at economies experiencing inflation is finding companies with pricing power – those that can boost their prices to maintain their profitability. We try to avoid companies that are price takers; that do not have that ability to raise their prices during inflationary times because their earnings will suffer.

What’s driving the record increase in IPOs in Asia?

The IPO boom is because many companies in Asia are looking to expand their businesses. It gives you an idea of the kind of dynamism that’s going on in Asia. The managers of these companies see growth opportunities and they’re looking to grow their capital and invest that capital to take advantage of the earnings potential that is there in Asia.

The consumption story in China is gaining adherents. How are you playing this theme?

There’s a great thematic in investing in the consumption sector within China because of the strong wage growth that’s coming through. With minimum wages growing 20% and the average wage earner seeing 15% to 16% wage growth, consumers are driving the economy more. People are moving beyond a subsistence lifestyle and for the first time are buying items such as fridges and televisions and so on.

The way I’m taking advantage of this theme is to invest in some Hong Kong-listed companies that have businesses that are growing strongly in China and that are expanding the number of stores they have there. I’m investing in some of the department stores within China as well.

Korea has several global brands. Can China replicate this achievement?

South Korea has developed some great global brands. Companies such as Samsung, Hyundai Motor and LG Electronics have been highly successful across the globe. China has the potential to develop similar brand names over the next five to 10 years. We’ve noticed how much money some Chinese companies are spending on R&D. The fact is that the Chinese companies don’t want to be the low-cost producers forever. They want to add more value to what they’re producing. As they step up that value chain, they will create brand names, locally at first, and potentially globally.

Corporate governance in Asia is a risk. How do you manage it?

Corporate governance in Asia is a challenge that we have to deal with. Our approach is to make sure that we have identified who the management are, how long they’ve been there and who the owners of the company are. We spend time with management teams to understand whether they are just focused on making money for themselves or for shareholders as well. We want to see if there are other agendas that the managements want to achieve – things that might be good for their egos but perhaps not good for the share prices of their companies. Our focus is really to identify companies that are running good businesses and delivering on the potential.

One of the great things happening within Asia is the adoption of international financial reporting standards. That means that you can compare companies within Asia and properly rate Asian companies against global peers. Most of the developed markets in Asia already comply with these reporting standards. Countries such as India and Indonesia are adopting them over the next couple of years.

How important are smaller countries in the MSCI Asia ex-Japan Index such as Indonesia, Thailand and the Philippines?

The smaller countries within Asia don’t get the same kind of profile as China and India but they are a key part of what’s going on in Asia. Indonesia, Thailand and the Philippines are all countries that have got big populations and are achieving improvements in the standard of living. Their GDPs are growing at healthy rates and wage levels are rising. These countries are urbanising. They are microcosms, to some extent, of what China’s already done. We see that to be a reason for investing in some of the companies in these countries.

How is the Fund positioned at a country level?

The Fund is overweight Hong Kong and Thailand while the key underweights are to Taiwan and Malaysia. Hong Kong is favoured at the moment because I see some of the Hong Kong-listed stocks as doing well out of China. The valuations are more attractive and there are fewer regulatory risks with some of the Hong Kong stocks than there are in Chinese stocks. Taiwan’s a mature market, one with a high GDP per capita. The growth rates are still reasonable but a lot of Taiwan’s growth is about exports, either to China or elsewhere. I see Taiwan’s competitors as being more attractive than the companies in Taiwan.

Chinese internet company Baidu is a large overweight in your portfolio. Can you tell us why you are so positive on the stock?

Baidu is effectively Google for China where there’s a good long-term growth story for internet usage. It does internet search and has over 85% market share for search in China. Google is the second-biggest player and Google has said that it is leaving China because it doesn’t want to be censored anymore.

Baidu has around 72% revenue share of search in China. We think given Baidu’s market positioning the company’s revenue share will become more reflective of its market share in search; in fact, even in excess of its market share. We expect Baidu’s market share in search revenues to become more like 85% to 90%, given the company’s dominance in the space.

Another overweight is Hyundai Motors. Can you tell us your investment thesis on this company?

