ESG Investing: More than what meets the eye
Author: Angus Kennedy | Vice President of Student Engagement
In the era of technology, we have hit unprecedented levels of interest in investing amongst old and young people alike. The 2020 ASX Investor Survey showed that 23% of all ASX investors began investing in the last 2 years; a large left skew considering the ASX is 34 years old. Whilst financial empowerment is certainly a positive, the amount of speculation seeping into strategies (a la the rise of Crypto and Wall St Bets) can be alarming when life savings are on the line. Now, I’m not here to preach hate on what is swiftly becoming one of the hottest investing trends on record, but trickling along in the background has been growing interest in a little friend known as ethical or ESG investing.
What is ESG?
ESG. Futureproofing. CSR. Triple bottom line. The world of finance is full of jargon and buzzwords that industry professionals love throwing around. But what do these concepts actually mean?
In simple terms, Environmental, Social and Governance (ESG) factors are those that look to analyse a business’ operations beyond the balance sheet. Instead of being purely profit driven, it demonstrates how businesses are creating value across a number of non-financial fields, working towards the betterment of society. More specifically:
Environmental: Analaysing how an organisation operates when it comes to sustainability, with factors considered including carbon footprint.
Social: Understanding whether a company’s operations align with the interests of communities, including employees, suppliers, customers and general citizens.
Governance: From an internal perspective, looking at at a company’s leadership and executive teams, whether they represent themselves faithfully and the rights of shareholders.
“So far in 2021, nearly USD3 of every USD10 of global equity inflows have been in ESG funds.”
And it is not just a fad. Bank of America recently published research highlighting that from the start of the year to April 2021, USD158.7 billion flowed into ESG investment globally. This was a 193% increase from the same period in 2020.
As more and more people look to invest with emotions alongside logic, we will look to evaluate the rise of ESG investing.
What are the advantages of ESG?
Financial markets are a barometer of what people think and feel . Apple, Facebook, Amazon and the like have been some of the best performing companies over the past decade for a simple reason: They are household names that have comfortably transplanted themselves into our daily lives. In line with the popular saying to "follow the money," researching market sentiments based on where people are investing is a great way to understand how ESG has performed.
“An investment portfolio that included the top 300 companies on the ASX but excluded companies involved in the fossil fuel industry would have improved annual returns by 8.6 per cent over the last decade.”
We have all probably heard about the (likelihood of) regulatory pressures being placed on companies to clean up their carbon footprints. Indeed, it is mind-boggling to see the sheer gulf in performance that arises from being associated with the fossil fuel industry.
Significant shareholders are also placing pressure on companies to act in alignment with ESG considerations. Albeit over a small sample size and highly dependent on the resolution itself, support for climate-related shareholder resolutions have increased in both volume and support over the past decade.
Shareholders are becoming more willing to flex their voting power in order to ensure companies are acting in a way that will future-proof their operations. Source: ACCR
This extends beyond just the environment however. In the aftermath of the 2020 George Floyd tragedy, the spotlight was shone on culturally insensitive practices rampant through the world. One such example was the name of a National Football League club, formerly known as the ‘Washington Redskins’ (a racially offensive term for Native Indians). After 87 years under this moniker, they renamed themselves the ‘Washington Football Team’ and are currently searching for a new nickname.
What were the catalysts for finally driving this action?
Many evidently, but a notable factor was as follows:
“At the end of June, three separate letters signed by 87 investment firms and shareholders worth a combined $620 billion directly asked FedEx, Nike and Pepsi to terminate their relationship with the franchise unless the Redskins agreed to change their name.”
The impact of shareholders can be felt both directly and indirectly across all areas of society, and the willingness of investors to assert their authority to ensure firms are acting in ways they deem appropriate are becoming increasingly pronounced.
But alongside the desire to do good comes firms that use this wave of interest as a method of marketing. This is something we all need to be aware of.
What are the criticisms of ESG?
Impact measurement is becoming a central part of reporting for firms, however there often remains blurriness regarding what impact is actually been created.
The concept of ‘greenwashing’ involves companies spinning their operations in a manner that looks to highlight achievements and their alignment with ESG factors. This can lead to much confusion amongst the public when assessing what brands to trust, given how important values are to decision making. It is a similar story when choosing where to invest.
