This was highlighted by John Wilson, Director of Corporate Engagement at Calvert, an Eaton Vance affiliate. Wilson says: “The COVID-19 pandemic has exposed numerous vulnerabilities in our market system.

“Increased corporate specialisation has left many companies highly dependent on a global network of suppliers and business partners, which can lead to greater efficiency and productivity in normal times, but can make it difficult for a company to adapt to radically changed circumstances. For example, food waste (and the associated losses for food and agricultural companies) has skyrocketed even as people go hungry because supply chains designed to serve restaurants struggle to adapt now that people mostly eat at home.

“Widespread economic insecurity resulting from rising income and wealth inequality has emerged as a second vulnerability.

“The novel coronavirus has exposed the degree to which the economy depends on workers whose low pay leaves them vulnerable to disruption of their lives or income. For example, many workers now risking infection because they are considered “essential” may suffer catastrophic loss because they lack access to health care or other resources to manage a health crisis. The nearly 22 million people (so far) who have lost jobs or businesses may never regain their incomes or have the opportunity to reach their full economic potential, especially the young and people of colour.

“The current health crisis will recede in time, and we will rebuild our economies. But a truly sustainable recovery will only be possible if companies confront the ways in which they failed to build resilience into governance and business strategy. While governments bear primary responsibility for managing pandemics, companies have a responsibility to anticipate risks arising from business disruption. Pandemics are only one such risk that will emerge in the coming years and decades.

“For example, the likely ecological and social effects of climate change have become much clearer over the last few years, including mass migration, risk to physical infrastructure and, yes, increased virulence of disease.

“The growth of artificial intelligence and the associated explosion of data will disrupt labour and commercial markets, create new risks to privacy, increase the potential of cyberwar and threaten political systems. Perhaps even more concerning, the well-documented decline in popular support for governments across the world will create further uncertainty for markets, which depend on stable public sector support. Each of these risks is well understood, but insufficiently incorporated into many companies’ business planning.”

Wilson adds “Through our engagement efforts, Calvert has consistently delivered the message that companies that maintain healthy relationships with key stakeholders, such as suppliers, workers and customers, will be best positioned to manage societal disruptions to achieve good financial performance over time. The importance of this principle has never been clearer, but barriers remain for companies to fully integrate long-term, global thinking into governance and business strategy.”

He says “One barrier is the contrast between long-term issues facing the planet and society with the shorter tenures of top executives. Climate change and inequality have potentially profound but uncertain impacts that play out over many years or even decades, which makes them difficult to plan for. Because companies are not directly or solely responsible for these issues, it may be easier to assign responsibility elsewhere and count on others to solve the problem.

“Moreover, managers may also be susceptible to common human biases. We tend to assume the future will be like the past, and discount the possibility of potential future events with which we have no experience. We place greater weight on the opinions of those who are most like us, and less on those who are different. For corporate executives, this may result in a weaker understanding of the lives and needs of ordinary workers, especially low-income workers.

“Finally, in the absence of clear metrics about how effectively companies are addressing stakeholder risks, companies may assume they are handling them well and concentrate their attention on typical business matters that may appear more urgent, undervaluing key risks to the company and the economy or perhaps missing important business opportunities to be part of the solution.

“For these reasons, companies benefit from independent, objective perspectives that challenge management and board thinking. Investors are credible both because we bring a knowledgeable, outside view of corporate governance, strategy and responsibility, and because we approach companies as fiduciaries who are aligned with the interests of management over the long term.

“In our engagement with our portfolio companies, we help them “connect the dots” between the experience of the present crisis and the importance of their stakeholders to their future success. We help them overcome the biases that may hinder them from anticipating risks and elevate the voices of stakeholders who might be otherwise ignored.

“We believe that companies may be more open to our perspectives now more than ever before, offering us an opportunity for change that will be beneficial both for investors and society as a whole.”

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Matt Christensen, Global Head of Responsible Investment for AXA IM, comments: “We are seeing increasing interest from clients in ESG analysis that can be applied to asset classes such as sovereign debt. The eurozone crisis has only amplified this interest as the evaluation of sovereign issuers’ creditworthiness has been brought to the fore.”

A research paper by AXA IM’s Responsible Investment team, ‘Sovereign debt investing: ESG framework and applications’ outlines two ways that investors can draw upon ESG analysis for their sovereign debt portfolios. The first addresses investors’ desire to limit reputational risk by screening the investment universe using specific ESG criteria before the portfolio construction phase. 

One of AXA IM’s clients asked the firm to minimise the reputational risk of their existing emerging markets sovereign portfolio holdings. The rules-based reputational screen identified 10 (from a total of 57) sovereign issuers that presented significant reputational risk – representing 9.7% of the universe’s market capitalisation.

The move to rules-based screening did not significantly alter the quality, yield and duration characteristics of the portfolio. In terms of credit quality, the risk screen reduced the percentage of highly speculative debts and this quality improvement was without significant impact to the yield and duration.

“A key issue for investors is the long-term sustainability of a country’s economic and political situation and therefore addressing ESG issues naturally aligns with this. In addition, many institutional investors wish to limit reputational or headline risk in order to avoid negative perceptions associated with a particular activity or regime. Investors may find a reputational risk strategy based on negative screening particularly useful for emerging markets since these countries tend to score poorly on governance measures such as control of corruption relative to developed markets” explains Matt Christensen.

The research also examined how an ESG overlay would impact a sovereign debt portfolio’s key characteristics. The study showed that an ESG overlay within defined risk parameters does affect country allocation and can improve the ESG performance of a sovereign debt portfolio whilst having a limited impact on other key portfolio characteristics including quality and duration.

