“With recent innovation in the ETF space, investors in 2022 will begin broadening their ESG investments across their portfolios. They can now do this without compromising on risk/return profiles or on price.”
It’s not just investors who are driving the action in the ESG space. Businesses chanting the mantra of corporate sustainability are showing evidence of a magical transformation in how they approach issues such as outsourcing, governance and compliance; processes and their impact on global carbon footprint; and the advisability of profit-seeking at any cost.
“We have seen a significant shift in businesses embracing corporate sustainability amid growing recognition of the benefits,” says Melior Investment Management chief executive Lucy Steed.
“Not only can sustainable companies lower their exposure to reputational, litigation and regulatory risks, they also have the ability to create significant value and competitive advantage through better retention of staff and enhancements to products and services to better meet customer demands.
“We are seeing businesses particularly increasing their focus on climate action, given the greater scrutiny they are under from a wide range of stakeholders including shareholders, customers and regulators.”
Net zero emissions targets are being adopted by more businesses not just because it makes sense from a compliance perspective but also because investors are interested in it.
“Based on Melior’s analysis, net zero targets have increased over the last year from 15 per cent of ASX300 companies to 35 per cent in December 2021,” Steed says. “There is, however, a wide dispersion in what encompasses a net zero target, in terms of the emission reduction trajectory, what emissions are included in the target, and dates for achieving targets. We expect targets to become increasingly better defined given the roll-out of science-based emission and net zero target standards. Companies with genuine targets will be the early adopters of these standards.”
More nuanced and highly differentiated approaches to ESG are being adopted by businesses – it is no longer just about the carbon footprint.
“Businesses have also improved their understanding of supply chains due to a changing regulatory landscape, which now requires them to disclose their modern slavery policy as part of their fiduciary duty,” Steed says.
“The importance of understanding supply chains has come to the forefront this year with supply chain resilience issues caused by the rapidly spreading omicron variant. We are also seeing companies improving sustainability governance, including boards setting up sustainability committees and adding ESG metrics to remuneration targets.”
Behind the new ESG-based business philosophy is the hidden hand of the investor.
“ESG investors and other stakeholders have a key role to play in pushing companies to articulate and track their sustainability goals,” Steed says.
As businesses take a tailored approach to ESG issues, investors are often left wondering if there is genuine action on corporate sustainability and social responsibility or if it is “greenwashing”, a semblance of action without any quantifiable or qualitatively significant change.
“We believe that there are core traits which help to differentiate truly sustainable practices from deceptive or unintentionally harmful approaches,” says Hamish Chamberlayne, head of global sustainable equities at Janus Henderson.
“These core traits are intentionality, transparency and consistency (ITC). It is crucial that sustainability issues are thoroughly considered from the outset when creating an investment process.
That is why a clear intentional framework that pre-defines how sustainability issues impact your investment decision-making is important. Transparent reporting proves that the fund has done what it set out to do and keeps investors well-informed. Finally, ESG investors must be consistent in their approach and not stray from the outlined framework.”
Sustainability goals are important signposts for investors. “Company engagement is a crucial way to understand and assess a company’s sustainability goals,” Chamberlayne says.
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“In fact, we believe that companies which perform well on sustainability issues will prove to be better long-term investments, so we see engagement as much about making the world a better place as about improving investment performance.”
In fact, business-as-usual is an evolving practice, it’s work-in-progress. In 2021, Morgan Stanley Investment Management checked the companies it had a stake in for their activities towards a low-carbon future, noting that at the beginning of the year about 54 per cent had made a good start, which increased to about 71 per cent at the end of the year.
“We believe that high-quality managements are more aware of the changing environment and that regular engagement by investors is the best way to ensure businesses are tracking sustainability goals,” says Laura Bottega, lead portfolio specialist at Morgan Stanley Investment Management’s International Equity Team. This year will see ESG approaches firming up in the core activities of businesses. “Work will likely turn from climate commitments to policy reality,” says Bottega.
“Expect more laws, fiscal initiatives, investor pressure as well as a continuation of rising climate litigation as the transition to low carbon continues.
“2022 could also prove to be the year of ‘nature’ as countries meet for COP15 to address the depletion of planetary resources,” she says. “Companies looking to future proof their business need to understand how dependent they are on planetary resources and how they impact nature through their products and services. More generally there is greater focus on the sustainable outcomes that investments achieve and not just ESG integration.”
Work will likely turn from climate commitments to policy reality.
— Laura Bottega, Morgan Stanley Investment Management’s International Equity Team
ESG and corporate sustainability involve well-defined sets of activities, and investors can hold companies responsible for carrying them out, says Bhanu Singh, director and head of Asia-Pacific portfolio management at Dimensional.
“Net zero commitments are increasingly the norm, often running well ahead of the capacity of companies to meet them,” he says.
“Making the pledge is one thing. Execution is another. As an investment manager, we expect company boards to exercise oversight of material environmental or social risks that may have economic ramifications for shareholders. And we believe portfolio companies should disclose those risks.”
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“Businesses are embracing corporate sustainability by focusing on active strategies that embrace sustainability disruption (such as digital) and involve effective customer engagement and business practices that contribute to society,” says Craig Keary, CEO Asia Pacific at Ignition.
“Digital financial advice is one such strategy that enables enterprises to use technology as an enabler for the greater good, allowing them to deliver more accessible and affordable advice solutions to their customers, and broader society, to improve financial wellbeing.”
The digital nature of the financial services sector will, in fact, be the greatest force of change in the coming years.
“Digital investing has significantly increased the transparency and ability for consumers to access financial markets,” says Kieran Moore, portfolio manager at Munro Partners. “For retail investors, this means they can access different financial instruments much more easily and therefore participate in parts of the market previously unavailable to them.
“The result of this can impact financial markets by increasing the trading flow and volatility in specific stocks and also can bring in different behavioural drivers of certain stocks as opposed to the traditional fundamentals.
“For managers, this can make accessing liquidity a lot easier but may also cause a stock to move in a certain way as a result of non-fundamental factors,” Moore says.