There are three key reasons for owning Hyundai Motor. The first is the company has a really strong base at home in Korea that’s growing healthily. Another is that the company has fantastic exposure to the emerging markets of China, India, Brazil and Russia, where they’re achieving strong market shares. In addition, Hyundai is growing market share in the developed markets thanks to improvement in the quality of the cars and its brand. Market share has risen from around 3% to 8% in Canada, for example. Hyundai’s market share is now around 6% in the US while in Europe it’s grown from around 2% to 4% in recent years.

What can investors expect from Asia in coming years?

I’m optimistic about the outlook for Asia over the next couple of years and over the next five to 10 years as well. We see that Asia will achieve faster GDP growth than the rest of the world. I think that investing in Asian companies is a great way for investors to take advantage of this expected growth. These companies have strong balance sheets and good cash flows. They are investing in their businesses, developing great products and building brand names. We look for the companies that can take advantage of this growth and deliver earnings-per-share growth to the shareholders.

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The 2010 Full Year Report examines the role and influence of proxy advisers, at a time when corporate governance is being more heavily scrutinised.

Referring to the Report, AMP Capital Investors Director of Sustainable Funds, Michael Anderson acknowledges that the importance of proxy voting is underpinned by the fact that for many shareholders proxy voting is the only way to communicate with the public companies in which they invest.

“Australian shareholders have differing approaches to proxy voting ranging from a detailed hands-on approach to those having insufficient resources to analyse in depth. Especially in the latter situation, proxy advisers have the potential to put investors in a better informed position on important issues such as board composition, executive pay and company-changing transactions.”

While proxy advisers research and recommendations may be useful to investors, advisers are sometimes criticised for the quality of their research and immense power and influence, although AMP Capital believes conflicts of interest are rare.

“Australian proxy research is of a high standard, and continues to improve. Australian advisers do not generally provide corporate advice to the companies they report on so there is less likelihood of conflicts of interest. Provided the research is used thoughtfully, investors are often better off with the additional advice from proxy advisers,” Mr Anderson said.

In Australia the two main providers of proxy advice are ISS (Riskmetrics) and CGI-Glass Lewis. A large number of Australian institutions subscribe to the services of either, or both of these.

The Corporate Governance Report, which is released twice a year, provides a summary of AMP Capital’s corporate governance activity. AMP Capital takes seriously its responsibilities as an investment manager, as an agent of shareholders in companies and as a steward of its clients’ assets. The latest Report includes an analysis of the 2010 proxy season and reviews proxy voting and corporate governance issues.

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“As a continuation of our organization’s long-standing commitment to corporate stewardship, we are pleased to sign on to the UN investment initiative,” said Grant Forster, chief executive officer of Principal Global Investors Australia. “It is intrinsic to who we are as an asset manager and aligns with our investment strategy and culture.”

Signatories commit to considering the six Principles of Responsible Investment related to environmental, social and corporate governance (ESG) issues in the course of doing business. Although the Principles are voluntary and aspirational, reporting on an annual basis is required. Governance is provided by a 13-person board made up of 11 elected signatory representatives and two representatives from the UN Environment Program and the UN Global Compact.

“As a leader in the global asset management industry, we believe appropriate consideration of these issues is part of delivering superior risk adjusted returns” Forster said. “We are committed to acting in the best long-term interests of our clients and will apply the Principles where consistent with our fiduciary responsibilities and in alignment with our investors’ expectations.”

For more about PRI or to view a complete list of signatories, go to www.unpri.org.

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• a 10% increase in managed responsible investment portfolios
• a 50% increase in responsibly invested financial adviser portfolios
• a 29% increase in Australian signatories to the Principles of Responsible Investment

Released at the “Inside RI” event on 15 November, Responsible Investment 2010 – the real facts about the growth and the size of RI in Australia and New Zealand, is the 10th annual Benchmark Report commissioned by the Responsible Investment Association Australasia (RIAA). It reaffirms that taking environmental, social and governance (ESG) issues into account has become best practice for those looking to improve investment performance in the short and long term.

