Responsible investing is value investing

Leading or laggard

Another report by the Australian Council of Superannuation Investors (ACSI) found 82 cents in every dollar invested in the Australian Stock Exchange top 200 (ASX200) was in companies rated as having either "leading" or "detailed" ESG reporting.

The ACSI survey found the number of companies not providing ESG reporting has shrunk from 31 in 2007 to 16 in 2018. ACSI’s latest report included six "laggards" that made no ESG reporting for two or more years.

But the demand for non-financial information in investment decision-making is increasing, even from "laggards".

A decade ago, there was a general lack of knowledge about responsible investing at board and senior management level, which sometimes led to a "tick the box" approach rather than applying real scrutiny to investments.

The demand is now driven by consumers and investors as much as by institutions. Indeed, the RIAA report found 42 per cent of Australia's responsibly managed investments were held on behalf of retail clients in 2018, up from 30 per cent the previous year.

The increasing investor support for responsible investing boils down to consumer choice, something not recognised by critics who complain about "shareholder activism". Consumers can choose fair trade coffee, bio-degradable packaging or tuna caught using handlines - and they can also make choices about their investments.

Risk assessment

At the same time, regulators like the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC) have warned directors and managers have a fiduciary duty on matters such as risk from climate change. Reputation and public opinion can also exert a powerful influence on the tidal flow of funds, as shown by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.

The most common approach to responsible investing involves applying environmental, social and governance (ESG) factors, which take account of non-financial considerations. This is often integrated with corporate engagement and shareholder action along with "negative screening" of companies engaged in industries such as weapons, tobacco, gambling and fossil fuels.

However, many fund managers effectively look at ESG as a risk assessment tool. A less experienced investor might see the mention of ESG as showing concern about the environment or the community but it is actually more centered on price and not paying too much for poor practice which leads to risk.

It's important to make the distinction between ESG and ethical investment, which also applies ethical and social principles. U Ethical applies these filters and doesn’t just evaluate risk.

But making informed choices depends on the quality of information, which is still a work in progress. A new survey by McKinsey & Co argued sustainability reporting differed from financial disclosures in having multiple standards and would benefit from improved frameworks and standardisation.

Exposing gaps

ESG reporting has come a long way in recent years with a huge increase in the number of companies integrating sustainability data in to their annual reports, even issuing dedicated sustainability reports. But there are still issues with the availability and comparability of the data. For example, environmental and social factors are measured and the methodologies used.

Improved and expanded data can expose gaps, uncover issues to address and produce new insights. The latest ACSI report on ESG reporting exposed one such gap: 67 companies in the ASX200 do not report safety data. Lapses in safety can have tragic consequences - 13 companies reported 22 workplace deaths, of whom 16 were contractors.

ACSI rightly poses the question whether there is a disconnect between the safety standards of these companies' direct workforce and those of their contractors.

An increasing number of the ASX200 are reporting on targets set out to 2030 using the United Nations’ Sustainable Development Goals, led by climate action, decent work and economic growth, gender equality, good health and wellbeing and responsible consumption and production. But Australia lags behind European countries such as Germany, France and the UK.

Apart from the quality of data, there are problems with "greenwashing". This takes two forms: the practice of companies applying a "green sheen" to investments for public consumption when the reality is rather different and the practice of investment managers promoting ethical credentials but paying them lip service in the evaluation of investments.

One thing is certain - companies big and small are increasingly expected to produce more and better information for investors.

Mathew Browning is Chief Executive Officer of U Ethical