The top ESG over-weights for emerging markets were Poland and Chile. For developed markets, Spain topped the list for its better than average ESG score, despite a poor S&P long-term rating and gloomy economic prospects. The top ESG under-weights for emerging markets were the Philippines, Columbia and Indonesia. For developed markets, Japan was the largest underweight largely due to governance issues, while sovereigns with high quality long-term ratings such as the United Kingdom and the United States were slightly underweight largely as a result of poor environmental indicators. 

Craig Hurt, Sydney-based Director of AXA Investment Managers in Australia and New Zealand, said ESG factors may be becoming more material to sovereign debt investing and investors are taking note. 

“We’ve begun to examine the different ways in which ESG criteria can be applied to sovereign debt portfolios. We are already using this ESG country framework in our core RI funds, but see an opportunity to expand this into our mainstream funds. The strength of our model is its flexibility, which allows us to propose different ways to integrate ESG criteria according to a fund’s specific objectives and the client’s requirements.

“Through the ongoing expansion of our global RI research and initiatives, we aim to offer Australian institutional investors – and their individual members and investors – a wider opportunity to invest in strategies incorporating ESG principles,” Mr Hurt concluded.

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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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High calibre entries from some of the country’s biggest broking and other financial services players mark the continued push by market leaders to factor Environmental, Social and Governance (ESG) research into mainstream investment analysis.

The annual Awards are conducted by ESG Research Australia (ESGRA), the industry association whose members include major superannuation funds and investment management firms with a combined $600 billion in funds under management.

Winners were announced today at a lunchtime event attended by some 120 ESGRA members and their guests who were addressed by Nigel Hartley, Executive General Manager, Sustainability of Oil Search Limited who discussed the numerous ESG challenges his organisation faces operating in Papua New Guinea.

This year’s winners are, in the ‘Best Piece of ESG Research by an Individual Analyst or Team’ category, Hamish Tadgell and Jien Goh of Goldman Sachs for their research work, Equity Strategy: Introducing the GS&PA Structural Leaders Framework. The ‘Best ESG Broking Firm as voted by Investment Managers’ went, for the second year in a row, to Citi, in recognition of work by analyst Elaine Prior. The awards apply to research undertaken in 2010.

Also highly commended was the work by Alva Devoy, Elliot Crane, Mark Williams and Michael Newbold of RBS, for their research: Australian Strategy: RBS ESG – Qantas.

According to the judging panel, which comprised 12 representatives from 10 ESG RA members, nominated ESG research this year covered a broader range of issues than last year’s, going beyond concern with emissions and other clear ‘environmental’ issues to address the ‘social’ and ‘governance’ parts of the ESG spectrum.

“This is a welcome feature that we called for in last year’s awards. Although final awards decisions were not easy to make, overall we were most impressed by reports that attempted to integrate ESG research into the mainstream,” said Amanda McCluskey Head of Responsible Investment at Colonial First State Global Asset Management and Chair of the Research Evaluation Committee of ESG RA.

In other comments, the judges welcomed the growing number of mainstream analysts getting involved in ESG research. And, while acknowledging the challenges of integrating such research into stock evaluations and macro strategy, the judges said that they were seeing a real effort to form a view on what’s material and what’s not. The days of merely ‘ticking a few ESG boxes’ are clearly long gone.

“The need to define objectively what factors are material, and how they can measurably affect investment performance one way or the other has been an ongoing issue in the development of ESG research,” said Rob Fowler, Chair ESG RA.

“In this year’s awards, it is clear that we are getting closer to research that has relevance to investment outcomes and can be applied and assessed in the same manner as other considerations that analysts look at in coming to their decisions.”

Another consistent feature of this year’s entries – which are judged against four key criteria (see below) – was increased rigour, with research becoming more thorough and detailed.

“We are extremely pleased with the breadth, quality and calibre of ESG research this year,” said McCluskey.

“While there is undeniably more work to be done, the improvements we are now seeing year on year augur well for the incorporation of ESG in to the investments made by the financial services industry to the benefit of the millions of people they are committed to supporting.”

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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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Chair of ESG RA, Rob Fowler, said: “We are delighted to have recently signed on our 50th member, CommInsure.  Pleasing as it is to have reached 50 members, the most important thing is that ESG RA is really making a difference in broker attitudes to the incorporation of ESG in their research.  Most major broking houses are now producing ESG research, and we have seen that research increase in quality and volume.  That is a real change from where we were when ESG RA started in 2009.

“We are now getting the cut-through that we really want.  We firmly believe that the incorporation of ESG factors into equity research will drive deeper understanding of company operations, more accurate valuations and better investment decisions.

“This ultimately will lead to better returns for superannuation fund members,” he said.

The awards will acknowledge research completed and published in 2010, and will cover:

• Best Piece of ESG Research by an Individual Analyst or Team; and
• Best ESG Broking Firm as Voted by Investment Managers.

Chair of the ESG RA’s Research Evaluation group, Amanda McCluskey, said: “We think it is important to publicly acknowledge excellence in the field of ESG research. While the Australian research in this area is increasing, we hope these awards further encourage and promote high quality ESG broker research into Australia equities”.

ESG RA is part of a global trend in focusing on better financial analysis.  There is, for example, a very direct connection between ESG RA and the United Nations Principles for Responsible Investment (UNPRI) – even though there is no requirement for ESG RA members to be signatories to the UNPRI.  ESG RA offers a practical way for UNPRI signatories to fulfil some of their key obligations.

The ultimate aim is to have ESG analysis included in mainstream financial research.  As Rob Fowler said, “We want ESG to be considered as integral to the core business of fund managers and stock brokers – we want ESG RA to be a catalyst in changing ESG from a niche to a mainstream activity”.

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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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