In a time when many are still reeling from the effects of the global financial crisis, the consumer demand for responsible investment products has almost doubled with ethical advisor portfolios growing an extraordinary 50% from AU $972 million to AU $1.46 billion after a decrease of 21% in the 2009.

This was also confirmed at a community briefing held at RIAA’s 7th International Responsible Investment Conference in September 2010 with 93% of the attendees stating they would adopt a responsible investment approach in the future.

RIAA’s benchmark report shows that not only is responsible investment a smart choice, it largely outperforms the average mainstream funds over one, three, five and seven years for Australian shares and international shares. Balanced growth managed funds outperformed mainstream funds over five and seven years.

Since the difficult times investors were facing in 2009, the RIAA report reveals that core responsible investment (a combination of specialised managed funds, community finance, green loans, RI charity investments and financial adviser portfolios) rose 13% from AU $16.15 billion to AU $18.19 billion.

Furthermore, managed responsible investment portfolios alone rose 10% from AU $14.02 billion to AU $15.41 billion. Growth in responsible investment portfolios fared better than the broader market of managed portfolios which rose 9% in that same period.

“We continue to see world changing events in areas which are deeply interconnected such as climate change, energy security, water scarcity, food shortages and environmental risk which are all driving responsible investment. These issues have serious implications for societies, economies and the entire investment chain. The 2010 Benchmark report figures exemplify the disappointment experienced by more and more people about the inability of traditional financial models to recognise the inherent impact of environmental, social and governance issues on investments. Taking these issues into account is both profitable and smart,” said Louise O’Halloran, Executive Director of RIAA.

Another shining star in responsible investment is community finance. This dynamic investment strategy continued on a steady growth path increasing 15% from AU $1.16 billion to AU $1.33 billion.

Over half all funds under management in Australia are now signed to the United Nations backed Principles for Responsible Investment. The RIAA report shows there has been a rise in Australian signatories up 29% from 2009 with 112 Australian signatories now representing 14% of the globally signatory base. Funds under management for this group are approximately US $591 billion.

“This year’s study is the most expansive edition of RIAA’s benchmarking report to date including revised definitions; data on ESG integration levels in Australian fund strategies; an enlarged section on broad RI initiatives; the second annual Cleantech Report; a comprehensive list of the growing body of Australian-based ESG research; and a full RIAA membership directory. This report is a tribute to the ever growing list of accomplishments of the RI industry in Australia, and most especially to the members of RIAA”, said Louise O’Halloran, Executive Director of RIAA.

A copy of Responsible Investment 2010 can be downloaded from the RIAA website. (http://www.responsibleinvestment.org)

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A greater focus on ‘responsible investing’ has seen many companies becoming good corporate citizens; examples include companies that rejuvenate land they have mined or contribute to the wellbeing of communities in which they operate.

Increasing investor appetite for such companies led to the emergence of a number of funds, varying described as ‘ethical’, ‘socially responsible’ or simply ESG (which stands for environment, social and governance). Each year, Lonsec researches and rates a number of funds so categorised, to help advisers find the applicable products for their clients.

How to categorise ‘responsible’ funds

The following broad definitions are a guide:

1. Ethical: Negative screening of companies in certain industries deemed to have a harmful societal impact. Avoiding investments in bad companies is the overarching investment motivation.
2. Socially Responsible Investing (SRI): Generally negative screening of certain sectors in line with above but may also include a positive screening element seeking to include socially responsible companies. Rewarding good corporate citizens is a partial investment motivation.
3. Sustainable investing (ESG): A belief that those companies with advanced approaches to environmental, social and governance risk management will exhibit superior performance than companies with sub optimal approaches. While it is likely that these companies will tend to rank highly on corporate ethics, unlike ethical investment, financial performance is the overarching investment consideration.

Lonsec takes fund categorisation a step further, focusing on the depth of responsible investment factors incorporated into the investment process; the output of which is a light, medium or dark green rating.

