What’s Environmental, Social & Governance (ESG) investing?

When constructing an investment portfolio, inside or outside of superannuation, consideration is given not only to investment fundamentals and your financial situation, goals and objectives, but also any preferences that you may have in terms of what you would like (or not like) to be invested in.

Certainly, an emerging preference over the last few years has been the desire by some investors to align their investment values with their personal values on issues, such as climate change (e.g. carbon emissions) or human rights (e.g. forced labour). This shift may be due in part to our increasing awareness that what we invest in cannot only affect ourselves, but also the wider community, with both positive and negative outcomes.

An example may be an investor’s aversion towards specific industries, sectors, companies, countries or regions linked to things, such as mining, armaments, gambling, tobacco, alcohol or forced labour. In broad terms, this can be categorised as investing with Environmental, Social and Governance (ESG) considerations in mind.

A recent report by the Responsible Investment Association of Australasia has served to highlight that responsible investments (e.g. with core or broad ESG considerations) have more than quadrupled over the past three years to $622 billion in assets under management – this consists of a large array of managed funds that are either invested in shares, property/infrastructure or multi-assets.

Generally speaking, ESG considerations can include issues, such as the following*:

• Environmental
  • Climate change, such as carbon emissions, energy efficiency and product carbon footprint.
  • Natural resources, such as water stress, biodiversity and land use, and raw material sourcing.
  • Pollution and waste, such as toxic emissions and waste, and packaging material and waste.
  • Environmental opportunities, such as renewable energy, green building and clean tech.

•  Social
  • Human capital, such as labour management and development, health and safety, and supply chain labour standards.
  • Product liability, such as product safety and quality, privacy and data security, and health and demographic risk.

• Governance
  • Corporate governance, such as board, pay, ownership and accounting.
  • Corporate behaviour, such as business ethics, anti-competitive practices, corruption and instability, and financial system instability.

Of note, has been the move by some ESG-minded managed funds to remove, or consider the removal of, Facebook from their underlying investments due in part to the recent data-privacy scandal involving Cambridge Analytica and 87 million Facebook users. This is despite Facebook being considered a leading company in terms of ESG considerations, such as reducing carbon emissions with renewable-energy investments.

As such, depending on your personal circumstances, in terms of integrating these ESG considerations into investment portfolio construction (and its continued management) this may involve things, such as:

• Investment screening strategies, for example
  • Negative screening. A process of systematically excluding industries, sectors, companies, countries or regions that do not meet specifically laid out minimum guidelines surrounding ESG considerations. As in the example used above, this may involve, for example, screening out those linked to things, such as mining, armaments, gambling, tobacco, alcohol or forced labour.
  • Positive screening. A process of systematically including industries, sectors, companies, countries or regions that meet specifically laid out minimum guidelines surrounding ESG considerations. This can also include a ‘best in industry/sector’ approach, namely, choosing to invest in a company that exhibits better environmental, social and governance practices than its counterparts.

• Investment ownership strategies, for example
  • Direct investment e.g. a diversified share portfolio with ESG considerations in mind.
  • Managed fund investment with ESG considerations in mind.
  • Or, a combination of both.

Moving forward
As you can see by the report from the Responsible Investment Association of Australasia, ESG investing is starting to become quite prevalent. To a large extent, it’s a movement that is being influenced by the desire for some investors to align their investment values with their personal values.

They want to focus on achieving their financial goals and objectives within investment fundamental frameworks (e.g. diversification, asset allocation, risk versus return, liquidity etc.), whilst also voicing their opinion and being involved in positive outcomes regarding environmental, social and governance issues.

Consequently, but not limited to this fact, when constructing an investment portfolio consideration is given not only to investment fundamentals and your financial situation, goals and objectives, but also any preferences that you may have in terms of what you would like (or not like) to be invested in.

If there is anything in this article that you would like to discuss, then please do not hesitate to book a time to have a chat with us.

*MSCI. (2015). ESG Ratings Methodology: Executive Summary. MSCI ESG Research.