From the CIO’s chair

AustralianSuper touts appeal of ESG

A company’s long-term success depends on how it operates today and, perhaps more importantly, how it allocates capital for future growth.

As a long-term investor, environmental, social and governance (ESG) issues are important factors in AustralianSuper’s investment philosophy on behalf of our more than 2 million members.

The building of our members’ A$110 billion ($81.5 billion) of savings into decent retirement outcomes requires strong investment returns over decades, not years. To achieve this, we need strong returns from companies we invest in over the long term.

ESG issues – including climate change, other environmental issues, health and safety, and labour rights in the supply chain – are determinants of the future operating environment. Other factors, such as technology and the regulatory environment, are also critical. Awareness of how these factors will unfold in the medium term will be critical to the success of capital allocation decisions.

As a long-term shareholder, we are acutely interested in how companies integrate ESG and other long-term factors into managing their business today and planning for the future. Specifically, we expect companies and their boards to incorporate this broader range of factors into their strategic and financial planning processes.

This is not always easy, especially as non-financial factors are more difficult to quantify than purely financial factors. However, this does not diminish their importance, particularly as the time horizon extends.

While there are encouraging signs that boards and management are realising that ESG issues are increasingly linked to long-term value, work remains to be done for these elements to be fully integrated into the capital allocation process.

In recent EY survey, 68 per cent of respondents said that in the past 12 months non-financial performance played a pivotal role in their investment decisions. While this was up from 58 per cent in 2015, it is still too low.

Only 60 per cent percent of institutional investors who responded to the survey said their clients were demanding ESG information, while, perhaps most alarming, 73 per cent said they conduct only informal assessments or no review at all.

There is clearly work to be done.

The key ESG areas for AustralianSuper are:

  • Encouraging companies to incorporate ESG factors into their analysis and reporting of current business conditions and future opportunities
  • Increasing direct engagement with company management and boards to better communicate our expectations as a long-term shareholder focused on long-term value creation
  • Ensuring remuneration frameworks deliver appropriate pay for performance outcomes, with reasonable pay levels and appropriate disclosures
  • Getting the right directors on boards to ensure the board operates effectively and that shareholder rights are appropriately protected.

We are finding that boards are increasingly willing to engage on ESG issues, as there is a greater understanding of our long-term view. More and more companies are coming to us as a sounding board throughout the year, which results in a much more productive relationship than waiting for an issue to come up to a vote.

In particular, forward-looking companies view ESG performance as an opportunity to better align the company’s long-term strategic goals and maximise opportunities by talking to their major shareholders.

This also benefits the companies, as directors and management are increasingly keen to engage directly with shareholders who have a long-term outlook and are, therefore, more valuable sources of long-term capital than investors with a more short-term focus. After all, our primary objective as a shareholder is the same as any director’s. We want the company to have sustained long-term success.

Remuneration still a sticking point

With regards to remuneration, we are still seeing far too many issues coming to the fore.

It’s an area that seems to be becoming more contentious and complicated, which means it can take up too much board and shareholder focus.

AustralianSuper is giving much thought to how we can communicate effectively to companies our expectations in relation to remuneration as a large, long-term shareholder. We are primarily interested in appropriate pay for performance outcomes, reasonable pay quantum, and clear disclosures that demonstrate how the company has performed on these issues.

Boards are increasingly willing to engage on these topics, as there is a greater understanding that we represent the interests of AustralianSuper members. The engagement process provides a valuable mechanism to express positions in relation to remuneration.

All of the above relies on having the right people with the right skills on boards. We need directors who can establish and clearly explain the links between strategy and ESG issues and demonstrate that the company is genuine in its approach to managing these issues and how this will create long-term value. This is what generates alignment with shareholders.

AustralianSuper seeks to assess the way a board operates in practice. To do this, we are developing a board evaluation framework.

Governance will always remain a high priority. The rights of shareholders and how they are treated in relation to stock issuance is a key issue, right alongside remuneration structures, getting the right directors on boards and effective board operation.

Sustainability reporting

We are seeing more companies using sustainability reporting frameworks than ever before, and it is increasing across the spectrum of companies in terms of size and sectors. Many companies are doing it well, especially in resources and financial services.

Of course, there is still room for improvement and we want to see more transparency, which we believe will ultimately benefit both companies and their shareholders.

ESG reporting has become an increasingly important forum for companies over recent years – to better explain their strategic intent. The firms that are doing it well have been able to show clearly how the strategic priorities of the company are directly linked to ESG issues.

AustralianSuper has seen many companies take a positive approach to engaging on these issues, and as we grow, it will be an increasing area of our focus, on behalf of our members.

Mark Delaney is deputy chief executive and chief investment officer of AustralianSuper.