A cohort of ESG risks like climate change, lost biodiversity and poor working conditions have pushed sustainability centre stage, a roundtable of industry-wide experts who connected via video conference recently discussed.

In a passionate and detailed discussion that spanned solutions, to investors’ role in driving policy and the rise of impact investment, the tragic events of recent months have one silver lining.

“Sustainability has never been so popular,” said Fiona Reynolds, chief executive of London-based Principles of Responsible Investment. “It has taken a long time to be an overnight sensation.”

Maria Elena Drew, director of research of responsible investment at T Rowe Price (pictured), one of 13 roundtable participants, also calling in from London, explained how the pandemic has driven the investment firm’s conversations with investee companies in recent months.

“We have had a lot of discussions about COVID-19 with our companies. Obviously, it’s a key topic for any company we are invested in right now,” Drew said.

T Rowe Price has developed its own proprietary model which integrates the social, ethical and environmental profile of companies into its research platform and flags any controversies that companies may be involved in.

Employee safety and treatment is one of the categories T. Rowe’s proprietary model evaluates. It can help the investment firm’s portfolio managers identify potential employee related risks, which can be significant and financially material, said Drew, who explained how the pandemic has exposed social risks around the lack of sick pay for employees and catalysed inequality issues, particularly around race.

“We have built a framework that flags any controversies. Over the last couple of years our team would flag controversies that companies have had with employees. Some analysts would wonder how this was that financially material to the investment case but when COVID-19 happened they started to understand the value of that,” Drew said.

“It gives you a really good insight not just into how they deal with employees but how they run the whole business,” she continued. “If that is how you are willing to treat your employees where else are you taking shortcuts?”

Another outcome from the COVID 19 has been for a lot of inequality issues to be catalysed, particularly in the US around racial divisions, the group discussed.

“This is an area we have been quite active in our engagement with companies. We have a lot of growth funds and invest heavily in tech companies and we’ve been concerned about the development process of AI technologies and whether they are really reflecting all of society or embedding biases,” Drew said.

Shifting the dial

The roundtable discussion focused on the role of investors in shifting the dial in sustainability issues, and the areas where investors should use their influence is shaping ongoing policy.

The pandemic has underscored the potential of governments to change the policy landscape, the group reflected. From lockdowns to massive stimulus packages, the policy response has ushered in radical measures with a wide-ranging impact for markets and industries.

“If push comes to shove, governments can do extreme things,” Tim Conly, head of responsible investment at the Australian investment contulting firm JANA, noted.

In a call for more investor action to influence the debate, panellists discussed how global investors are beefing up their stewardship from traditional engagement with investee companies to applying wider pressure on policy makers.

Stewardship’s traditional focus on working with companies to make sure they do the right thing is increasingly running alongside robust engagement with governments around aligning the stimulus (between $10-20 trillion) to climate change goals and job creation.

Investors should use their influence to ensure the unprecedented government stimulus in response to the coronavirus finances a sustainable recovery rather than funnelling money down traditional high carbon pathways, said the PRI’s Reynolds. For example, government bailouts to the airline industry should be linked to conditions that they cut emissions, she said.

Elsewhere, panellists reflected on the need for investors to help drive policy to encourage innovation and create a level regulatory playing field. In contrast to Europe where a new green deal will drive investment – described by Helga Birgden, partner and global business leader of responsible investment at Mercer, as “a light in the darkness” and a model for others – policy in the US and Australia is not encouraging enough innovation.

 

 

Left to their own devices, markets are bad at pricing negative externalities, lamented Chris McAlpine, investment analyst at WA Super, while Susheela Peres Da Costa, head of advisory at Regnan, agreed that policy is essential to spur companies – and investors – into action. “Regulation alters what is profitable,” she said.

T Rowe Price’s Drew agreed and pointed to the example of recycling which is not profitable without rules in place to encourage it, while carbon capture technology needs a high enough carbon tax.

“When you think about performance in climate change and sustainability there are three different tracks. Those investments that are profitable today like renewables versus fossil fuels – you see the valuations in renewables much higher than in fossil fuels. Then there is the whole innovation category that could be profitable in the future but have a lot risk. Then there is a third category that is regulation dependent,” she explained. “It’s one of the things that makes sustainability tricky from an investment point.”

Stop the lobbying

Delegates also touched on the need for investors to do more to stop Australian industries negatively affected by regulation pushing back on policy change.

“Regulation is influenced by corporates,” said Peres Da Costa, who urged investors to dig beneath headline figures on a company’s emissions to analyse their policy stance and impact on the policy agenda.

Industries wanting to preserve the status quo will try and “manufacture” a climate friendly narrative, warned Stuart Palmer, head of ethics at Australian Ethical Super, naming Australian gas group Santos as one culprit. He said investors should engage more with polluting companies to force root and branch reform. It involves investors not buying their story, saying it is not aligned with net zero by 2050 and urging companies to come up with another strategy, he said.

Some corporates are not only lobbying to prevent policy change around climate. Palmer also voiced his concerns that companies lobby against policy change that is meant to improve wealth distribution and tax policy. Vested interests risk obstructing big picture, systemic reforms in this area, he warned.

Positively, panellists also noted how some of Australia’s listed companies are taking a more active role engaging with government and helping to drive public debate. Companies have withdrawn advertising from Facebook because of the company’s inability to police hate speech, observed Peres Da Costa who said the traditional idea of corporate citizenship and philanthropy amongst listed companies is evolving into a realisation that they have a bigger impact on the world.

Integrating impact, SDGs and social issues

Increasingly investors are integrating impact and aligning investments with the SDGs, the discussion heard.

