As investors begin to look beyond the social and economic upheaval of COVID-19, they’re seeing Responsible Investing as a way to make a difference for causes they believe in, from medical research to climate change or gender and racial equality. Supported by a Biden presidency that aims to cut US domestic emissions by 50% in just 9 years, Responsible Investing is emerging as a dominant investment theme of the 2020s.
While Responsible Investing is poised to accelerate post COVID, demand has actually been growing strongly for several years. According to Morningstar, 2020 saw the fifth consecutive annual record of new money into US sustainable funds. Sustainable funds last year attracted a record US$51.1 billion in net flows, more than twice the previous record set in 2019 and nearly one quarter of overall flows into funds in the U.S.1
It’s a trend reflected here in Australia. Funds managed under Responsible Investment approaches in Australia increased 17% over 2019 to $1.15 trillion, representing 37% of total professionally managed Assets Under Management, according to the most recent Responsible Investment Association Australasia’s (RIAA) 2020 Benchmark report.2
What is Responsible Investing?
According to RIAA, Responsible Investment is defined as a broad-based approach to investing which factors in people, society and the environment, along with financial performance, when making and managing investments.3 However, Responsible Investing is just one term for this style of investing.
“Responsible Investing, ethical investing, sustainable investing, ESG investing – these are all terms that are used interchangeably,” says Andrew Garrett, National Investment Specialist for Perpetual Private.
“The reality is that there are reasonable nuances between them. It’s important to understand some of these nuances,” Andrew added.
Environmental, Social and Governance (ESG) investing refers to the broad range of criteria that companies are measured by – and therefore, influence investment decision-making.
Here are just some of the considerations investors and analysts look at for each category:
- Environmental – climate change, pollution, natural resources, waste
- Social – human rights, diversity, equal opportunity, community impact, product impact
- Governance – corporate responsibility, board remuneration
When investors do know about ESG criteria, it can make a big difference to their investments. According to Perpetual’s research4, 56% of investors who have heard of ESG investing prefer to invest in companies that satisfy ESG criteria. Just 17% of investors who are unfamiliar with ESG investing would do the same.
What’s driving the growth in ESG investing?
“This is something that has been developing for a number of years. Certainly, there are structural things such as the Paris Climate Accord, which have encouraged it,” Andrew believes.
“But equally people are becoming more aware of the impacts on the world,” Andrew added, “and the influence that an appropriate investment strategy can have to not only generate investment returns, but also do good.”
Outside of significant international milestones, racial, gender and human rights issues in Australia and internationally have also shown that non-financial risks may affect a company’s long-term market value as much as financial performance. The prospect of increased regulatory pressure is also driving investors towards investments that can – and do – transparently report on their ESG outcomes.
Responsible Investing and financial performance
The effect of Responsible Investing on overall portfolio returns is a common question for financial advisers says Brianna Choi, a Senior Financial Adviser with Perpetual Private.
Andrew Garrett agrees, suggesting that many investors believe that Responsible Investing means sacrificing financial returns.
“If you went to someone who has more of a traditionalist mindset, they would assume you are going to inhibit performance returns by placing restrictions on the way investment managers can invest,” says Andrew.
A wide range of data, from Morningstar 5 to Morgan Stanley 6, suggests that ESG funds outperformed traditional non-ESG funds in 2020 and indeed, over the last decade.
“If anything, they don’t tend to hurt performance and in some cases, they can improve performance. That stands to reason – in a lot of cases what it really means is the investment managers having to look even closer at the company or investment than they otherwise would.”
“So what it really leads to is a deeper level of due diligence,” Andrew concluded.
ESG screened funds have a smaller pool of investment options, so why then have they outperformed in recent years?
- Many large ESG screened funds have benefited by investing in tech stocks that performed well over the past decade. In the short-term, ESG screened funds are also less exposed to fossil fuel investments, particularly oil and gas, which suffered from a plunge in prices in April 2020 as well as the more structural shift towards renewable energy.
- More and more companies generate revenue from intangible assets such as innovation and brand recognition. ESG screened funds are more focused on identifying and managing these non-financial assets, which over time is reflected in a superior market valuation.
Constructing your ESG portfolio
Just as your values are personal, your ESG investment goals are likely to be very different to the next person. Some investors may be happy to simply avoid harm, while others strive to contribute to solutions and drive change and make an ‘impact’.
“There’s a growing amount of investment options,” Andrew says. “In its most basic sense, you have something called negative screening, so that might be where I’m trying to avoid investing in fossil fuels or companies that behave badly.”
“You then move up a bit… where you are looking for investments that have a positive impact on the world, whether that’s improving water availability in developing nations or whether that’s simply people working to drive the efforts towards more sustainable investment performance,” Andrew added.
While negative and positive screening are common investing techniques, the following table outlines the broader spectrum of different investing considerations that all come under Responsible Investing.
Perpetual and ESG investing
At Perpetual Private, we’re part of the evolution towards sustainable investing. We have been running a Socially Responsible direct Australian equities portfolio for over five years and ESG investments are broadening and deepening as part of all our portfolios. Last year Perpetual also acquired pioneering US ESG firm, Trillium Asset Management. Established in 1982, Trillium has one of the longest track records globally within responsible investing, including fossil fuel free strategies that have been operating for over 20 years.
How to start your ESG investing
- Talk to your adviser
Many of your investments may already be in companies that are aligned to your values. Before you make any changes, your adviser can help break down for you exactly where you are – or aren’t – invested.
- Decide where you want to make a difference
Whether you want to focus on renewable energy advancement to reduce climate change, support companies that reduce deforestation or support the development of ethically sourced products? There are many ways to make a difference – and usually a fund that works towards that goal. Spend some time thinking about what’s meaningful to you.
- Choose your investments
Responsible investing is personal,” Brianna says. “As an investor, it’s really important to think about what are the causes you really, deeply care about and how you can translate your value into your investment strategies and how it fits into your overall financial plan.”
4. Lembit, G., (2020) ‘What do you care about: The personal edition’, Perpetual Client Insights and Analytics, released 13 August 2020
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