These classifications are aimed to give a general indication of Lonsec’s assessment of the level of ethical / Socially Responsible Investing (SRI) / Environmental, Social and Governance (ESG) criteria applied to, and evident in, the Manager’s investment process. The classification is not intended as an investment rating or recommendation.
Lonsec categorises the funds in its Responsible Investment universe as follows:

Client considerations –not a one-size fits all

ESG and sustainable investment funds now tend to dominate the Responsible Investment sector replacing traditional ethical and SRI approaches. Broadly, the market seems to have less appetite for funds focused solely on avoiding corporate bad guys compared to those investing in sustainable companies.

Despite progress, the sector still presents challenges for those providing financial advice. Investors in this sector are broadly grouped together under a ‘Responsible Investment’ categorisation, though bring different investment motivations which can make it tricky for advisers to confidently select investment managers for clients. Importantly, Lonsec believes that with some research, responsible investment investors can relatively easily determine a more suitable investment option for their needs than provided by a mainstream equities fund. The following are suggested priority areas for consideration in discussion with clients interested in this sector:

How Green is my client? It is important to sample investors’ green motivations. While Responsible Investors are commonly linked by a motivation to take account of a broader range of factors than solely fundamental financial analysis in their investment decisions and a concern about the community impact of corporate activities, the investment motivations can vary greatly across the sector. Ethically motivated investors may be aggrieved to allocated capital to major miners such as BHP and RIO, while ESG investors may be comfortable with such holdings given those companies’ risk management practices, community engagement, workplace safety record and so forth.

Does investment team buy-in matter? The level of ESG engagement in portfolio management teams varies across the sector. Lonsec believes this aspect is an important credibility test for investment managers and most likely a central consideration for investors in these products. In general a portfolio manager who is motivated and engaged with the Responsible Investment agenda brings added focus to the fund and is an important factor in increasing alignment of interest with investors. While Lonsec is primarily interested in the investment credentials of the Manager, whether the investment team is displaying a degree of engagement with the responsible investment sector is a relevant consideration in Lonsec’s appraisal of these products. This may be evident through the inclusion of positively screened companies at the margins of the portfolio where supported by the underlying investment research. Factors such as elevated corporate commitment to the sector, evident in participation in industry forums, production of research papers and company engagement can also suggest increased motivation.

Manage performance expectations. Spend some time with clients to discuss performance expectations. The depth of ethical screen can significantly constrain the investment universe and may have a performance impact during periods when certain sectors outperform (e.g. materials). Similarly, the screen can make it challenging to obtain adequate diversification in portfolios. The inclusion of a significant weighting to small caps in some funds may alter the risk/return characteristics of funds (e.g. resulting in higher tracking error versus traditional large cap core Australian equity funds).

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Observations on the Responsible Investment Sector

While it was a fairly unremarkable year in terms of product development, there were a number of significant team movements impacting on the sector. ‘Offerings from AMP Capital, Australian Ethical and Challenger all experienced significant personnel change,’ said Steve Sweeney, Lonsec’s Senior Investment Analyst responsible for reviewing the sector.

The lack of new entrants highlights the Responsible Investment sector’s continuing adjustment to subdued post credit crunch appetite for equity products. “There are a few exceptions (e.g. emerging market funds) but generally this trend is consistent with product development across most equities categories as fund managers continue to consolidate product lines,” said Sweeney.

Sweeney also attributes the lack of new Responsible Investment product development in some part to the failure of last year’s UN Climate Change Summit in Copenhagen to produce a meaningful outcome on achieving global emission reduction targets.

“Responsible Investment proponents were hopeful that a positive agreement committing economies to material emissions reduction would significantly progress the climate change agenda boosting the sector with some positive regulatory developments for key industries and companies,” said Sweeney.

Despite the lack of product growth, Lonsec observed an increased integration of ESG (assessment of environment, social and governance practices) into the mainstream company research process.

Sweeney noted that this trend has not been exclusive to funds in the traditional ethical or SRI sector but across other sectors including Australian equities, global equities, Asian and emerging market funds.

Although this trend is blurring the lines between the Responsible Investment sector and mainstream equity funds, Sweeney commented that there still remains “considerable grounds of distinction between ethical and sustainable or ESG style funds, including philosophical approach, that are likely of material interest to investors in these funds”.