In order to address this, regulatory bodies are constantly looking at new ways to measure impact and to enforce standards regarding the reporting of this. One such effort has been the B-Corporation Certification which is only granted to companies that meet a certain set of criteria. Sounds great, right? The only issue is that a lot of these methodologies are arbitrary and dependent on the type of business.
“B-Corp certification is a competent heuristic that generally allows market participants to evaluate the most beneficial corporations, creating a benchmark that enhances overall impact and considers a multiplicity of stakeholders.
However, this isn’t a guarantee, with methodological concerns and personal ethical quandaries meaning that companies you may find unethical in certain respects receive certification. This means that it is still worthwhile for consumers and other market participants to conduct their own research.”
Alongside these issues with quantifying and prioritising impact-based metrics, another problem arises around what you define as being impactful.
The ESG trilemma is an appropriate place to start, as often there is a huge emphasis on environmental and sustainability factors, and less of an understanding as to the social and governance areas.
For example, impact motivated fund manager Ausbil recently spruiked Afterpay a perfect ESG play given it offers credit in a way that protects the interests of users through no fees and restrictions. Other funds would not touch the Aussie fintech with a 10 foot pole given the fact it casualises incurring debt and can encourage poor budgeting habits.
You can read more about MMI’s analysis on the buy now pay later space here:
Ultimately, this hinges on your interpretation of what sustainable investing is. Afterpay certainly ticks the environmental box as a tech company. But what do you think about its social implications and governance practices?
What can you do to get exposure to sustainable investing?
So far, the discussion around the concept of socially conscious investing has been high-level and conceptually very broad. This is often the reason many feel frustrated when learning about the space: There is a lot of talk but little advice for how an individual can act. The following section looks to demonstrate how you might consider getting exposure to the theme, but is in NO WAY OR FORM investment advice – simply an informative exercise in thinking.
Companies (Equities)
The first thing you probably think of when we talk about investing. Buying shares in publicly traded companies is a great way to get direct exposure to companies that align with your values. Choosing this option encourages you to go learn about different businesses out there and find the ones that align with your definition of impact. Themes and example companies as a springboard are as follows:
Sustainable energy:
TPI Composites (NASDAQ: TPIC) and Vestas (CPH: VWS): Turbine manufacturing companies looking to reduce the cost of wind energy by increasing efficiency of the blades.
Mercury (ASX: MCY): Renewable energy producer based in New Zealand.
Food waste:
DSM (AMS: DSM): Focused on decarbonising the food production process, such as reducing the methane production from cows.
HelloFresh (ETR: HFG): Food delivery and meal prep service that can predict orders and reduce food expiring on grocery store shelves.
Electric vehicles:
Tesla (NASDAQ: TSLA): The premier electric vehicle manufacturer at the moment. Despite all the controversy, they are driving a direct impact by taking traditional cars off the road.
Infineon (ETR:IFX): Producer of the semiconductor chips that are required in any electric device, focused on vehicles.
Aptiv (NYSE: APTV): Car part manufacturers that also specialises in electronic active safety features.
Other:
Strategic Education (NASDAQ: STRA): Looks to democratise access to education and create more job ready students.
Arcadis (AMS: ARCAD): World-leading engineering firm that focuses on sustainable design, engineering, and consulting.
If you ever want to get an initial indication as to a company’s ESG prospects, Sustainalytics has a great measuring tool. (https://www.sustainalytics.com/esg-ratings)
Is Tesla a good bet? Source: FT
Exchange Traded Funds (ETFs)
So, you like the concept of ESG but don’t know which stocks to pick. That is where ETFs can come in and offer support: They are effectively buckets of stocks picked by an investment expert to fit a certain theme. Examples of these include:
o BetaShares Australian Sustainability Leaders ETF (ASX: FAIR)
o BetaShares Climate Change Innovation ETF (ASX: ERTH)
o BetaShares Global Sustainability Leaders ETF (ASX: ETHI)
o Vanguard Ethically Conscious Australian Shares ETF (ASX: VETH)
o Vanguard Ethically Conscious International Shares ETF (ASX: VESG)
o eInvest Future Impact ETF (ASX: IMPQ)
However, with someone else doing the picking, you need to ensure that you pay close attention to what the companies are actually investing in: Just because they are named one thing doesn’t mean they are necessarily aligning with your vision. Doing so will also help you distinguish the difference between products that all sound like they’re doing the same thing.