Contrary to expectations that investing for impact is difficult, at WA Super, one of the first superannuation funds to introduce an impact investment option, integrating impact proved less contentious than seemingly straightforward exclusion strategies. ESG integration at the fund already includes factor tilts in the passive allocation, explained McAlpine. Yet expanding strategy to exclude the worst ESG offenders from the index proved contentious with the fund’s trustees and the investment committee.

Contention turned to consensus when “negative” screening was replaced with a “positive” focus on impact, however.

“By framing discussions in terms of a portfolio that supports rather than excludes, progress returned. This was a far easier discussion to have with our trustee board,” said McAlpine, enthusing how investing in line with the SDGs bought both “best in class” ESG integration, positive outcomes and returns. “We are backing companies that are competitive, it is not philanthropy, we are pursuing market returns,” he said.

 

In another sign of growing momentum behind impact, T. Rowe Price is actively developing an investment framework that links to the SDGs, aiming to launch its first global impact fund linked to SDGs in the first quarter of next year. One of the challenges of developing an impact investing framework is showing clients exactly how the fund is delivering positive environmental and social impact in a listed equity universe. It is easier to measure impact in smaller, less complex private investments in comparison to the listed and large cap world, said Drew.

“We have three pillars that all link into the SDGs. One is environmentally focused, the other is more socially focused and one around innovation. We will show percentage of companies within the portfolio that are linked to each one of these, as well as more anecdotal indicators.”

 

At First State Super, one of the largest investors in Australia and recently renamed Aware Super, investing for impact is increasingly focused on the challenge of integrating impact in large passive mandates according to the fund’s head of responsible investment, Liza McDonald.

Aware Super recognised climate change as a risk to its portfolio in 2015 and established a plan to respond to these, although this did not include specific targets around that. It has since aligned its portfolio with the target of net zero by 2050 and a 45 per cent reduction by 2030.

Another target is by 2023 to have a 30 per cent reduction in carbon in its listed equities.

“A lot has changed over the past five years and we felt our response needed to change also. To really shift the dial we need to see action and leadership now. We are starting to see more industry funds, like us, turning their minds to this and setting some clear targets. While we can go this alone, it is so much more powerful when investors collaborate to engage with companies to encourage them to set meaningful targets to deliver real and lasting change,” McDonald said.

“We are focussed on increasing the impact we are making and the policies and frameworks we need to support this. We have a lot invested in passive mandates by market cap – which effectively means a company do do as it likes and this will not impact the investment. Increasingly though we are considering whether we should be rewarding companies that we think are contributing positively (or neutrally) to our community based on their ESG credentials? How do we move capital into those strategies and indexes and send a clear signal to companies that we want to invest in sustainable organisations that create positive outcomes for our members and their community?” she asked.

Mercer’s Birgden, who heads up the firm’s sustainability effort globally, noted that the pandemic’s heightening of social risk has led more investors to begin to integrate SDG 5 which focuses on gender equality, and SDG 10 which looks at reduced inequalities.

“We are seeing many investors focus on the SDG’s to help them navigate here,” she said.

Over the course of the conversation the investors also discussed how the pandemic has raised the profile of social risks within ESG.

“We had a visceral experience of being constrained, and as Mark Carney said, what has bought the economy to its knees was a social issue,” said Mercer’s Birgden.

Time is now

Panellists discussed the importance of long-term investment and warned that extreme climate events will usher in the same volatility as the pandemic triggered. Mercer’s Birgden suggested investors decide now what assets to bring into and take out of their portfolios to successfully navigate the transition to net zero. She suggested investors think about their portfolios in terms of grey (risk) and green (solutions) – as well as those investments that fall between the two (companies capable of transition). She also referred to the importance of decarbonisation “at the right price,” flagging the need for a portfolio that both delivers on investment objectives and decarbonisation.

Successful ESG policies that provide a robust enough framework to navigate extreme events are enshrined in beliefs and purpose. It’s the kind of framework put in place at $125 billion Aware Super and McDonald spoke of how climate change was singled out as one the biggest risks and opportunities to the portfolio over a decade ago.

“Beliefs helped clarify what we want to be known for and how we want to lead to ensure we deliver for our members while being a force for good in our community,” she said.

The need for collaboration to drive change to solve interconnected, systemic risks was another roundtable theme.

The pandemic has highlighted that today’s challenges are all linked – it is impossible to have a healthy economy without a healthy population, or planet.

“We can set targets and do what we can do, but when investors collaborate we really achieve so much more,” McDonald said, urging more investors to lead on meaningful engagement with companies.

The $10 billion Statewide Super is working more and more on integrating ESG into its portfolio, working closely with consultant JANA and recently appointed a dedicated person to cover this.

Con Michalakis, chief investment officer of the fund, said that the virus has had terrible consequences for people less well off.

“My concern in the shorter term is that they are looked after and have jobs. The longer this goes the more people will be worried about making ends meet in terms of the bigger picture this is a concern,” he said. “In a crisis you can get short term behaviour and that’s a little bit of my fear at the moment.”

Michalakis also cautioned that effective engagement and global collaboration outside Australia’s “small market” is more challenging. He noted that growing enthusiasm for ESG aside, building back better is threatened if governments use the stimulus to prop up failing industries or prioritise tax cuts over long-term sustainability.

“In a crisis you can get short term behaviour, this is my fear,” he said. The need to act for the long-term is more important than ever, Michalakis concluded, drawing the passionate two-hour panel to a close.

Sarah Rundell is a staff writer for Top1000funds.com based out of London. She writes on institutional investment across all asset classes, global trade and corporate treasury.
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