Lonsec noted that while the sector’s Australian equity peer universe is modest (7 funds) there has been a wide variance in performance for the past 12 months and that this highlights that it is not a ‘one size fits all’ investment approach.

‘It’s important to recognise the structure of these funds can have a significant performance impact either through restricting the investment universe (e.g. no exposure to resources) or introducing increased volatility compared to mainstream large cap Australian equity funds due to greater exposure to smaller companies” said Sweeney.

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Mr Kirkman will be responsible for continuing to build on the strong foundation AMP Capital has set in employing the United Nations Principles of Responsible Investing (UNPRI) and ESG considerations.
He will facilitate the continued implementation of responsible investment practices in all asset classes including listed equities, infrastructure, fixed interest and credit. Mr Kirkman will engage with Australian companies on ESG issues and support the implementation of environmental targets for the broader AMP group.

AMP Capital Director, People and MD’s Office Sharon Davis said AMP Capital was one of the pioneers of sustainable investing in the Australian market and Adam’s appointment reinforces our commitment to ESG considerations.

“ESG considerations are embedded in our policies and guidelines and in 2007 we signed up to the UNPRI. ESG issues have financial implications and can affect the performance and reputation of investment portfolios so we are taking a firm position on how we meet and lead on these matters,” Mrs Davis said.

“Adam has a strong passion for sustainability issues. He is highly experienced with more than 15 years of international experience working with public and private sector organisations on business risk, sustainability, energy and climate change issues.”

Most recently Mr Kirkman was the global Director of Sustainability and Climate Change at international consulting firm Proviti where he led a team advising blue-chip clients across the sustainable development agenda including climate change and carbon risk, greenhouse gas reporting and verification, emissions trading, investment analysis and sustainability reporting. Prior to this he was Program Manager Energy & Climate Change at the World Business Council for Sustainable Development (WBSD) in Geneva. He also led the environment and sustainability practice at Ernst and Young in Sydney and has held roles at engineering consultancies WSP Group, CH2M Hill and Dames and Moore (URS).

Mr Kirkman joins AMP Capital on Monday 13 September and will report to Sharon Davis.

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The mid year Report outlines how the Global Financial Crisis brought to light numerous structural problems, resulting in various moves to strengthen remuneration practices. However, while some improvement is needed, it’s important to carefully assess any unintended consequences that may come from new hard and soft rules.

In fact AMP Capital Investors Director of Sustainable Funds, Michael Anderson identifies that with each company having its own unique characteristics it is difficult to find a remuneration structure that will be right for everyone.

“There are many remuneration methodologies that can be used and while each approach has its merits, there is no perfect tool that satisfies both shareholders and employees, and no one-size-fits all solution. It’s this balancing act that regulators and boards must consider and it’s no easy feat.”

Despite the complexity, AMP Capital Investors has a preference for performance hurdles that include a measure of long-term relative Total Shareholder Return (TSR). This model compares the performance of different companies’ stocks and shares over time by combining share price appreciation and dividends paid to show the total return to the shareholder.

“AMP Capital strives to invest in companies that will provide our clients with the best long-term returns, and in our opinion relative TSR typically provides the greatest alignment with that objective. As a performance hurdle, relative TSR is not only aligned with shareholder interests, but also has the added benefits of being easily defined, measured and communicated. While every approach has its problems relative TSR is one of the most robust in a wide range of situations.” Mr Anderson said.

The latest Corporate Governance report also examines gender diversity on the boards of Australian companies. The report identifies how discussions around board diversity are now becoming more focused on how to accelerate the progress of women into senior positions.

“As this focus on gender diversity continues, the selection of company boards will need to change. Having more women on boards has been linked with better performance and there have been many reasons cited as to why. Increasingly, shareholders will consider gender imbalance when engaging with the companies they choose to invest in,” Mr Anderson said.

The Corporate Governance Report, which is released twice a year, provides a summary of AMP Capital’s corporate governance activity. AMP Capital takes seriously its responsibilities as an investment manager, as an agent of shareholders in companies and as a steward of its clients’ assets. The latest Report included an analysis of the first half of the 2010 proxy season, detailing the votes cast and the governance issues considered.

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