For example, check out the top holdings in Betashares ‘Climate Change Innovation ETF’ (ASX: ERTH). You will quickly notice Zoom (the tele-conferencing software) and Docusign (a software that allows you to securely sign documents online) have very large allocations. The argument here is that these companies are reducing environmentally harmful behaviour in travelling and printing, however they themselves are not creating a positive impact. Whether that satisfies your personal preference is up to personal discretion. But it does highlight the importance of knowing exactly what you are buying, as opposed to trusting a focus-group generated name.
The following video highlights an example of this as applied to China focused ETFs.
Funds
If you want an expert to handle your money, you can deposit it in an investment fund itself. These professionals will then go away and choose options that align with your goals. As with ETFs above, be sure to read about what they are trying to achieve prior to making a decision. For example, the Morgan Stanley Investment Management fund looks to apply ESG considerations as a way to screen out companies that will be threatened by future trends towards sustainability, whilst the Pengana WHEB Sustainable Impact Fund looks to find companies that are creating a real impact. Other fund managers to consider include:
o Robeco
o ARK Invest (focus on innovation and future industries)
o Private/Venture capital firms: Impact Investment Group
Baillie Gifford Global Stewardship Fund is the most successful sustainable-investment fund. Source: AFR
Listed Investment Companies (LICs):
At the intersection of ETFs and Fund Managers are Listed Investment Companies. These were made to make access to professional fund managers easier for the average investor as one can buy and sell shares of the company on the share market as you would with any company. These securities generate returns for shareholders based on their ability to grow the amount of funds they are managing, with the share price moving in line with their performance.
o Future Generation Australia and Global (FGX and FGG): These LICs are run by a group of professional fund managers and do not charge any sorts of fees. Instead, 1% of assets are invested in charities supporting at risk youth and youth mental health. There does not appear to be a strict mandate on what companies can be invested into, but together the 2 funds have sent $41.2 million to charity since inception.
o Hearts and Minds Investments (HM1): This LIC runs very similar to the above, however with a focus on funding medical research with 1.5% of the fund’s holdings. Established in 2018, it has donated over $15.5 million to a range of Australian medical research institutes.
Superannuation
Finally, but certainly not least, we have a good old Aussie favourite in Superannuation. An ‘industry super fund’ is one that returns profits to members as opposed to shareholders (usually a good starting point), and tends to invest in projects relevant to the interests of its members. Superfunds control over $3 trillion in Australian assets, so they are certainly some of the most active investors within the Australia.
o AustralianSuper: Australia’s largest superannuation fund. Typically offered investors a standard choice of ‘low-risk’ to ‘high-risk’ but have recently begun to offer an ‘ethical’ investment option. They are now embedding ESG processes in screening any prospective investments before even considering it as an option.
o Australian Ethical, Usuper, Future Super, HESTA: Smaller funds that are all committed to impact and sustainability in their every investment decision.
Australian Ethical’s funds cover emerging companies that invested in new low-carbon economy, fund medical breakthroughs, technology breakthroughs and efficient transport.
Source: https://ecowarriorprincess.net/2016/08/ethical-finance-rolling-super-australian-ethical-super/
The intersection between impact and financial gain is constantly growing, and that is undoubtedly exciting. The ESG space is set to continue growing as conscious consumerism rises and environmental zero carbon commitments start becoming a reality.
Through this piece, there has been a focus on reading beyond the headlines. In a finance world already full of marketing and flashy slide decks, you must do your own due diligence to determine whether an investment opportunity suits your needs. Being critical is key.
Invest early. Invest smart. Do your own research.
Easier said than done, but taking the time is worth it.
Additional Resources
An introduction into impact investing, published by the Impact Update.
Robeco's sustainable investing crash course enables you to learn about the space through (free) educational modules and a quiz, endorsed by global bodies such as the CFA Institute.
"Can a tobacco firm really be sustainable? Yes, according to flawed ESG ratings," is an article written by ESG Clarity that explores how effective ratings are
Building back better is WHEB Sustainable Impact Fund's annual impact report for those interested in seeing how a fund manager approaches impact investing.
Impact Startups Benchmark Report 2021 by Giant Leap gives an overview of the startup ecosystem in Australia with a focus on companies doing good.